Independent Contractor or Employee – More Than a Question of Taxes
The saying is familiar: If it looks like a duck, walks like a duck and quacks like a duck, it is a duck, no matter what someone calls it. Similarly, if a worker serves a company like an employee, the law may treat the worker as an employee, regardless of whether the worker was called an “independent contractor” or was paid as an independent contractor. The parties’ characterization of the relationship will have some relevance if the worker, a government agency or a court later second-guesses whether the worker was in reality an independent contractor. But what the company and worker had called their relationship is not conclusive.
There are certain ways to discern a duck from a goose or a platypus, but distinction of an independent contractor relationship from that of an employee-employer may be quite unclear. Various requirements or factors are considered and applied to each case depending on the particular law and circumstances at issue. The weight to be given to each factor and circumstance can be a matter of perception and judgment.
Wide Ranging Effects
If a person who was considered by a company to be an independent contractor is found in retrospect to have been an employee, there can be many legal ramifications. The company may be responsible retroactively for payment of overtime and minimum wages, workers’ compensation (to cover an injury), payment of state and federal payroll taxes, income tax withholding, unemployment benefits and premiums, and applicable interest and penalties. In addition, the employer may be subject to liability if it is alleged to have violated discrimination laws protecting employee rights. The company may have vicarious liability to a third party for any negligence or other wrongdoing by the “employee” acting in the scope of employment.
Under a law enacted in 2009, large fines can be imposed through the Colorado Department of Labor and Employment against an employer who, with willful disregard, has misclassified an employee as an independent contractor. The fine can be up to $5,000 per misclassified employee for the first such misclassification. After that, the employer can be fined up to $25,000 per misclassified employee, and the employer can also be prohibited from contracting, or receiving any funds for performance of contracts, from the state for up to two years. Any person can file a complaint with an official of the Department, who has the power to investigate, make findings and issue orders. The law provides a process for appeals. To minimize the risk of misclassification before there is any complaint or audit, an advisory opinion can be obtained from an official of the Department, but the advisory opinion is not binding.
Different Factors for Different Laws
As previously indicated, a variety of factors can be used to determine whether someone is working as an independent contractor or as an employee. Different variations of factors are used when applying different laws, so “one size does not necessarily fit all.” Colorado’s employment security and workers’ compensation statutes provide one set of factors, which is different from “common law” factors that the courts have used for other legal questions involving independent contractor status. Another set of factors is used under federal law for purposes of the Fair Labor Standards Act (FLSA), governing overtime and minimum wages for certain employees. Yet another set of factors has been applied to distinguish independent contractors from employees under anti-discrimination laws.
The trick is to try to have a uniform determination of independent contractor status under whichever set of factors may apply. A properly drafted independent contractor agreement can help to cover the bases. A couple examples of the requirements to be addressed are summarized below.
Examples from Colorado Statutes
The Colorado Employment Security Act (providing for unemployment compensation) and Colorado Workers’ Compensation Act state that service performed by an individual for another person shall be deemed to be employment, unless it is shown that such individual is “free from control and direction” in the performance of service, both under his contract and in fact, and the individual is “customarily engaged in an independent trade, occupation, profession, or business” related to the service.
To make this showing, these two Acts list nine conditions that may be satisfied by the weight of evidence or a document signed by the parties. The first condition is that the individual is not required to work exclusively for the person (or company), except that the individual may choose to work exclusively for a finite period specified in a document signed by the parties. Another of the nine conditions indicates the company cannot oversee the actual work or instruct the individual as to how the work will be performed. However, these laws later indicate that if one of the parties is a licensed professional and Colorado law requires the professional to exercise a supervisory function with regard to an entire project, such supervisory role shall not affect the professional’s status as part of the independent contractor relationship. One of the other conditions to be an independent contractor is that checks be payable to the trade or business name of the individual, and that payment not be made to the individual personally.
Under these Acts, a “rebuttable presumption” of an independent contractor relationship can be created by a signed contract which contains certain disclosures. The document can also be used as evidence in addressing the statutory conditions.
The Acts include various exceptions. Under the Employment Security Act, one exception is for services by a licensed real estate broker if: “All the remuneration” is directly related to sales or other output, instead of the number of hours worked, and the services are performed pursuant to a written contract that provides that the person shall not be treated as an employee with respect to such services for federal tax purposes. The Workers’ Compensation Act and the federal Internal Revenue Code have similar exceptions, but for the remuneration requirement, their statutes use the phrase, “substantially all.”
Some companies prefer to use independent contractors to provide services in situations where the companies are not ready to engage in an employment relationship. This is especially true in uncertain economic times. Every company should be careful to check whether its engagements truly qualify as independent contractor relationships or not. Use of appropriate provisions in an independent contractor agreement may help to avoid or withstand any challenge to the status of the parties’ relationship.