New and growing businesses often face the dilemma of whether to hire employees or engage independent contractors. A business may have the need for a specific task to be performed by an individual with a unique skill set, or the business could generally be increasing its workforce. Regardless of the reason, it is critically important to properly classify employees and contractors to ensure compliance with the law and avoid serious legal problems down the road.
Why does the classification matter?
Both state and federal employment laws address a wide variety of issues such as minimum wage, overtime pay, workday hours, break times, worker’s compensation benefits, unemployment insurance coverage, family medical leave, and the obligation to pay taxes. Most of these laws are designed to protect the rights of employees. Independent contractors are often not afforded these legal protections.
Proper classification matters because the government wants to both collect tax revenue and ensure that the nation’s workers are covered by laws designed to protect them. The failure to properly classify a worker may lead to the devasting consequences discussed a little further below.
Written agreements are not determinative
A common misconception is that a simple independent contractor agreement, stating that the individual (or separate company) is in fact an independent contractor, suffices to make a classification. However, written agreements are not always determinative of a proper classification. Even with an independent contractor agreement in place, the worker may be classified as an employee and not a contractor.
The law looks more to the realities of the relationship than what the parties may put in writing. If in reality, the worker’s relationship with the business is one of employment, the worker will be classified as an employee regardless of what any private agreement may otherwise state.
In Arizona, there are also specific statutes designed to help businesses properly memorialize a worker’s relationship with a business. These statutes may provided added protection for Arizona companies.
Employee or Contractor?
There is no single rule or test to determine whether a worker is an employee or an independent contractor. Instead, different federal and state agencies apply different rules and tests in making this determination. It’s thus wholly possible for different agencies to arrive at different conclusions relative to the same worker.
Some business owners may think that if a worker has independence concerning the hours and location of the work, the worker may be safely classified as a contractor. This is a vast oversimplification, and one that may result in significant adverse consequences to the business.
Most agencies apply varying versions of balancing tests when classifying workers. The tests generally consider factors such as:
- The level to which the worker’s function is integral to the business’ primary function.
- The degree of control that the business has over the worker.
- The level of skill or specialized education needed to perform the services.
- The permanency of the relationship between the company and the worker.
- Whether the worker is expected and permitted to perform services for other businesses.
- Whether the business is providing the worker with a regular salary or any minimum, regular payment.
- Whether the worker is economically dependent upon the business.
- Whether the worker is responsible for all expenses incurred by the worker in performing the services.
- Whether the worker is insured under the business’ health insurance coverage or workers’ compensation insurance coverage.
- Because there is no single test used by all agencies, determining how to properly classify a worker can be exceedingly complex.
Penalties for Misclassification
It is understandable that businesses want to hire independent contractors for both strategic and economic reasons. The government, however, leans heavily on the side of the worker and exacts serious consequences for businesses that fail to make proper classifications.
The laws generally do not allow for a company to plead ignorance, mistake, or lack of intention to classify a worker incorrectly. Additionally, the job title given by the company and a worker’s understanding or belief that they are a contractor are not relevant. The government will hold a company responsible for misclassification regardless of the reasons if the worker was misclassified.
Aside from being illegal, the failure to properly classify a worker as an employee or contractor can have devastating consequences for businesses. The business may be required to pay things like back wages, past overtime compensation, back taxes, or large amounts for past unemployment and worker’s compensation insurance. The business may even be hit with civil and criminal penalties for an improper classification.
What’s a company to do?
When hiring workers, a company would be best served by seeking the counsel of an experienced attorney to evaluate how each open position should be classified. It is worth the time to critically evaluate the specifics of each job opportunity so that the business and worker enter into the new relationship with a clear understanding of the law and of how the law classifies the work that will be performed.
NOTE: THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES. IT DOES NOT CONSTITUTE LEGAL ADVICE, NOR DOES IT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. EACH SITUATION IS DIFFERENT. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE YOUR LEGAL RIGHTS, REMEDIES, AND DUTIES.
By Wendy M. Anderson, Esq.
Law Office of Wendy Anderson, PLLC
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