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By: Jake Curtis, Esq.
Burch & Cracchiolo, P.A.
Phoenix, Arizona

The difference between an independent contractor and an employee is not always obvious.  There are some real benefits to hiring independent contractors to handle some aspects of your business, but there are pitfalls if it is later determined that the independent contractor is really an employee.

You may not be aware that the law independently determines whether a worker is an independent contractor or an employee.  That determination does not depend on what you call them, what they call themselves, or whether you have a contract identifying the worker as an independent contractor. What matters is how much control you have over the worker.

Why Should I Care Whether a Worker Is An Employee or Independent Contractor?

If someone you pay to perform work for your company is misclassified as an independent contractor, you could face a whole host of problems, including, liability for:

  1. Payroll taxes that were not withheld, along with applicable penalties and interest;
  2. Overtime and/or the minimum wage to the extent it was not paid;
  3. On-the-job injuries that your workers’ compensation insurance may not cover;
  4. Injuries caused by the worker to third-parties in the course and scope of his employment; and
  5. State and federal discrimination and wrongful termination claims.

How Do I Determine Who Is My Employee?

In Arizona, the “right to control” test is typically applied to determine whether a worker is an employee.  The question comes down to how much control the company has over the worker.  The Arizona Supreme Court identified the following non-exhaustive list of criteria to help determine whether an employer has sufficient control such that he/she will be deemed an employee: 1) the extent of control exercised by the employer over details of the work and the degree of supervision; 2) the distinct nature of the worker's business; 3) specialization or skilled occupation; 4) materials and place of work; 5) duration of employment; 6) method of payment; 7) relationship of work done to the regular business of the employer; and 8) the belief of the parties.

The analysis is not particularly clear cut.  The company must look at the specific situation.  A classic independent contractor is a plumber who comes to your house to fix the leaky toilet.  She uses her own tools, controls the time when the repair will occur, sets her own rates, and decides the best way to make the repair.  A classic employee is an office worker who arrives at the company each work day, uses company equipment to do his job, is required to adhere to company policies and procedures, has no discretion over what work to accept, and has no control over the rate of pay.

On July 2015, the Department of Labor issued updated guidance on employee misclassification that is likely to limit the use of independent contractors for purposes of the application of the Fair Labor Standards Act.  It reduces reliance on the “control” factor and focuses instead on whether the worker is “economically dependent” on the employer.  The IRS also provides information on its website to help you determine how to classify a worker for purposes of federal taxation.

What Could Happen If I Misclassify An Employee?

In the usual case, misclassification results in a few lost man hours to properly classify the workers and maybe some back pay.  In the worst case, misclassification can undermine your entire business model, as shown by the following recent decisions:

  • In 2014, the 9th Circuit Court of Appeals concluded that the company used by Sears to deliver its products to consumers In California had mischaracterized its delivery drivers as independent contractors, reviving a class action for overtime and other compensation.
  • In 2013, a New York federal court held that a class of 1900 exotic dancers were employees entitled to overtime and other benefits. The case was ultimately settled for more than $15 million.
  • Just last month, the California Labor Commissioner found that Uber drivers are employees of Uber rather than independent contractors.

What Should I Do Now?

The issue of misclassification is often overlooked until there is another problem, like a lawsuit for harm caused by a worker you thought was an independent contractor or during an audit.  Protect your business by periodically reviewing your relationships with independent contractors.  Look for independent contractors with whom you have longstanding relationships, who work almost exclusively for you, or who are integral to your business model. If it’s a close call, consult a lawyer or human resources professional.

For more information about Burch & Cracchiolo, P.A., please visit the International Society of Primerus Law Firms.