Employee or independent contractor?  Misclassification can be costly

Many companies use independent contractors in their business, and their use is growing.  They do so for a variety of reasons, including:

• lack of time to manage more employees
• need for specialized expertise for a discrete project
• lower administrative costs
• avoidance of overtime
• avoidance of workers compensation and unemployment tax costs
• lower cost of benefit plans

Employee or independent contractor? it’s expensive if you misclassify

All of these are good reasons to use independent contractors, but it is critical that an independent contractor meets the legal definition.  If not, that person could be considered an employee entitled to benefits, back pay, minimum wage, and other compensation.  The employer can be subject to fines and penalties, which are higher if the misclassification was intentional. For example, in 2014 a drywall installer in Arizona paid $600,000 in back wages and penalties after misclassifying 445 current and former employees.  In 2015, a company that misclassified construction workers in Utah and Arizona had to pay $700,000 in back wages, damages, and penalties.

How is “independent contractor” defined?

Who defines what an independent contractor is, and what is that definition?  As with many things in our federal system, there are several players involved:  the Internal Revenue Service, the U.S. Department of Labor, and state departments of labor (in Colorado, the Department of Labor and Employment).  Their definitions do not line up exactly, so it is important to consider all of their regulations.

• Behavioral control: does the business have the right to direct or control the worker in how and when they do the work contracted for?  The greater the level of control, the more likely it is that the worker is an employee
• Financial control: does the worker have a significant financial investment in his or her work, does the worker bear his or her expenses of doing the work, and is there an opportunity for profit or loss? To the extent the answer to these questions is “no”, the worker is probably an employee
• Relationship:
• Is the contractor required to work exclusively for the business for which he or she is providing services? If so, that looks more like an employer-employee relationship
• Does the person receive benefits such as paid leave or health insurance? This would indicate that he or she is an employee
• Is there a written agreement or contract spelling out the terms of the engagement, including the scope of work, the fees, etc.? If not, the person providing services may be considered an employee

No single factor in any of these agencies’ lists will determine the classification; instead, the agency will look at the “totality” of the circumstances, so it is important to look at the overall relationship and level of control in each case.

Special considerations in Colorado for classifying independent contractors

Unlike federal regulations, under Colorado law the state Department of Labor and Employment will presume the person is an employee unless there is a written agreement. That written agreement or contract must contain the following clauses (this is taken from the Department’s web page):

• the individual is not required to work exclusively for the organization for whom services are performed; except that the individual may choose to work exclusively for the organization for a finite period of time specified in the document;
• The organization does not establish a quality standard for the individual; except that the organization can provide plans and specifications regarding the work but cannot oversee the actual work or instruct the individual as to how the work will be performed;
• The organization does not pay a salary or hourly rate but rather a fixed or contract rate;
• The organization cannot terminate the work during the contract period unless the individual violates the terms of the contract or fails to produce a result that meets the specifications of the contract;
• The organization does not provide anything more than minimal training for the individual;
• The organization does not provide tools or benefits to the individual; except that materials and equipment may be supplied;
• The organization does not dictate the time of performance; except that a completion schedule and a range of mutually agreeable work hours may be established;
• The organization does not pay the individual personally but rather makes checks payable to the trade or business name of the individual; and
• The organization does not combine their operations in any way with the individual’s business, but instead maintains such operations as separate and distinct.
• The written agreement must contain a disclosure, in type which is larger than the other provisions in the document or in bold-faced type or underlined type, that the independent contractor is not entitled to unemployment insurance benefits unless unemployment compensation coverage is provided by the independent contractor or some other entity, and that the independent contractor is obligated to pay federal and state income tax on any moneys paid pursuant to the contract relationship.

Note that these requirements apply both to for-profit and non-profit organizations.

Takeaway for businesses and nonprofits?

If you want to bring someone on board to perform work as an independent contractor, it is critical to make sure that person meets these criteria.  If you are doing this in Colorado, you must have a written agreement of some kind that contains the required clauses listed above, and it’s a good idea to have a written agreement regardless of the state.  If your business does not do this, and the person files a complaint with the state Department of Labor, the state may consider the person an employee, eligible for workers compensation, unemployment, benefits, and possible back pay. In addition, your business could be subject to fines and penalties.

If you have questions or would like additional information, feel free to contact me by phone or text at 720-575-0440 or by email at mark@spitzlegalcounsel.com.