The Dangers of Misclassifying Construction Workers as Independent Contractors in California

• Publication year: 2016
• Author: Kathleen Hsu and Christine C. Lee

The Dangers of Misclassifying Construction Workers as Independent Contractors in California

Kathleen Hsu and Christine C. Lee

Kathleen Hsu is an associate in the Washington, DC office of Smith, Currie & Hancock LLP. Kathleen concentrates her practice in the areas of construction law, litigation, government contracts, and appropriations. She received her Juris Doctor from American University, Washington College of Law. She served as Managing Editor of the American University Business Law Review.

Christine C. Lee is Of Counsel in the San Francisco office of Smith, Currie & Hancock LLP. She practices in the areas of employment, construction, and commercial and real estate litigation. Ms. Lee emphasizes her practice in counseling construction employers and employees on their rights and obligations under California employment law. Christine received her juris doctor degree from the University of California, Hastings College of the Law, where she was a member of the Communications & Entertainment Law Journal.

Construction companies must be aware of the difference between employees and independent contractors. State and federal agencies are increasingly targeting the misclassification of workers in the construction industry. The repercussions for misclassifying employees as independent contractors, intentionally or not, include government audits, lawsuits by the government or by the misclassified worker, and payments of back wages, past taxes, civil penalties, and damages.

The United States Department of Labor ("DOL") recently issued Interpretation No. 2015-1, explaining the proper classification of workers as either employees or independent contractors for purposes of Fair Labor Standards Act ("FLSA")¹ compliance. An estimated 3.4 million employees are misclassified as independent contractors annually. Employer avoidance of the FLSA causes state and federal governments to lose millions of dollars in tax revenue every year.

Under the FLSA, "employ" is broadly defined as "to suffer or permit to work." In light of the FLSA's broad definition of employ, to determine whether a worker is an employee or an independent contractor, the DOL examines six "economic reality" factors.

Difference In Employees And Independent Contractors In The Workplace

The difference between employees and independent contractors is an important one. Employees are subject to the FLSA's minimum wage and overtime requirements as well as California's stricter minimum wage and overtime requirements, while independent contractors are not. Further, employers must pay state and federal unemployment tax, social security and Medicare taxes, and unemployment taxes on employees' wages, but not wages of independent contractors. When employers misclassify employees as independent contractors, the workers lose workplace protections and state and federal agencies lose tax revenue.

Classifying Workers Using "Economic Reality" Factors

In light of the broad applicability of the terms "employ" and "employee" whether a worker is an employee or an independent contractor depends on an analysis of six "economic reality" factors.² The economic reality factors are taken as a whole, as indicators of a worker's economic dependence or independence.³

1) The Extent the Work is an Integral Part of the Principal's Business

The more "integral" work is to the principal's business, the more likely that the worker performing that work is an employee.⁴ An independent contractor's work is typically not integral to the principal's business.⁵ The DOL cites as an example the difference between a carpenter and a software developer on a construction project.⁶ The carpenter is integral to the business of a construction company that builds homes, because framing structures out of wood is critical to constructing homes.⁷ On the other hand, a software development company that schedules projects and tracks bids and orders performs work that is not integral to a construction project.⁸

[Page 10]

2) The Extent a Worker's Managerial Skill Can Affect Opportunity for Profit or Loss

If a worker's managerial skills, including hiring, purchasing, and advertising decisions, affect the worker's opportunity for profit or loss on a future job, the worker is typically an independent contractor.⁹ On the other hand, if a worker's only opportunity for profit or loss is in earnings and overtime on the current job, then the worker does not have any managerial skills that may affect his or her profit or loss, likely making him or her an employee.¹⁰

3) The Extent of the Worker's Investment in Relation to the Principal's Investment

If a worker makes substantial investments as a business beyond working on the current project, the worker is typically an independent contractor.¹¹ However, if the worker makes minimal investments, such as minor investments in tools in relation to the investment of the principal, the worker is likely an employee.¹² The DOL explains that a worker who provides a substantial investment in relation to a principal's investment, such as investments in vehicles, rental space, and advertising, is likely an independent contractor.¹³ However, a worker who invests in some tools on a project would not be making an investment beyond working on the current project.¹⁴Therefore, a worker who makes minor investments in relation to the principal would typically be an employee.¹⁵

4) The Amount of Special Skills or Initiative Used by the Worker

When a worker uses special skills in an independent manner while demonstrating business-like initiative, the worker is typically an independent contractor.¹⁶ This includes exercising business skills and judgment in ordering materials and determining the quantity of materials needed.¹⁷ On the other hand, workers who exercise their skills in a dependent matter and rely on a principal to dictate when and where to perform work are typically employees.¹⁸ The DOL cites as an example that a highly skilled carpenter who works for a construction firm and does not make decisions on the sequence of work, ordering of materials, or bidding on additional work is an employee, because he or she does not exercise any managerial or business skills.¹⁹ However, a highly skilled carpenter that markets his or her specialized services to construction firms and orders materials for jobs is an independent contractor.²⁰

5) The Permanence of the Relationship between the Worker and the Principal

A worker who does not have a permanent or indefinite relationship with a principal due to his or her own independent business initiative is typically an independent contractor.²¹ Workers that are at-will, or permanent, are typically employees because they work continuously for the principal.²² Even seasonal workers are considered employees when they work continuously during the season.²³

6) The Nature and Degree of the Principal's Control

If a worker exercises meaningful control over his or her work and functions as a separate, independent entity running his...