Are your workers independent contractors or employees? How can you tell the difference? What are the rules to determine whether a worker is an independent contractor in Texas or elsewhere? Why does this even matter?
Why You Need to Classify Employees Correctly
It is expensive to get the answer wrong. Misclassification lawsuits can run in the millions depending on the number of employees involved. For example, New Jersey’s lawsuit against Uber found that Uber owes $649 million for unpaid unemployment and disability taxes for misclassifying drivers as independent contractors.
California’s AB5 law, which made it harder for a number of workers to be independent contractors (as workers must meet all 3 of the ABC factors to be employees as discussed below), may spread to other states. Even if it doesn’t, there will still be the risk of a misclassification lawsuit in a number of states because companies in the gig economy are generally seen by state governments and plaintiff’s attorneys as misclassifying independent contractors and thus are a target for lawsuits.
Proper classification also matters for employees and the states that they work in (as shown by New Jersey’s lawsuit against Uber). Misclassified workers can cost states to collect less unemployment insurance, worker’s compensation insurance, and income taxes. Workers lose out on unemployment insurance (unless they can show in a proceeding that they were misclassified) and workers compensation insurance as contractors. On the other hand, many workers prefer to be independent contractors due to the benefits that they can obtain such as certain tax write offs, more control of their business, and better opportunities to profit. The most recent example of this are freelance writers and truckers in California.
What is an Independent Contractor?
States and the federal government have a wide variety of tests that they use to determine whether a worker is an independent contractor.
To determine whether a worker is an independent contractor under the Fair Labor Standards Act (which governs most wage and hour issues at the federal level) courts use the economic reality test. The test has the factors in the bullets below. All of these factors are considered, and a worker need not meet every factor to be an independent contractor.
- The extent to which the services rendered are an integral part of the principal’s business.”
Essentially the question is whether the person performing work that is an essential part of the service that the business provides? A traditional plumbing company that only has plumbers that are independent contractors would not pass the test. Plumbers are a main part of the services provided by the plumbing company. In contrast, a worker that only mows the plumbing company’s lawn every 2 weeks is not an integral part of the plumbing business.
- “The permanency of the relationship.”
Is there a definite end to the employment relationship or are the services only provided periodically? A cleaning person that comes once a week could be an independent contractor). Both factors would tend to indicate that the workers are independent contractors.
- “The amount of the alleged contractor’s investment in facilities and equipment.”
If the contractor provides their own tools, then that is a good indication that they could be independent contractors. If the company provides all the tools, then that weighs in favor of a finding that they are employees.
- “The nature and degree of control by the principal.”
Does the worker have the ability to determine how to perform the work? Are they able to determine the means that they use to complete the project and perhaps the time that they use to complete the project? For example, suppose you hire someone to develop an app for your company. If they can determine the means that they use to develop the app; are free to work on the development when they want; and can choose the programing language they use to complete the app (even though the company decides what the app is supposed to do), then this factor would tend to show that they are independent contractors.
- “The alleged contractor’s opportunities for profit and loss.”
Independent contractors typically can make money, lose money, and don’t have a fixed amount of money that they can make (or at least are usually not getting paid an hourly rate).
- “The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.”
Do workers compete with others in the marketplace? Is it possible for them to lose the business? Does the work require them to use independent judgment to complete the work? If so, then this factor supports a finding that they are independent contractors.
- “The degree of independent business organization and operation.”
Do they have their own business? Do they set their own schedule? Do they send out invoices? Do they do the things that separate businesses typically do? If so, then they are more likely to be independent contractors.
The ABC Test for Independent Contractors
Many states, like California, use the ABC test to determine whether a worker is an independent contractor. The factors in the test are generally:
- The worker is free from control (they determine how to do the work)
- The work is outside the usual business of the company
- The worker is customarily engaged in an independently established trade, occupation, or business.
In California, all 3 aspects must be met. Meeting all 3 factors can be difficult and is one of the reasons why there is such a fight over workers in the gig economy right now especially in California. Their main issue is whether the workers provide a service that is in the company’s usual course of the business (is Uber a company that provides a ride sharing service) or whether the companies merely connect providers (like Uber drivers or DoorDash workers) with potential clients that need their services. It is a question that will eventually be determined in the courts and legislative branches.
Independent Contractor Tests in Texas and Elsewhere
The Texas Workforce Commission does a great job outlining additional tests that are used in Texas.
Section 401.012 of the Texas Worker’s Compensation Act states that:
“’employee’ means each person in the service of another under a contract of hire, whether express or implied, or oral or written,” and “includes: (1) an employee employed in the usual course and scope of the employer’s business … .” That term does not include “an independent contractor or … a person whose employment is not in the usual course and scope of the employer’s business.” In section 406.121(2) of that law, an independent contractor is defined as “a person who contracts to perform work or provide a service for the benefit of another and who ordinarily:
A. acts as the employer of any employee of the contractor by paying wages, directing activities, and performing other similar functions characteristic of an employer-employee relationship;
B. is free to determine the manner in which the work or service is performed, including the hours of labor of or method of payment to any employee;
C. is required to furnish or to have employees, if any, furnish necessary tools, supplies, or materials to perform the work or service; and
D. possesses the skills required for the specific work or service.”
The Texas Unemployment Compensation Act does not directly define “independent contractor”. Instead, it sets forth a broadly inclusive test, known as the “direction or control” or “common law” test, for who is an employee: “’employment’ means a service, including service in interstate commerce, performed by an individual for wages or under an express or implied contract of hire, unless it is shown to the satisfaction of the Commission that the individual’s performance of the service has been and will continue to be free from control or direction under the contract and in fact”. By implication, an “independent contractor” would be a person whose services do not meet the above test. To aid in application of the common-law test, TWC has adapted the old IRS twenty-factor test for use by the agency (online at
Other agencies have their own tests. The National Labor Relations Board has a test called that is outlined here. As a reminder, the National Labor Relations Act applies to all companies with more than one employee whether unionized or not. The NLRB’s test is useful to determine whether workers are employees (and thus eligible to form a union) or independent contractors (the workers cannot unionize under federal law or at least not with the company that they work as independent contractors for. It is possible that they could be employees of another company where they could unionize.).
The IRS’s test is available here. The IRS’s definition is obviously used for federal tax purposes.
Essentially, there are a ton of rules to follow to determine whether someone is an independent contractor or employee. Almost every state has a different test (and sometimes more than one test for different areas of the law). Different tests may even lead to conflicting results.
Middle Ground
Currently there is no middle ground between independent contractors and employees. Someone is an employee or independent contractor.
Texas did clarify that gig workers are independent contractors last year under 40 TAC §815.134 (the provision relates to unemployment insurance).
The rule defines a “digital network” as (essentially) an app or other piece of software/website that is used to connect the public with contractors that can provide a service that the public is looking for. A marketplace platform is a company that operates a digital platform (ex. DoorDash owns and operates its delivery app).
A worker that uses a digital network (typically an app like Uber or Lyft) to find members of the public to provide services to is a contractor as long as the following factors are met (from 40 TAC §815.134):
–All or substantially all of the payment paid to the contractor shall be based on a per-job or transaction basis;
–The marketplace platform does not unilaterally prescribe specific hours during which the marketplace contractor must be available to accept service requests from the public (including third-party individuals and entities) submitted through the marketplace platform’s digital network;
–The marketplace platform does not prohibit the marketplace contractor from using a digital network offered by any other marketplace platform;
–The marketplace platform does not restrict the contractor from engaging in any other occupation or business;
–The marketplace contractor is free from control by the marketplace platform as to where and when the marketplace contractor works and when the marketplace contractor accesses the marketplace platform’s digital network;
–The marketplace contractor bears all or substantially all of the contractor’s own expenses that are incurred by the contractor in performing the service or services;
–The marketplace contractor is responsible for providing the necessary tools, materials, and equipment to perform the service or services;
–The marketplace platform does not control the details or methods for the services performed by a marketplace contractor by requiring the marketplace contractor to follow specified instructions governing how to perform the services; and
–The marketplace platform does not require the contractor to attend mandatory meetings or mandatory training.
Essentially, the law was passed as a way for Texas to clarify what it took for a worker to be an independent contractor rather than an employee in the gig economy.
What Rules Apply to Your Business
Ok, you just read a number of different laws about independent contractors. How do you know what applies to your business? Before I give a checklist, I need to reiterate that this is a complicated issue. There is a lot of case law about a variety of workers, duties, and positions under these tests. It is an incredibly fact specific question to determine whether a worker is an independent contractor and is often very confusing.
Here are some steps to consider to determine what law to apply:
- Why are you trying to determine whether the worker is an independent contractor or employee? Is it a federal tax, federal wage and hour, unemployment insurance, unionization, or workers compensation insurance issue? Workers should almost always be classified the same under the different laws.
- What state does your business operate in?
- Based on what issue applies and the state, you would then need to examine the law for that area, the state, and potentially the federal laws.
- You need to gather the relevant information about the individual worker under the test.
- You then need to follow the test and review how courts have looked at cases similar to yours in the past to reach a determination on the proper classification.
Correctly Classifying Workers
As noted above, it is incredibly important that you correctly classify your workers. If you are in an industry that has a history of misclassifying workers, then you should take extra precautions. Common industries where misclassification occurs includes construction, certain medical professionals, and the gig economy.
To avoid these problems, many employers benefit from conducting a review of a worker’s duties and other information to determine whether or not they have been properly categorized. To do this, you must also have good job descriptions. I’ve written about this before in the context of ADA accommodations and white-collar exemptions, but it is also useful for classifying independent contractors.
Conclusion
You need to classify workers correctly. If you fail to classify workers properly, then your company could be subject to an expensive lawsuit that could upend your business. Do your due diligence utilizing the tests available to ensure your workers are classified appropriately.
The information provided in this blog is for educational purposes only and is not legal advice. If you need legal advice, then you should speak with a lawyer about your specific issues. Every legal issue is unique. A lawyer can help you with your situation. Reading the blog, contacting me through the site, emailing me or commenting on a post does not create an attorney-client relationship between any reader and me.
The information provided is my own and does not reflect the opinion of my firm or anyone else.