Are You Misclassifying Your Employees as Independent Contractors?

On October 13, 2010, former Governor Ed Rendell signed into law House Bill 400, establishing the Construction Workplace Misclassification Act (CWMA). This new law went into effect on February 10, 2011, and will have a dramatic impact on all construction companies utilizing independent contractors. For years a much-debated issue in Workers’ Compensation, employment, and tax law has been the treatment of workers as independent contractors. This new law will further shape whether workers are considered employees or independent contractors.

Generally, if a worker is an independent contractor, workers’ compensation benefits are not available for any injuries sustained on the job. The independent contractor must have his or her own insurance. The practical effect of this is that many employers would classify, or misclassify, their workers as independent contractors, when they were actually employees. By calling workers independent contractors, employers can avoid the cost of carrying expensive workers’ compensation benefits, and can be kept out of long and costly litigation over work injuries. This practice is especially prevalent in construction businesses, such as roofing and general contracting, where workers compensation insurance is prohibitively expensive, and injuries are often quite severe and debilitating.

For many years, the workers’ compensation courts have muddled by with a relatively vague test which basically came down to how much control an employer had over a worker to determine whether that worker was an employee or an independent contractor. However, under the CWMA, an individual who performs construction work may be considered and paid as an independent contractor only if:

• The individual has a written contract;

• The individual is free from control or direction over performance of such services, both under the contract and in fact; or

• The individual is customarily engaged in an independently established trade, occupation, profession, or business.

Thus, a written contract seems to be essential; however, this aspect alone certainly would not suffice. For years, many employers have simply written up Employment Agreements, which name employees as independent contractors. However, the addition of codified degrees of control over services and the addition of an “individual (who) is customarily engaged in an independently established trade,” certainly clarifies things even further. 

Before the CWMA, employers seeking to be free of the liability and costs of workers’ compensation insurance could attempt to do so by simply having each worker sign a contract labeling each worker as an independent contractor. However, under the new law there must be a definitive lack of control over a true independent contractor, and there would likely need to be a showing that this worker is not simply performing a task for the employer, but rather, that the worker performs this task independently as part of an established trade or business. Thus, a showing that the worker performs the same task for numerous employers would be an ideal way to meet the above requirement. 

With respect to the third criteria above, the CWMA states that an individual is customarily engaged in an independently established trade, occupation, profession, or business only if:

• The individual possesses his/her own tools;

• The individual's arrangement is such that he/she can realize a profit or suffer a loss as a result of the individual’s performance of services through a business in which the individual has a proprietary interest;

• The individual maintains a separate business location; or

• The individual previously worked as a bona fide independent contractor (as defined by the CWMA) or holds him/herself out to the public as a bona fide independent contractor.

These requirements basically codify the factors that workers’ comp lawyers have used for many years. When workers supply their own tools, the typical conclusion is that they are not just employees, but outside contractors, who clearly possess a skill and specialized knowledge that requires tools to perform that service. For example, an electrician who is hired by a contractor to wire a home and comes with his own tools to do so is clearly an independent contractor. However, an electrician who wires a home with tools provided by the contractor would certainly be more likely to be considered an employee.

The second requirement regarding profits or losses seems to indicate that while an employee gets paid for a job whether performed well or not, an independent contractor would be more likely to lose money on a poorly performed job, or conversely make more of a profit on a job performed well and under budget.

Under the CWMA, there are many hurdles to clear in order to establish that a worker should be classified as an independent contractor. The overwhelming majority of workers in the construction industry in Pennsylvania who are currently classified as independent contractors will now be considered employees. Further, the failure to withhold Federal or State income taxes or pay unemployment compensation contributions or workers compensation premiums will not be considered in determining whether an individual is an independent contractor. 

Under the CWMA, the consequences for misclassifying an individual as an independent contractor are severe. Administrative penalties may be up to $1,000.00 for the first violation, and up to $2,500.00 for each subsequent violation, and each misclassification of a worker is considered a separate offense. In addition, violations of the CWMA can lead to a "stop work" Order requiring the cessation of work by misclassified individuals within 24 hours, individual liability, and criminal sanctions. Thus, it is clear the Pennsylvania legislature means business, and plans to stomp out any abuse of the classification of workers as independent contractors to avoid the liability under the Workers’ Compensation Act. Questions about this new law and its impact on workers’ compensation or employments issues should be directed to competent counsel.