The Legal Significance of an Independent Contractor Classification and the Potential Pitfalls of Misclassification
Classifying any worker as an independent contractor is an important decision with serious legal consequences. The good news is that if your business is considering an independent contractor classification, many workers can and want to be lawfully classified as an independent contractor rather than an employee.
In fact, an independent contractor classification may be the perfect “win-win” working relationship for your business and many of its workers. Your business may not be in a position to assume the legal, tax and financial obligations that come along with an employment relationship. Additionally, your business may have a specific need or position that can be filled with an independent contractor or your business may utilize a business model that works better with independent contractors rather than employees.
Likewise, many workers prefer to be classified as an independent contractor for the independence, flexibility and freedom that a lawful independent contractor classification provides. Technological advances, tax law changes, and a growing number of workers who enjoy being their own boss and working on multiple projects in today’s gig economy are additional reasons for considering independent contractor working relationships.
Now for the legal reality! Arbitrarily throwing an independent contractor label on the working relationship, using a generic independent contractor agreement you found online or drafting one yourself can get you in legal hot water. Even if the worker wants to be classified as an independent contractor and your company and the worker sign an independent contractor agreement, the legal reality is that there are numerous legal requirements, tests, regulations and variations, many of which are state-specific, that must be considered and evaluated to determine if the worker can be “lawfully” classified as an independent contractor rather than an employee.
The potential consequences for misclassifying a worker as an independent contractor can be significant. If not properly evaluated and classified, there can be wage and hour violations, unemployment tax issues and penalties, worker’s compensation law violations and penalties, federal income tax issues and problems related to the insurance covering you and your business’ assets. Many businesses have been bankrupted or incurred severe financial hardships as a result of class action or individual lawsuits seeking damages, fines and penalties for alleged independent contractor misclassifications.
There are various standards to consider when your business is determining the proper classification for a worker, but typically the key litmus tests are the company’s right to control the worker and whether the worker is in “business for himself or herself.” To contrast with an employment relationship, an employer generally has the right to control what an employee will do, how it will be done, and when it will be done. Additionally, an employee is subject to and must comply with company policies; is usually paid compensation and benefits even if the final work product or service is not completed; can terminate the employment relationship at any time without any breach or penalties; is reviewed or provided performance evaluations; has an inflexible work schedule; and has no unilateral right or authority to hire and pay for another employee to perform the job (i.e., no right to subcontract or hire other workers).
Examples of Lawful Independent Contractor Classifications
While no single element or factor is usually determinative of whether a worker is an independent contractor or an employee, the examples below provide a basic primer on when an independent contractor classification is proper.
Independent contractors are usually hired to perform a discrete project or service for an agreed upon fee or price (not a salary, no benefits, etc.). A painting contractor, for example, is hired to complete one discrete project, e.g., to paint a specific room a specific color by a certain date for a set price. Unlike most employment relationships, independent contractors are not typically hired to continuously perform services for an indefinite period of time.
An independent contractor retains control to determine the methods and techniques to achieve the final work product or result. A painting contractor is not typically instructed on what paint brushes to use, what wall to paint first, or the painting techniques or methods to be used. Conversely, in many employment relationships, employees are required to adhere to company policies, protocols and procedures, and the employer may exercise significant control over the methods used and as to how to achieve the final work product or result.
Independent contractors usually supply their own materials, pay for many, if not, all of their own expenses, and are not typically trained by the company hiring them. Painting contractors, for example, typically supply the ladders, paint and brushes necessary to complete the project, pay for office rent, phone service and other overhead expenses, and are not trained by the person who hires them. Employees, on the other hand, are usually provided company materials or equipment to complete their job, are not responsible for overhead expenses and are trained by their employer.
Independent contractors usually have freedom to work for other businesses or customers. Alternatively, employees usually work for one employer and may have restrictions on their employment opportunities with other individuals and entities during and after their employment relationship.
Independent contractors usually have a formal agreement or contract in place describing the nature of the relationship and the terms of the project. These agreements usually set forth the price or fee for the product or service to be completed and any deadlines associated with the project. Beware, however, a contract stating that a worker is an independent contractor will not, alone, establish an independent contractor classification. In some situations, employees are subject to written employment contracts and/or are governed by company policies and procedures setting forth the terms and conditions of their employment.
Businesses must carefully evaluate federal and state laws to properly classify its workers as independent contractors or employees. It is very common for federal and/or state agencies and prosecuting attorneys to catch independent contractor classification mistakes. Unfortunately, the legal expenses and penalties necessary to resolve the problem invariably cost more than getting the classification right in the first place. Legal guidance, especially with an attorney knowledgeable about independent contractor classification terms, models and practices is strongly recommended.
LegalStandard.com offers a number of services that can help your business with this issue, including drafting an independent contractor agreement for $900.00, reviewing an independent contractor agreement for as little as $295.00, or assisting your business with this issue on a regular basis through an outside general counsel plan.