Independent Contractor or Employee? How to know the difference.

One of the biggest sources of confusion I see from businesses in Whatcom County is trying to figure out the difference between independent contractors and employees. Whether someone is your employee (v. an independent contractor) can impact many aspects of your business, including minimum wage and overtime laws, employment security, worker’s compensation, and federal taxes, and potential liability for their actions.

There are a number of tests used to evaluate whether a worker is an independent contractor or an employee. Some of the factors in the tests overlap, some do not. The Washington State Department of Labor & Industries has a fairly rigid test it applies. If your independent contractor situation cannot pass this test, the person is likely your employee and covered under worker’s compensation laws—meaning you as the business are on the hook for payment of premiums/taxes into the worker’s comp fund, likely any workplace injuries, etc.

A worker/employee is every person engaged in employment or working under an independent contract the essence of which is his or her personal labor. RCW 51.08.180. A worker is covered under worker’s compensation laws unless they meet a six-part test (there is a seventh element for registered contractors). RCW 51.08.180. If an independent contractor is engaged for something other than their personal labor (e.g. they have heavy machinery or other equipment which is what you really need from them) they may also be exempt from coverage (i.e. they are likely not an employee).

The worker must meet all elements of the test:

1. The individual is free from control or direction over the performance of the service (under contract and in fact);
2. The service is outside the usual course of the business or performed outside all the places of the business, or the individual has and pays for a principal place of her business for the service;
3. The individual has an independent trade, occupation, profession, or business involving the service or has a principal place of her business eligible for federal tax business deduction;
4. The individual is required to file a schedule of expenses with the IRS for her business;
5. The individual has a Department of Revenue account (and account with other agencies as required) and has a UBI number; AND
6. The individual maintains a separate set of books reflecting incomes and expenses for her business. [AND The individual has a valid contractor registration or electrical contractor license.]

RCW 51.08.195. [RCW 51.08.181 seven-part test for registered contractors and electricians.] The Department of Labor & Industries publishes guides on its website: Is Your Subcontractor Really an Employee?; Independent Contractor Guide.

It is the employer’s responsibility to ensure each part of the test is met if you want to treat the worker as an independent contractor. You must require your independent contractors to meet the requirements (e.g. have a principal place of business, meet the IRS requirements, etc.). You should check with the Department of Revenue to make sure they have an account and UBI number [and check with Labor & Industries to verify they have a valid contractor registration or electrical contractor license]. It is important to have written contracts with your independent contractors and vendors.

Other tests that also must be considered to determine if you’ve hired an employee and not engaged an independent contractor come from:  the Washington Minimum Wage Act (MWA); the Fair Labor Standards Act (FLSA); the Internal Revenue Service (IRS); Title VII of the Civil Rights Act of 1964, and other federal laws enforced by the Equal Employment Opportunity Commission; and Washington common law (when determining whether an employer/principal is responsible for act of an employee/agent in tort (civil liability claims) or contract cases. Case law—administrative and appellate court decisions—that interpret these rules/laws must also be considered.

As businesses know, employment issues are challenging, complex and case-specific. The above is meant to provide some basic insight into one area that businesses struggle with. If you have an issue involving an independent contractor or employee or what to do during the contracting/hiring process, contact an experienced attorney to assist you.

If you are being audited by a State agency for misclassifying someone, see our April 28, 2016 blog post on Successfully Navigating Employment Tax Audits.