Are Your Workers Misclassified?

This Advisor column was originally published in April 2007.

Important consequences flow from the determination that an individual is a regular employee, as compared with a temporary or seasonal employee or independent contractor. The common law definition of employee and potential consequences of failing to appropriately classify a worker as a “regular employee” are discussed below.

Common Law Definition of Employee

Various factors have been considered to determine whether an individual is an employee, independent contractor or in some other type of relationship with the employer. The Supreme Court has adopted the common law definition of employee as follows:

In determining whether a hired party is an employee under the general common law of agency, we consider the hiring party's right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party; the extent of the hired party's discretion over when and how long to work; the method of payment; the hired party's role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party.

Nationwide Mutual Insurance Co. v. Darden, 530 U.S. 318, 112 S.Ct. 1344 (1992)(citations omitted). The IRS applies the following 20-factor analysis in determining whether an independent contract is an employee:

• whether the individual is required to follow instructions;
• the amount of training of the individual related to that particular job;
• the amount of integration of the individual into the employer’s business;
• whether services are rendered personally by the individual;
• whether the individual hires, fires and pays his/her own assistants;
• the existence of a continuing relationship;
• the establishment of a set amount of work hours;
• whether the individual must devote substantially full time to the job;
• whether the individual works on the employer’s premises;
• whether the individual works according to a sequence set by the employer;
• whether the individual must submit regular or written reports to the employer;
• whether the individual is paid by time rather than by project;
• whether the individual is reimbursed for expenses;
• whether the individual furnishes the necessary tools and equipment;
• whether the individual has invested in the facilities for performing the services;
• whether the individual can realize a profit or a loss;
• whether the individual works for more than one firm at a time;
• whether the individual makes his/her services available to the public;
• whether the employer has the right to discharge the individual; and
• whether the individual has the right to terminate the relationship without incurring liability.

26 U.S.C. § 3401(c). Washington common law focuses on the following factors.DeWater v. State, 130 Wn.2d 128 (1996):

• the right of the purchaser of work to control and direct the work of the worker;
• the kind of occupation, with reference to whether the work usually is done under the direction of a supervisor or is done by a specialist without supervision;
• the skill required in the particular occupation;
• whether the purchaser of the work or the worker furnishes the equipment used and the place of work;
• the length of time during which the person has worked or the length of time that the job will last;
• the method of payment, whether by time or by the job;
• whether the work relationship is terminable by one party or both parties, with or without notice or explanation;
• whether annual leave is afforded;
• whether the work is an integral part of the business of the purchaser of the work;
• whether the worker accumulates retirement benefits;
• whether, with respect to the worker, the purchaser of work pays taxes levied on employers, such as social security tax, unemployment tax, workers’ compensation tax, or withholds federal income tax;
• whether the worker treats income from the work as salary or as business income;
• whether, with respect to the worker, the purchaser of work keeps and transmits records and reports required of employers, such as those required under the workers’ compensation act; and
• the parties’ intentions.

While none of the above factors is dispositive, the principal inquiry is whether the party has the right to control the manner and means by which the work is performed.

Washington Law Prohibits Public Employers From Misclassifying Employees

Public employers must be particularly careful about appropriately classifying their employees due to RCW 49.44.160, which makes it illegal for a public employer to misclassify employees to avoid providing or continuing to provide employment-based benefits. The Legislature explained the intent of the statute as follows:

The legislature intends that public employers be prohibited from misclassifying employees, or taking other action to avoid providing or continuing to provide employment-based benefits to which employees are entitled under state law or employer policies or collective bargaining agreements applicable to the employee's correct classification.

RCW 49.44.160. “Misclassify" and "misclassification" means to incorrectly classify or label a long-term public employee as "temporary," "leased," "contract," "seasonal," "intermittent," or "part-time," or to use a similar label that does not objectively describe the employee's actual work circumstances. RCW 49.44.170(2)(d). The Legislature explained this in the Final Bill Report:

Background: Public employers sometimes provide a lower level of health insurance coverage, retirement plan coverage, sick or annual leave, or other employment-based benefits to persons who are employed on a part-time, temporary, leased, contract or other contingent basis. The practice or providing less general compensation to come contingent workers is sometimes justified on the basis that the employer should provide more generous compensation to persons who perform full-time services, or have performed services for a longer period of time. In some cases, however, public employers use labels to justify providing different levels of benefits to employees who have rendered identical levels of service, for identical periods of time, for the employer. In these cases, the employer may misclassify an employee as “temporary” or “leased” or “seasonal”, when in fact the employee renders exactly the same services, for the same period of time as another employee who is labeled “permanent” or “full time”, and hence qualifies for better benefits.

In determining whether an employee has been appropriately classified as part-time, seasonal or temporary, the law provides that objective standards, such as control over the work and the length of the employment relationship, should determine whether a person is an employee who is entitled to employee benefits, rather than the arbitrary application of labels, such as "temporary" or "contractor".

In Mader v. Health Care Authority, 149 Wn.2d 458 (2003), two part-time community college instructors alleged that they were inappropriately classified to avoid paying their health care coverage during the summer quarter because they did not teach classes during that quarter. Both instructors taught more than half-time in the fall, winter and spring quarters for many years, and claim they should have been classified as “career seasonal/instructional employees” which would have entitled them to benefits. Career seasonal/instructional employees work half-time or more on an instructional year or nine month basis. In contrast, part-time employees are only entitled to benefits during the second consecutive quarter/semester. Because these instructors did not work during the summer quarter, they would not be entitled to benefits if considered “part-time.” The Washington Supreme Court held that the lower courts failed to analyze whether the instructors were truly part-time or whether they met the definition of career seasonal employees. The Court emphasized that based upon RCW 49.44.160, this must be an objective analysis, noting by enacting this law, the “legislature indicated that the HCA should not exclude employees from eligibility for comprehensive health care coverage simply because they are labeled ‘part time.’ Id. at 474. According to the court, the “HCA must examine the actual work circumstances of a state employee, rather than the contracts or titles under which he or she is employed, to determine whether the employee satisfies the eligibility requirements.” Id. at 476.

Tips to Avoid Misclassification Problems

There have been several claims recently filed under RCW 49.44 by temporary workers and independent contractors alleging misclassification. The consequences for misclassifying employees can be significant, including loss health and retirement benefits. The following guidelines are intended to help you evaluate your working relationship to ensure workers have been appropriately classified.

1. Review Your Independent Contractor Agreements.

Based on the various tests set forth above, the most important terms to consider incorporating into an independent contractor agreement include:

• A statement that the contractor is an independent contractor and not an employee, and that the parties understand and intend such a relationship;
• A statement to the effect that the worker, not the employer, has the right to control the manner and means in which the particular project is accomplished. It is acceptable to add that the employer shall retain the right to ensure that the project meets specifications;
• A provision for payment by the project, if possible, rather than by time increments (i.e., by the hour, week or month);
• A provision specifying the methods of termination by either party, including the consequences of termination;
• A provision requiring that the worker pay all out-of-pocket expenses of the project, including, for example, copying costs, telephone calls and travel;
• A provision requiring that the worker supply all tools and equipment, if possible. If appropriate, also include a provision requiring that the worker provide the workplace in which the work is to be performed;
• A statement that the worker shall be responsible to account for all payroll and other taxes for himself/herself/itself and the worker’s own employees;
• A provision requiring that the worker provide workers’ compensation coverage for its employees (or a provision making the worker a special employee for the purpose of workers’ compensation coverage only);
• A provision expressly exempting the worker from any benefits to which the employer’s regular employees are entitled;
• A provision addressing the duration of the agreement. If possible, the agreement should terminate with the completion of a particular project. If the nature of the contract demands that the agreement be open-ended instead of project-based, consider including a cut-off date for the agreement.

2. Actions Speak Louder than Words: Ensure the Work Relationship Is Consistent with the Written Agreement.

Having a strong independent contractor agreement will not be enough if the individual is truly subject to the control of the employer and acting like an employee. Therefore, it is important to ensure that the individual is actually being treated like an independent contractor in performing his/her services for the entity.

3. Make Sure Temporary and Seasonal Employees Are Truly Temporary.

As noted in Mader v. Health Care Authority, 149 Wn.2d 458 (2003), an employer must evaluate the actual work experience of the worker to determine if he/she is appropriately classified as a temporary, seasonal or part-time employee. This analysis must be performed on a case-by-case basis. Titles and contracts will not be dispositive. To ensure temporary or seasonal employees do no become “regular employees” by default, an employer may want to consider taking the following actions:

• Require temporary and seasonal employees to reapply with each assignment or project;
• Make sure their employment terminates at the end of the project or season so there is no expectation of continued employment;
• Review what factors, if any, differentiate temporary employees from regular employees, or whether they are fully integrated into the workforce. Consider whether temporary or seasonal employees are invited to participate in employee functions, such as meetings, training opportunities, and whether they are granted access to the same resources as permanent employees. The more factors that differentiate the two groups of employees the less likely temporary employees will be considered permanent.

4. Review Policy Definitions and Eligibility Requirements Under Benefit Plans.

Review how groups of employees are defined in the personnel policies and applicable collective bargaining agreements to ensure that employees are consistently defined in the same manner. Then, make sure that employees are being treated according to their classification. Finally, even if an individual is misclassified as a temporary employee or independent contractor, they may not automatically be entitled to certain benefits. Review the plan documents to make sure that they are have met the eligibility requirements even if appropriately classified.