When you hire contract labor for your business, you must ensure that you are not misclassifying an employee for the tax and reporting benefits – if you do, you may have unexpected expenses when the government requires you to pay back taxes and penalties.
In this article, we will review the basics of independent contractor law in Texas, including:
- The difference between an independent contractor and an employee in Texas and according to the IRS,
- The benefits of classifying a worker as an independent contractor, and
- The tests used by the Texas Workforce Commission (TWC) and the IRS to determine whether a worker is a regular employee or an independent contractor.
What’s the Difference Between an Independent Contractor and an Employee in Texas?
There are many reasons why a Texas business would want to classify a worker as an “independent contractor,” but just calling it “contract labor” is not enough to get you there.
What is the legal difference between an independent contractor and an employee of a business, and why does it matter?
An independent contractor is self-employed (or a business separate from the business that has retained its services). They are responsible for their own taxes and their own expenses, and, more importantly, they are not under the control and direction of the business or businesses to whom they provide services.
An employee is directly employed by the business – the business has the responsibility for reporting their wages and paying their taxes, and, more importantly, the business controls and directs the employee’s actions as they perform work.
These are not the only factors that determine whether a worker will be considered an employee or an independent contractor, though – see below for a more detailed analysis of the tests used by the Texas Workforce Commission (TWC) and the federal government.
Why does it matter?
There are many reasons why it matters to a business whether a worker is classified as an employee, including simplifying the employment relationship, tax reporting requirements, and determining whether a worker is entitled to unemployment or workers’ compensation benefits.
Simplifying your Business Model
Classifying a worker as an independent contractor simplifies matters for your business. For example:
- An independent contractor does not require training and supervision to complete the tasks they are assigned,
- An independent contractor should provide their own equipment and resources to get the job done, so your business does not have to spend funds on tools that will be used once or infrequently,
- Independent contractors are not entitled to the benefits that must be offered to regular employees, including unemployment insurance and workers’ compensation insurance,
- The use of independent contractors simplifies your business’ accounting because your business is not responsible for tax withholdings or payroll for the contractor, and
- When the agreed-upon services are completed, your business can terminate the business relationship with the independent contractor with no strings attached.
Tax Reporting Requirements for Independent Contractors
If an individual who provides services to a business is an employee of that business, there are federal and state reporting and withholding requirements, and, if the business does not comply, they will be required to pay employment taxes and potential penalties at the end of the year.
The reporting and withholding requirements include:
- Income taxes,
- FICA (Social Security and Medicare), and
- Unemployment taxes.
A business has additional obligations to its employees, including compliance with employment laws like the Family and Medical Leave Act, the Fair Labor Standards Act, and the Worker Adjustment and Retraining Act, and there are penalties (and the potential for lawsuits) when the business does not comply with the requirements of federal or state employment laws.
Unemployment and Workers’ Compensation Benefits
If an employee is injured on the job, in many cases the employer is required to compensate their employee through their workers’ compensation insurance – sometimes temporarily, and sometimes for permanent disabilities caused by the employee’s injury.
When an employee is terminated from their job position, they may be entitled to unemployment benefits as well. An independent contractor, however, cannot collect benefits from your business for workers’ compensation or unemployment – they are required to cover these expenses for themselves.
What is the Test to Determine Whether a Worker is an Employee or an Independent Contractor?
Because of the substantial benefits of classifying a worker as an independent contractor instead of a regular employee, many businesses will take care to refer to a worker as “contract labor.”
Just calling someone an independent contractor is not enough, though – not even if the employee agrees and consents to perform work as an independent contractor for reporting purposes.
The TWC and the IRS each have separate tests for determining whether a worker is an independent contractor or an employee that your business should be paying taxes for, and they will impose penalties when an audit finds that a company has misclassified employees as independent contractors.
The Texas Workforce Commission’s (TWC) Test
The Texas Workforce Commission (TWC) uses the 20-factor common law test to determine whether a worker is an employee. Not all of the factors will apply in every case, and the weight given to each factor can change depending on the facts of the case.
The bottom line is if the “purchaser of that workers’ service has the right to direct or control the worker, both as to the final results and as to the details of when, where, and how the work is done,” the worker is an employee, regardless of what the employer calls them.
|Is given instructions on when, where, and how the work is to be done.||Completes the work on their own with minimal instruction as to the details or methods of completing the work.|
|Employees are often trained by their employer, required to attend meetings, and may be required to complete training courses.||Does not typically receive training from the purchaser of their services.|
|The employee’s services are integrated into the company’s overall operations.||Services are separate from their client’s operations.|
|Employee’s services are rendered personally – they do not hire their own employees or delegate work to others.||Is not required to render services personally and can assign others to do the work for them.|
|Helpers are paid by the employer, although an employee can act as supervisor or foreman.||Helpers are retained, paid, and supervised by the independent contractor.|
|Employees are expected to continue employment over a long period of time.||Independent contractors are hired for a specific job and there is no expectation that they will continue employment once that job is completed.|
|Employees work the hours set by their employer.||Independent contractors set their own hours.|
|An employee typically either works full-time for the employer or devotes a substantial part of their time to the company.||An independent contractor does not work exclusively for one employer.|
|The location of services provided by an employee is determined by their employer, whether that is remote work, work in an office setting, or work in the field.||Independent contractors choose where they will complete the work, and it is not necessarily on the business’ premises.|
|Employees perform work in the order prescribed by their employer.||Independent contractors are ordinarily concerned only with the finished product and the client does not tell them how the order in which the work should be completed.|
|Employees may be required to submit regular reports about work they are completing.||Are not typically required to submit regular reports about the work they are completing.|
|Employees are ordinarily paid regular amounts at regular intervals, whether they are hourly employees or salaried employees.||Independent contractors are usually paid by the job.|
|Business and travel expenses are usually covered by the employer.||Independent contractors cover their own business and travel expenses without reimbursement by their clients.|
|Employers typically provide the tools and equipment needed for an employee to complete their job duties.||Furnish their own tools and equipment that they need to complete the job.|
|Employees do not ordinarily invest in the company they work for – they are economically dependent on their employer.||Independent contractors will ordinarily invest in their own business.|
|An employee’s income is not determined by the company’s profit or loss – they are paid wages or salary based on the work they provide.||An independent contractor is responsible for managing their own income and expenses and therefore is directly impacted by profits or losses.|
|Employees usually work for one employer, and they can be prohibited from working for competitors.||Works for multiple clients and can provide services to competitors.|
|Employees’ services are not available to the public.||Independent contractors make their services available to the public, market their services, and hold a separate business license.|
|An employer can terminate an employee’s services at will (assuming there is no discrimination or violation of state or federal employment laws).||If the employer terminates an independent contractor’s services, the contractor may have legal recourse through an action for breach of contract.|
|An employee can quit their job at any time and for any reason.||If an independent contractor quits before fulfilling the terms of the contract, the employer may have legal recourse through an action for breach of contract.|
The Internal Revenue Service’s (IRS) Test
Although the IRS previously used the 20-factor common law test outlined above, they have “simplified” their test by reducing it to 11 factors grouped into three broad categories:
- Instructions given to the worker as to when, where, and how to complete the work, and
- Whether the employer provides training to the worker.
- Unreimbursed financial expenses will favor independent contractor status,
- The extent to which the worker invests in the business,
- Whether the worker makes their services available to the public,
- How the worker is paid (hourly, weekly, or by the job), and
- The extent to which the worker realizes profits and losses based on income and expenses.
Type of Relationship:
- The details of written contracts between the parties,
- Whether the business provides employee benefits to the worker,
- The permanency of the relationship, and
- The extent to which the services provided are integrated into the company’s regular business operations.
If your company provides services in other states or countries, it can complicate the analysis even further – different jurisdictions may have variations of the test for determining whether a worker is an independent contractor, and there may be filing requirements to designate a worker as an independent contractor in some jurisdictions.
If you intend a worker to be classified as an independent contractor, you should 1) consult your business’s attorney to ensure you are not penalized for misclassifying an employee, and 2) use the above factors as a checklist to ensure that the business relationship is that of an independent contractor to ensure the TWC and IRS do not accuse you of misclassifying employees.
Please feel free to contact one of our Murray Lobb attorneys to obtain our legal advice regarding the classification of independent contractors vs. employees. We also remain available to help you with all your general construction law, business, corporate, and estate planning needs.