Employers Must Distinguish Between Employees and Independent Contractors
Feb. 26, 2023
Remember that employees are the default status and that you must qualify in several ways to opt into contractor status. If someone suggests you use contractors instead of employees, have them explain that you pass every criterion of the test that permits you to categorize a worker as a contractor. Another evaluation method is to look at the everyday cost savings of a contractor compared to the egregious fines for misclassifying an employee to determine where the organizational risk level lays. .
Due to tax considerations, employers must understand the difference between employees and independent contractors. The distinction between these two classifications of workers is essential because federal and state labor and employment laws apply almost entirely to employees. If a worker is classified as an independent contractor, this means they are personally responsible for their obligations to the IRS, and employers who hire them are relieved of any potential tax liability. But workers who belong to the employee classification are entitled to certain rights and benefits from the employer as defined by state and federal labor laws.
Why Does Employment Classification Matter?
State and federal labor laws apply to employees and do not apply to independent contractors. If the employer misclassifies an employee and given the status of an independent contractor, the misclassified worker could potentially miss the opportunity to be paid bonuses or overtime wages. Misclassifications can also mean that workers could not take advantage of vacation pay, sick days, or other employee benefits. Unexpected tax consequences are also possible when misclassification occurs, and a misclassified worker could be obligated to pay additional taxes.
Employers are Obligated to Provide Certain Benefits to Employees
According to state and federal law, the benefits that employers must provide to their employees include:
1. Employers must pay their employee’s a minimum wage.
2. Employers must pay an employee’s overtime wages, when applicable.
3. Employers must pay their employees at least twice a month.
4. Employers must provide an earnings statement for each pay period showing the employee’s hours worked, gross, and net pay.
5. Employers must provide their employees with a W-2 wage and earnings statement at tax time.
6. Employers must pay employment taxes.
7. Employers must pay for workers' compensation insurance (There are circumstances when Texas allows employers to opt out of workers' comp.).
8. Employers must pay for unemployment insurance.
9. Employers must provide a safe working environment for their employees
Note: The benefits listed above apply only to employees and these benefits do not apply to independent contractors.
Employee or Independent Contractor?
Federal law and Texas labor and employment laws regarding independent clearly distinguish between an employee and an independent contractor. According to the Texas Workforce Commission and the United States Department of Labor, employers should consider the following questions when determining a worker's classification:
· Does the worker furnish their own resources and equipment?
· Does the worker submit bids for contract work?
· Can the worker accept or refuse an assignment or project?
· Is the worker's compensation related to the completion of a project?
· Does the work have an expected start and completion date?
· Can termination of the worker lead to a lawsuit for breach of contract?
· Does the worker pay their own employees or use subcontractors to complete projects?
· Does the worker serve more than one person or business entity or does the worker have multiple clients?
· Does the worker’s income depend on one client or multiple clients?
· Does the worker present themselves an independent contractor and represent to the public that they have a business?
· Does the worker have a separate phone number, business address, and business cards?
· Does the worker advertise their services?
· Does the worker perform tasks under their own business name?
· Does the worker maintain insurance coverage for liability, errors, and omissions?
· Is the worker registered under their business name or other legal entity?
· Does the worker file tax as self-employed?
· Does the worker perform services for clients of their choosing?
· Is the worker a separate entity, not a part or component of another party’s business?
How Much Control Does the Worker Have?
One of the most critical considerations that employers must consider when determining a worker's status is the degree of control the employer has over the worker’s duties, responsibilities, and schedule. If the business exercises significant direction over the worker's tasks, the worker would likely be classified as an employee. Such considerations, however, are nuanced, and the distinctions between them are important. For instance, a specific job title or a set work schedule is often insufficient to determine a worker's status. Employers need to note that there are multiple factors to consider when determining a worker's status:
Your worker is an independent contractor if any of the factors listed below apply:
The worker is in control of their own projects and tasks.
The worker supplies their own equipment.
The worker's duties are performed within a specific timeline.
The worker controls their own schedule.
The worker does not supervise others within the company in a managerial capacity.
Your worker is likely an employee if any of the factors listed below apply:
The worker is paid a salary.
The worker is essential to the business's daily operations.
The worker is subject to termination at the will of the employer.
The worker's performance and tasks are closely supervised.
The worker has a managerial role within the organization.
IRS Common Law Rules
For federal employment tax purposes, the IRS applies common law rules to determine if a worker is an independent contractor or an employee. Under the common law, the most important component, according to the IRS, is to consider is the relationship between the worker and the business. Employers must consider three categories. These include behavioral control, financial control, and relationship of the parties.
1. Behavioral Control
This covers facts that indicate if the business directs and controls the duties of the worker. This includes what work is accomplished and how the work is accomplished.
According to the IRS, behavioral control factors fall into the following categories:
Type of instructions given by management
Degree of instruction
2. Financial Control
This covers facts that indicate if the business directs or controls the financial and business aspects of the worker's job. According to the IRS, financial control includes the following:
The extent to which the worker has unreimbursed business expenses.
The extent of the worker's investment in the facilities or tools used in performing services.
The extent to which the worker makes his or her services available to the relevant market.
How the business pays the worker.
The extent to which the worker can realize a profit or incur a loss.
3. Relationship of the Parties
This covers facts that indicate the type of relationship the parties had. This includes:
All written or verbal agreements that describe the relationship between the parties.
Whether the business provides the worker with any of the benefits that an employee would receive. These benefits could include insurance, vacation time, sick days, or a pension plan.
The permanency of the relationship.
The extent to which services performed by the worker are a key aspect of the regular business of the company.
Employers Must Be Careful Not to Misclassify Their Workers
The law says that workers are employees unless the company can clearly show that they do not belong to this classification. Workers who are often misclassified include temporary workers, contract laborers, construction workers, housekeepers, domestic help, nannies, gardeners, and other workers who do not have enough control over their work to be classified as independent contractors. Whether the worker you hired is an employee or an independent contractor, their classification depends entirely on the conditions of their employment, not their job title or work schedule.
Workers Could Be Classified as Employees Even When:
1. The worker signed a contract stating that they agreed to work as an independent contractor.
2. The employer provided the worker with a 1099-MISC instead of a W-2 Form (wage statement) to file with the IRS.
3. The worker was paid in cash or paid per project.
4. The worker created their own hours and performed their duties based on a flexible schedule.
It is important for employers to ensure they are classifying their workers correctly. When businesses misclassify their workers, the employer could face tax evasion charges and penalties for wage and hour violations. They could also be confronted with legal claims from workers who have experienced significant losses due to unpaid overtime wages or employee benefits.
When seeking to accurately classify a worker as an employee or an independent contractor, employers should consider a combination of factors and ask themselves the following questions:
How long is your worker supposed to work for your organization? If there is no end date, your worker is likely an employee.
How much control do you have as an employer over the worker's tasks? If the employer controls the meaningful aspects of the worker's duties, the worker is probably an employee.
Does the employer determine the work schedule of the worker? If the answer is yes, then your worker will likely be classified as an employee.
Is your worker an "integral part" of the business operations? If your worker is an "integral part" of your company's daily operation, the worker would likely be categorized as an employee.
Does your worker require "special skill and initiative?" (Special skills mean skills in making business decisions, not technical skills.) If your worker does not make business decisions, then he or she should likely be classified as an employee.
How Employers Can Protect Themselves:
When employers are confronted with a legal claim to recover unpaid wages or some other legal issue surrounding a worker misclassification, it is essential to gather the facts of the matter and consult with an experienced labor and employment lawyer. The attorneys at the Lynch Law Firm can help you collect all the details of the worker's history with the company and analyze any written agreements that outline the relationship between the parties regarding the work that was to be performed.
Contact the Lynch Law Firm for Help Now
Employers are encouraged to use this information when seeking to correctly classify their workers as independent contractors or employees. The information contained in this blog post, however, should not be used as a final determination. If you have questions about your workers' classification, please contact the labor and employment lawyers at the Lynch Law Firm today to discuss your legal issue.
We Offer a Free Consultation
The Lynch Law Firm has a team of experienced employment lawyers who are familiar with the details of Texas independent contractor laws. Our attorneys can help determine your worker's status under Texas law and protect your interests as an employer. We offer a free consultation to our prospective clients and are happy to be of assistance to you.
About Natalie R. Lynch: Founding Member
Natalie R. Lynch, a business and employment law attorney in Austin, Texas, has demonstrated expertise in workplace investigations, employment law, and entity formations. Credentialed through the Association of Workplace Investigators (AWI), Natalie is the only consulting and credentialed expert in Central Texas who conducts investigations into allegations of harassment, discrimination, and hostile work environment. Having lived abroad in Spain and Ghana, Natalie brings unique perspectives to help organizations achieve business nationally and internationally. As a credentialed dispute resolution mediator, she routinely collaborates with general counsel, internal and external counsel, employment litigators, employment generalists, and senior human resources professionals.
Natalie is the outgoing Chair of the Austin Bar Association's Labor and Employment Section. It serves in leadership roles for the Texas State Bar Association, including the International Bar Section and the Animal Law Section. In Colorado, Natalie was a two-term president of the Aurora Bar Association, the first recipient of the Colorado Bar Association's Future Leaders award, and a member of the Bar Association's Executive Council. With her extensive business background and solution-focused, purposeful, no-nonsense approach, Natalie excels at:
· Business formation
· Transactional matters
· Employment law
· Workplace discrimination matters
· Employment litigation avoidance
· Harassment Prevention Training Modules
As a credentialed AWI investigator, Natalie has extensive training in interviewing techniques and a unique and beneficial skill set in the legal field. Natalie insists that each investigation represents the standards of quality and litigation avoidance on which she built the Lynch Law Firm. Before becoming a business owner, Natalie prepared by obtaining her undergraduate degree in international studies from Texas A&M University and her J.D. from South Texas College of Law. She also studied at the University of Denver. Natalie is licensed to practice law in Texas, Wyoming, and Colorado, and she holds certifications from Women-Owned Business (WBE), Minority-Owned Business (MBE), and Historically Under-Utilized Business (HUB).
Call the Lynch Law Firm Today
If you are an employer seeking to resolve a labor and employment issue, protect yourself, your employees, and your business by contacting the lawyers at the Lynch Law Firm. Our team can help you navigate the complexities of your legal matter from inception to resolution. Our firm can also assist you in developing:
· Legal issues related to labor and employment.
· Unlimited vacation policies
· Employment contracts
· Employee handbooks
· Performance evaluation materials
· Drafting legal agreements
· Workplace Investigations
· Harassment Prevention Training Modules
If you have questions regarding labor and employment matters, contact us for help now. Please email the lawyers at the Lynch Law Firm or call us at 512 298 2346.
Topic No. 762 Independent Contractor vs. Employee | Internal Revenue Service (irs.gov)