Contactor or employee

Fundamentals For Small Business Employers – Independent Contractors vs. Employees

By Rachel Luna, Attorney and Owner of Luna Law, PLLC

A common belief among business owners is that any person hired to perform services on behalf of the organization can be classified as an independent contractor so long as the worker agrees or has signed a written contract. However, this is a misconception, and inadvertently misclassifying an employee as an independent contractor leaves businesses open to substantial liability. Read on for some guidance to help avoid common pitfalls concerning this issue.1

What is the difference between an independent contractor and an employee?

Employees and independent contractors both provide services in exchange for compensation; however, they differ in many ways, including:

  • Independent contractors usually work for a business for only a specified duration and/or until a project is completed, retain control over the method and manner of their work, maintain economic independence, offer their services to and perform work for multiple businesses, and provide services that are distinct from the business.
  • Employees are customarily employed for an ongoing duration, subject to substantial oversight by the business, economically dependent on the business, work full-time and/or exclusively for one business, and provide services that are an integral part of the business.

Additionally, independent contractors, often business owners in their own right, are not safeguarded to the same extent as employees. For example, in Texas, independent contractors generally are not protected:

  • With regard to their pay by the Texas Payday Act and/or minimum wage laws.
  • If they are injured on the job by the Texas Workers Compensation Act.
  • If they need medical leave as afforded by the Family and Medical Leave Act.
  • If they lose their job by the Texas Unemployment Compensation Act.
  • If they are subject to discrimination by federal and/or state employment anti-discrimination laws.

A consequence of the lack of legal protection afforded independent contractors, is that businesses often save money when retaining independent contractors, because, for example, they do not have to pay unemployment taxes or procure workers compensation insurance for such workers. Likewise, independent contractors typically do not receive paid time off or other employee benefits.

Why does it matter if an employee is misclassified as an independent contractor?

Misclassification issues often arise during routine agency audits as well as when a worker files a claim for workers compensation, unpaid wages, unemployment, and/or discrimination. When issues arise, a business often has the burden of establishing that the worker meets the requirements to be classified as an independent contractor and faces significant liability for unpaid wages and benefits, back taxes, interest, fines, liquidated damages, attorneys’ fees, and other costs if the business has incorrectly classified any employees as independent contractors (or otherwise improperly paid any employees, because the scope of such audit often expands beyond the issues of the initial claim).

How do I determine if my worker is properly classified as an independent contractor?

In determining whether someone has been properly classified as an independent contractor or whether they are really an employee, the law looks to the relationship between the business and the worker. Generally, in Texas, a worker:

  • Is your employee if you have the right to control the progress, details, and methods of operation of the worker.
  • May be classified as an independent contractor if you control only the end results of the worker.

Please note that because various governmental agencies at the state and national level use different factors in determining whether someone is an independent contractor, there is no single test or checklist available to ensure you make the correct determination for all purposes (for example, the Comisión de la Fuerza laboral de Texas considers different issues when determining whether a worker is really an employee for unemployment purposes than the IRS uses when making the same determination for tax obligation purposes). However, the Independent Contractor Common Factors Checklist linked below summarizes some of the more common factors considered by agencies reviewing this issue.

Independent contractor common factors checklist

What steps can I take to protect my company from potential misclassification liability?

There are many steps you can take, in coordination with your human resources professional and/or your attorney, to help protect your company from potential misclassification problems, including:

  • Pre-hire/self-audit evaluation. Review relevant circumstances, such as those listed in the Independent Contractor Factors Checklist, to determine whether a worker can be classified as an independent contractor. Be sure to review such factors whenever you are considering retaining someone as an independent contractor and/or you are auditing your current workforce. Performing this review can help you tailor the position as well as determine if a position needs modification and/or reclassification.
  • Training. Train your team on classification issues to ensure hiring managers and any personnel that interact with contractors understand the distinction between such personnel and employees so that they treat the worker as required to ensure compliance with applicable laws.
  • Agreements. Draft agreements with independent contractors in a manner that documents their distinction from employees when such personnel are hired by your organization.
  • Record retention. Consistently retain key documents in your vendor files for each of your independent contractors, including:
    • The contracts and a record of dates of engagement.
    • Payment records and copies of 1099s.
    • The independent contractor’s Employer Identification Number, contact information, insurance information, and any other documentation of their independent business (such as business cards, letterhead, invoices).

Implementing processes to ensure employees have not been misclassified as independent contractors involves effort, however, taking proactive steps now is recommended as the work can save you and your organization from being required to endure a substantially more difficult and expensive assessment in the future.

[1] Please note that this post does not consider or review: (1) COVID relief for independent contractors; (2) issues specific to transportation network companies and other industries expressly regulated on this issue; and/or (3) workers specifically classified by regulatory agencies, such as those considered by the IRS to be statutory employees or statutory non-employees.

This update is for informational purposes only and does not provide legal advice. Every legal situation is different and must be independently analyzed by an attorney. Please consult with an attorney for specific guidance.

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