If business owners are not concerned about the make-up of their workforce, they should be. In recent years, the number of lawsuits concerning misclassification of employees has risen exponentially. This is because companies routinely call members of their workforce independent contractors (“IC”) when in reality they are employees.
If an audit by the Texas Workforce Commission (“TWC”) shows a business has incorrectly classified employees as independent contractors, and therefore failed to properly report wages and taxes, the company could be reported to the Internal Revenue Service (“IRS”). The company could then be liable for back taxes and interest, not to mention a possible IRS audit. And, the IRS audit would likely reveal the company was not eligible to receive the federal tax credit the company claimed with respect to the wages paid out to the contract labor in question.
According to the TWC’s website, a number of scenarios could bring about a TWC audit. It could arise from an unemployment claim, a competitor or former agent making a claim that the company incorrectly classifies workers, a random audit, or the TWC may “target a specific industry.”
The TWC uses similar guidelines to those set out by the IRS regarding the classification of workers. IRS Publication 15-A outlines the IRS test to determine whether a worker is an employee or independent contractor. According to the IRS, there are three main criteria that classify a worker. These criteria boil down to: 1) the type of relationship that exists between the parties; 2) the amount of control the worker retains over how they do their jobs; and 3) how they handle the financial aspects of performing their work.
Here are some of the things to consider when determining whether a worker would be classified as an employee or an independent contractor:
The nature of the relationship with the workforce
Is there a written contract describing the relationship with our workers? Even a contract that clearly states workers are independent contractors may not be enough. The nature of the relationship could work trump the language in the contract.
Are benefits like insurance and a 401K provided? These are employee type benefits
What about the permanency of the work relationship? Do the workers have a specific project or time-frame delineated in their contracts? If not, their relationship with the company could continue indefinitely and this permanency is indicative of an employer-employee relationship.
The amount of control the company exerts over its workers
This is where many small business owners run afoul of the IRS and TWC guidelines. Most companies exercise extensive oversight regarding how its workers do their jobs. Do the workers have a set schedule? Independent contractors do not have schedules as they work for themselves. Does the company provide training to the workers? This should not be necessary for contract labor. Independent contractors generally use their own methods to achieve the company’s desired results. Has the company laid out a definitive set of policies and procedures on how to perform their duties? If so, this is clearly an excessive amount of control over an IC, and this alone would likely lead the TWC and the IRS to classify the company’s workers as independent contractors rather than employees.
The amount of control our workers have over the financial aspects of their work
Independent contractors generally incur un-reimbursed business expenses during the course of their contract. These kinds of expenses include rent for office space, travel expenses, and marketing expenses. Does the company cover any or all of these expenses? Do the workers have any significant financial outlay in the performance of their work? Does the company provides the office space, phone, business cards, desk, Internet, leads or marketing materials? This kind of equipment and support is generally provided to employees and not to independent contractors. Does the company restrict the workers’ ability to market their services on the open market? Traditionally, a contractor is free to market their services however they see fit.
How the company pays its work force
Is the worker paid by the hour or for a finished product or service? Does the worker submit invoices or expenses? Does the worker receive any advances or draws? And finally, does the company withhold taxes and issue a 1099? While not insurmountable, any one of these could reclassify a worker.
In summary, in Texas, a worker is presumed to be an employee. However, if the classification is challenged by the TWC, the IRS, or in the courts, it is up to the company to prove the independent contractor classification is correct.
Tressie E. McKeon is an associate in the firm’s Litigation Department and head of its Aviation practice, resident in its Dallas office.