Is Your Independent Contractor Really an Employee? Take a Closer Look at the Rules
Independent contractor or employee? For an independent contractor, the company does not have to pay workers’ compensation or unemployment insurance premiums, withhold federal and state income taxes, or pay its share of employment taxes. So companies try to avoid classifying workers as employees and instead, make them fit as an independent contractor. But simply designating someone an independent contractor is not enough if you are treating them like an employee. And getting this classification wrong can lead to trouble. This blog discusses some of the rules around classifying workers under Colorado law.
For state law, classification as an independent contractor primarily affects whether you have to pay unemployment insurance premiums and workers’ compensation premiums for that individual. Under the Colorado Employment Security Act, as a general matter, an individual is an independent contractor if (1) “such individual is free from control and direction in the performance of the service, both under his contract for the performance of service and in fact,” and (2) “such individual is customarily engaged in an independent trade, occupation, profession, or business related to the service performed.”
Businesses must ensure that anyone classified as an independent contractor meets these requirements, both under any contract, and in reality. So how is this done in practice?
Meeting the Requirements in Contract: Ensure Your Independent Contractor Agreement Is Properly Drafted for the Presumption
If you are classifying an individual as an independent contractor, having a contract outlining your agreement is beneficial. First, it helps make your mutual promises clear. But more importantly, it can help you defend the classification in the event of a challenge. Under Colorado law, the presumption is that a worker is your employee. A company can shift that burden, however, if it has a proper contract. This does not guarantee that the government won’t come calling and challenge your classification. It just shifts the burden of proof for such a challenge so that the government has to prove you misclassified the person rather than you having to defend your actions.
But not any contract will do. Under the statute, in order to shift the burden, the written independent contractor agreement signed by both parties must contain (1) meet-the-statutory factors, which are essentially assurances that the company will not take certain actions; and (2) the required disclosure.
1. Meet the Statutory Factors.
First, the contract has to contain assurances that the company will not do the following:
- Require the individual to work exclusively for the person for whom services are performed, except that the individual may choose to work exclusively for the said person for a finite period of time specified in the document;
- Establish a quality standard for the individual, except that such person can provide plans and specifications regarding the work but cannot oversee the actual work or instruct the individual as to how the work will be performed;
- Pay a salary or hourly rate but rather a fixed or contract rate;
- Terminate the work during the contract period unless the individual violates the terms of the contract or fails to produce a result that meets the specifications of the contract;
- Provide more than minimal training for the individual;
- Provide tools or benefits to the individual, except that materials and equipment may be supplied;
- Dictate the time of performance, except that a completion schedule and a range of mutually agreeable work hours may be established;
- Pay the individual personally but rather make checks payable to the trade or business name of the individual; and
- Combine his business operations in any way with the individual's business, but instead maintains such operations as separate and distinct.
2. Contain the Required Disclosure.
In addition to including the statutory factors, the contract must contain a required disclosure. The disclosure must state “that the independent contractor is not entitled to unemployment insurance benefits unless unemployment compensation coverage is provided by the independent contractor or some other entity, and that the independent contractor is obligated to pay federal and state income tax on any moneys paid pursuant to the contract relationship.” It must also be in larger type than the rest of the contract or in bold or underlined.
What Is the Reality?
Meeting the statutory standards will get you the presumption that the person is an independent contractor. And if you don’t meet all the statutory standards, you can still argue that the person is an independent contractor, but the burden of proof is now on you. Either way, a lawyer can help you draft such a contract, but in the end, it will only do so much good if the contractual provisions do not match up with reality. That is because having a contract that outlines these requirements is not sufficient if the actual working relationship does not follow suit. So, it is also important to make sure your actual working relationship with an individual in fact meets the standard for an independent contractor under Colorado law.
Meeting the Requirements in Fact: Ensure You Have Properly Classified the Worker in the First Instance
A good first step to check proper classification is to review the statutory factors listed above and see where your working relationship falls. These factors are important distinctions between employees and independent contractors. They will be considered in the event of a challenge. But so too will other factors. For example, things like whether the independent contractor has his own business cards or business phone number might also be relevant. The Court or Division will look at the totality of the circumstances. If the nature of your company’s working relationship with an individual looks more like an employee-employer relationship, chances are, it probably is.
Another option available to employers seeking guidance on whether an individual is an employee or independent contractor is an Advisory Opinion from the Colorado Unemployment Insurance Employer Services, Audits. You will be required to submit a form with information, along with $100, and the Division will provide you with guidance on how to classify a worker. This can be helpful to put any close questions to rest. The link to the form is available here.
Potential Penalties for Misclassifying an Employee as an Independent Contractor Can Be Steep
While it may be tempting to label a worker as an independent contractor to avoid the expenses associated with having an employee, misclassification can lead to serious consequences and cost in the long run. The Division may charge you penalties for not paying unemployment compensation insurance premiums for the employees. You may need to get legal counsel to challenge these findings, and the administrative review process has multiple levels. An audit may occur, which is both stressful and disruptive to the business. And this is just what could happen with the state. Misclassification can also have federal tax implications, and getting tangled with the IRS is never a good thing. Federal rules are distinct (though similar), so it is important to consider those as well when making a determination. Avoid these issues by being honest with yourself about the nature of your working relationship with an individual and take steps to ensure proper classification.
1 § 8-70-115(1)(b), C.R.S. 2017.
2See § 8-70-115(1)(c), (d).
3 § 8-70-115(1)(c)(I)-(IX).
4 § 8-70-115(1)(d); see also Independent Contractors, Colorado Department of Labor and Employment (2017), https://www.colorado.gov/pacific/cdle/independent-contractors.
5See ICAO v. Softrock Geological Servs., Inc., 2014 CO 30 (statutory factors for contract are not the only factors that should be considered when determining whether an individual is an independent contractor).
Because of the generality of the information on this site, it may not apply to a given place, time, or set of facts. It is not intended to be legal advice, and should not be acted upon without specific legal advice based on particular situations