Both federal and state labor authorities are hot on the trail of companies who hire employees and call them “independent contractors.” The United States Department of Labor (DOL) has entered into a Memorandum of Understanding with a number of states, including Arizona, mandating the enforcement of laws pertaining to properly classifying employees as employees. The DOL and these states have made this issue an enforcement priority and may soon be asking questions at your place of business.
An independent contractor is hired on a contract basis to do work that is typically independent, unsupervised and limited in time, scope and duration. An employee is hired on an at-will or contract basis to do work that is typically supervised, regular and ongoing and is only generally limited in scope by the kind of work she is hired to do. Payments to independent contractors are reported on 1099s. Payments to employees are reported on W-2s.
Companies may think that hiring independent contractors rather than employees saves them money. If you hire an independent contractor, you avoid having to withhold FICA and state and federal income taxes and paying for workers’ compensation, health insurance and other benefits that are otherwise available to your employees.
The only problem is you likely can’t get away with it. You can’t call an employee an independent contractor if the employee is not really an independent contractor – if it looks like a duck, etc. If you do, and any one of a number of government agencies finds out, you could be liable for years of unpaid payroll withholdings, insurance benefits and even on-the-job injuries that should have been covered by workers’ compensation. One government agency talks to the other, and, if found guilty by one, you can bet the others will be in quick pursuit. Before you know it, you’re dealing with the DOL, the IRS, the Arizona Department of Economic Security and some government agencies you’ve never even heard of.
Of course, not all independent contractors are really employees. There are many people who own their own business, who are truly independent and who market their services to multiple clients or customers. They are legitimate independent contractors. An “outside” IT professional, for example, is likely to be an independent contractor if she owns her own business, serves other clients and works on your computers only if and when her services are needed. That same IT professional, however, may be an “inside” employee if she has only one client (you), works regular hours (either full or part-time) and is paid an hourly wage or salary for being there to work on your computers. That is usually an easy call to make. In many other cases, however, it is not so easy to tell if someone is an independent contractor or really an employee.
Take exotic dancers. Strip clubs in Phoenix and elsewhere around the country are being sued by exotic dancers for alleged violations of the Fair Labor Standards Act (FLSA), a federal law that requires employers to pay their employees minimum wages and overtime pay. These dancers claim that strip club owners have misclassified them as independent contractors and that, because they are really employees, the owners have violated the FLSA and similar state laws by failing to pay them as employees entitled to minimum wages and overtime pay. So what makes them employees and not independent contractors?
There are various “tests” that courts and government agencies use to determine whether someone is an employee or an independent contractor. Each test is somewhat different, but all of them share a common goal of protecting the rights of workers who look like, but are not treated like, employees.
Arizona’s “Right to Control” Test
Arizona courts and state agencies use a “right to control test.” This test, found in A.R.S. ¶23-902, examines: (1) whether an employer “procures work to be done for the employer by a contractor over whose work the employer retains supervision or control,” and (2) whether “the work is a part or process in the trade or business of the employer.” A.R.S. ¶23-902(B). If these criteria are met, the person doing the work is an employee. Conversely, if someone is “not subject to the rule or control of the business for which the work is done, but is engaged only in the performance of a definite job or piece of work, and is subordinate to that business only in effecting a result in accordance with that business design,” the person doing the work is an independent contractor. A.R.S. ¶23-902(C).
Courts consider the “totality of the circumstances of the work and various indicia of control between the parties” to apply this test. Reed v. Indus. Comm’n, 23 Ariz.App. 591, 593, 534 P.2d 1090, 1092 (1075). The “indicia of control between the parties,” or factors that agencies and courts consider when applying the test, include:
(1) The duration of the employment;
(2) The method of payment;
(3) Who furnishes necessary equipment;
(4) The right to hire and fire;
(5) Who bears responsibility for workmen’s compensation insurance;
(6) The extent to which the employer may exercise control over the details of the work; and
(7) Whether the work was performed in the usual and regular course of the employer’s business.
Read, 534 P.2d at 1092, citing Home Ins. Co. v. Indus. Comm’n, 123 Ariz. 348, 350, 599...
