Nearly every Washington State business will be faced with a choice between independent contractors versus employees when populating their workforce. Or, more precisely, businesses in Washington face a choice of whether they will classify their workers as independent contractors or employees.
With the ascent of the gig economy, there’s widespread belief that using independent contractors can simplify your business and save money. While some companies may reap those benefits, others may be seriously harmed by using contractors instead of employees, whether through diminished ability to control its contractor workforce or being penalized for misclassifying employees as contractors.
You need to understand the benefits and drawbacks of using independent contractors before you build out your workforce. The choices you make will have lasting consequences for your business.
What Is An Independent Contractor?
This is a loaded question without a particularly useful answer in the abstract. But generally speaking, an independent contractor is a self-employed worker that is usually retained by a client to perform a specific, limited task or set of tasks, and whose payment is based on completion of that task.
This is unlike an employee who is usually hired on an on-going basis to perform a variety of different tasks and who is paid based on increments of time. Employees and contractors further differ in that the employee is subject to oversight and control of how he/she does the job, whereas the contractor typically has the freedom to determine how the task is completed.
Related: Employee Offer Letters In Washington State
Consider attorneys as an example that illustrates this difference. If you’re a small business, you probably work with an attorney on discrete projects, like setting up an LLC or applying for trademark registration; however, you’re only one of many of that attorney’s other clients. In that setting, the lawyer is functioning like an independent contractor. But if you’re a very large company and have an in-house counsel who provides ongoing legal services only to your company, then the attorney is functioning like an employee.
Why Businesses Like Using Independent Contractors
Washington businesses, especially small ones, are often tempted to classify workers as independent contractors, rather than employees. They may be drawn to contractors for a number of reasons, but the most common reasons include the following:
- No employment tax obligations to the IRS or the Washington Department of Revenue (“DOR”).
- No requirement to pay minimum wage or overtime compensation.
- No requirement to provide benefits, like health insurance, 401K, or sick leave.
- No requirement to pay workers’ compensation premiums.
Independent contractors are considered to be self-employed, and so businesses that use independent contractors don’t have to pay employment taxes for their contractors. Instead, contractors are required to pay self-employment taxes. In addition to lowering a business’ tax obligation, using independent contractors reduces burdens imposed by administrative obligations, regulatory compliance, and benefit programs.
Note: The National Employment Law Project estimates that it costs around 30% less to use an independent contractor than to hire an employee. [source]
Why Classifying Workers As Independent Contractors Is Risky
As should be clear by now, one of the main reasons employers often want to use contractors is to avoid paying employment taxes. But, of course, both federal and Washington state agencies want to collect employment taxes from employers, as well as enforce employment law standards.
This creates an incentive for federal and Washington state agencies—like the IRS, the Department of Labor (“DOL”), and the DOR, just to name a few—to aggressively police the line between employees and contractors. And they have an arsenal of enforcement mechanisms at their disposal, including imposing payment obligations of the following:
- Unpaid employment taxes.
- Back pay, which may include overtime pay.
- The value of employee benefits.
- Civil (and, in rare circumstances, even criminal) penalties and interest for failing to pay workers’ compensation premiums or failing to file accurate unemployment tax reports.
If your small business gets audited and then hit with sizable back taxes, civil fines, or penalties, it could not only wipe out the original cost savings from using contractors, but effectively cripple your ability to make payroll and continue to operate.
So if your primary reason for classifying your workers as independent contractors is not because of how they function, but instead because you’d like to have lower costs, you need to consider whether you’re prepared to risk your business in exchange for the potential for cost savings. Because that’s what you’re doing.
What Qualifies Someone As An Independent Contractor?
Now that you know some of the benefits and risks of using independent contractors, let’s talk about how to determine whether a worker is properly classified as an independent contractor under federal and Washington state law.
What You Call Your Workers Doesn’t Matter
Simply calling a worker an “independent contractor” or “consultant” does not make it true. Even if it’s in a written contract. So don’t think you can just find a free independent contractor agreement, have your worker sign it, and then be excused from all obligations you’d have to an employee.
What you call your workers doesn’t determine their status as contractor or employee—it’s how you treat them. That means the IRS, the DOL, the DOR, and the rest of the investigating agencies will look at how you behave in relation to the worker, rather than taking your word (or the words in a contract) for it.
Different Agencies Use Different Tests
As you might imagine, how you behave in relation to a worker is a fact-specific and often complex question, which can be difficult even for experienced Washington employment attorneys to answer with certainty.
This complexity is compounded by the fact that different state and federal agencies use different tests for determining contractor status, meaning that a worker could be classified as an independent contractor under one test and an employee under another. A handful of the different tests are listed below:
- Federal courts and the DOL use the “economic realities test” for determining proper classification under the Fair Labor Standards Act.
- The IRS has its own test, which is based largely on control.
- Washington courts apply the Restatement of Agency test for common law claims.
- Washington courts apply the Department of Labor and Industries test for claims that fall under the Washington Industrial Insurance Act.
- Washington courts apply the Employment Security Department test for claims that fall under the Washington Employment Security Act.
Again, these tests are not straightforward to apply and they may lead to differing results. If you have doubts about your workers’ status as independent contractors, it’s important that you work with a Washington employment attorney.
The Concept Of “Control” Is A Guiding Principle, But Is Just A Starting Point
While there are an array of different tests, generally speaking, the more control you exercise over a worker, the more likely it is that worker is your employee.
Tip: The primacy of “control” is especially evident in the test used by the IRS, which focuses on behavioral control, financial control, and the relationship to determine proper classification.
For instance, if you require a worker to be in the office five days a week from 9-5 every day, you’re exercising considerable control over the worker’s behavior and so more likely have an employment relationship with that worker, though there are many other factors that would need to be considered.
If, on the other hand, you let the worker do the job in whatever way he or she wants and are only interested in getting a certain result, you’re exercising little control over the worker’s behavior and so you’re more likely dealing with an independent contractor, though, again, there are many other factors that would need to be considered.
Ultimately, the proper way to classify your workers turns on a variety of factors, as well as a variety of different tests, and so, to reiterate, it’s critical you work with a Washington employment attorney on proper classification.
Is It Better To Use Independent Contractors Or Employees In Washington?
When businesses ask this question, what they’re really asking is what kind of company should we be? It may sound cheesy, but it’s true. Let’s investigate.
If you want to be a company that has a tight-knit culture or a reputation for consistency or a program with great benefits, you’re looking at hiring employees. That’s because you need to exercise a high degree control of your workforce to create and maintain a certain type of culture or a certain way of doing things. You can only exercise this level of control over employees. If you try to do so with independent contractors, you’ll be in hot water very quickly.
If those things don’t concern you, and if you’re willing to give up control, then maybe independent contractors are right for you. Consider the example of Uber. While Uber has corporate employees, the bulk of its workforce—the drivers—are classified as independent contractors. Because Uber can't exert too much control over how its drivers perform, you the passenger never really know what kind of Uber experience you’ll get. It might involve a smooth ride in a new car with water bottles on offer, or it could involve a jerky ride in August with no air conditioning.
Uber may not be the best comparison for your company, but it’s useful for highlighting the difference in what kind of business you’re able to build using independent contractors versus employees.
Plenty of workers are, in fact, functioning like independent contractors and should be classified in that way. But if you have doubts about whether your workers will function like employees or a contractors, you should consider the existential threat to your business posed by the potential consequences for misclassification, rather than focusing on the short-term savings you could reap from using independent contractors. Above all else, you should work with an employment attorney to assess the risks and rewards of structuring your workforce with independent contractors or employees.