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August 13, 2015
Builders, general contractors, architects, engineers and others in the construction industry often use independent contractors in their work. But is the “independent contractor” you're using really an independent contractor, or could they be considered your employee? And why should you care?
There is a common misperception that engaging a subcontractor and labeling them an “independent contractor” or having them sign an independent contractor agreement is all a business has to do.
Another common misperception is that satisfying L&I's seven-factor test for determining whether a business must pay workers' compensation premiums is all a business has to do.
Unfortunately, these steps, while advisable, are not enough to prevent or minimize a business's risks.
Apart from workers' compensation laws, businesses must comply with state and federal laws on minimum wage, overtime, record-keeping, income and payroll tax withholdings, and breaks.
Generally, if a business hires an employee, then the business must comply with these laws, and must pay them minimum wage, pay them overtime for any hours worked over 40 hours in a week, keep records of the time they work and the pay they receive, ensure that they receive meal and rest breaks, and withhold some of their pay for taxes.
These requirements generally don't apply if a business engages someone who is an independent contractor.
Determining whether someone is an independent contractor or an employee under these laws was often confusing, in part because different tests applied for different laws, and different agencies enforce those laws. These tests often boiled down to whether a business had control over the person and their work, often called the “right to control” test.
Over the past few years, however, the focus has shifted away from questions of control and to an “economic realities” or “economic dependence” test. The Washington Supreme Court in 2012 made this change. Questions of whether, under Washington law, a worker has to be paid minimum wage and overtime, a worker has to be provided rest and meal breaks, and an employer has to keep more careful track of time worked and amounts paid are now answered by determining whether the worker is economically dependent on the business.
Shifting ‘economic realities'
In 2014, the Washington Supreme Court applied this “economic realities” test to the question of joint employers, finding that the employees of a business's subcontractor's subcontractor could also be considered the employees of the top-level business, despite the subcontractor layers.
Last month, the U.S. Department of Labor also made this shift. The DOL enforces the federal minimum wage and overtime laws. In new guidance, it announced that it will use an “economic realities” test to determine whether those laws apply to a worker. You can read the guidance at tinyurl.com/DOL-Misclass.
The DOL used the construction industry as an example, explaining that carpenters, construction workers and electricians may be misclassified as independent contractors. The DOL warned that under its new interpretation, “most workers are employees,” and not independent contractors.
The DOL's new guidance doesn't necessarily change how businesses in Washington characterize relationships with workers as employees or independent contractors (given the 2012 change in Washington state law). But it still poses a risk to Washington businesses. The DOL, which enforces federal wage laws, frequently conducts more audits of businesses than L&I, which enforces state wage laws.
The DOL's announcement of this shift signals a likely focus on this issue in audits. And whenever the DOL or another enforcement agency announces it will focus on something, lawyers representing employees usually take notice.
Why do contractors and building professionals care? If a business or its subcontractor engages a worker on an independent contractor basis and the DOL (or another agency) determines that characterization is incorrect, the business faces several risks, including:
Payment of additional wages if the worker was not paid minimum wage or overtime
Payment of penalties for not paying those wages in the past
Liability for income and payroll tax withholdings on the pay to the worker, plus possible interest and penalties
Liability for contributions to employee benefit plans, including health plans and pension or retirement plans, plus possible penalties for late contributions
Two things compound the potential risks for businesses.
First, a business rarely engages a single person as an “independent contractor” in a particular role or context — often a business will engage many “independent contractors” doing the same thing (framers, siding installers, electricians, plumbers, painters, etc.). So if a business is found to have misclassified one worker, this often affects groups of similar workers, multiplying the risk and leading to expensive class-action litigation.
Second, the DOL and IRS share information about suspected misclassifications, and the DOL and L&I do the same thing. The risk is not just that one enforcement agency will reclassify a worker or group of workers, but that multiple agencies will do so. The potential impact could devastate a business.
So what should contractors, architects, engineers and building professionals do? Identifying and addressing these risks is typically a three-step process:
1. Identify all independent contractor relationships. This includes any person or entity that was paid and issued a 1099, even if that entity is a business with its own employees or subcontractors. The entity structure is often ignored in making these determinations.
2. Evaluate those relationships under the state and federal tests. Include every person working on a project or job site, even if the business's relationship with that person is indirect or through one or more subcontractor relationships. Though the tests are similar, and now hinge strongly on economic dependence, the tests differ. So it might be possible that a person is an employee under L&I's test for payment of workers' comp premiums but is an independent contractor for purposes of wage and hour laws or employee benefits.
3. Recharacterize relationships that are truly employee relationships and not independent contractor relationships. In some circumstances, this may involve making some back payments to avoid enforcement penalties.
In addition, businesses should evaluate their contracts with their subcontractors to minimize their risk.
The independent contractor/employee issue continues to evolve, and this evolution has not been in businesses' favor. Businesses that use independent contractors regularly or on a widespread basis face potential risks and costs. Taking preventative steps now could help eliminate or reduce significant liability later.
Brian Keeley is an employment and employee-benefits attorney with Schwabe, Williamson & Wyatt. Jeremy T. Vermilyea is a shareholder with the firm, representing contractors, developers, design professionals and other members of the construction industry.