A Sustainable Workforce Starts With You

Employee vs. Independent Contractor – The Dangers of Misclassifying your Workforce

Running a business is no simple endeavor, and the challenges that are a part of navigating employment law, especially, seem to be endless. Whether you are hiring someone for the first time or the 50th time, one of the most important questions a construction company must answer about its workforce is whether they should be classified as employees, independent contractors, or subcontractors. If someone is an employee, they are entitled to minimum wage and overtime, and you also must keep proper payroll records and withhold the proper amount of taxes from their paycheck. These same requirements do not apply to someone who is an independent contractor. Failing to classify your workforce properly, neglecting to follow the FLSA (Fair Labor Standards Act), and overlooking your state or federal minimum wage and overtime laws can seriously affect your business. A mistake like that can cost you hundreds of thousands of dollars, or even worse, put you out of business. 


The Most Important Factors that Determine your Workers Classification

So, what is the difference between an employee and an independent contractor, and who decides? The tricky part is that what you label someone does not affect their proper classification. In addition, the person you are hiring cannot agree to be an independent contractor or a subcontractor when they actually should be classified as an employee. So, if the workers themselves and the company cannot decide their classification, then who can? Only the Law and Judges can determine if someone is an employee or an independent contractor by evaluating the following five factors:

  1. Degree of Control Exercised by Employer - How much control does the employer have? The more control, the more likely the person is an employee. Things that are often considered when determining the amount of control:  Who sets the work hours? Does the person work for other companies? Who sets the rate of pay?
  2. Permanency of Relationship - How long has the person been employed? The longer they have been employed, the more likely they are an employee.
  3. Skill and Initiative Required - How much skill and initiative is required? Does the position require an elevated level of training or education? Does the worker own their own company and do their own advertising? The higher level of training and the more initiative the worker does on their own, the more likely they are an independent contractor or subcontractor. If the employer provides the training, the more likely the worker is an employee.
  4. Relative Investment of Worker Compared to Employer - Who pays for overhead? If the worker provides their own tools and pay their own overhead expenses, they are more likely to be considered an independent contractor. If you reimburse the worker for their expenses and provide the tools, they are more likely to be considered an employee.
  5. Potential for Profit and Loss - What happens to the worker if the company makes or loses money? If the workers' pay stays the same regardless of an increase or decrease in the company's financial situation, the more likely the worker is an employee. If the worker's pay changes based on how the company does, they are more likely to be an independent contractor.

These are the most common and heaviest-weighted factors when determining when someone is an employee and entitled to all the benefits of being an employee or an independent contractor. The courts say each factor is weighted evenly in its decision, but the "control" factor often matters the most. The above analysis applies in Texas on both a State and Federal level. Texas does not have separate wage and overtime laws, so you only deal with Federal. However, some states do have laws you must obey in addition to the Federal laws. For example, a worker who may be deemed an independent contractor under the Federal laws may be deemed an employee under California's wage and overtime laws.


Employees – Who's Exempt from Overtime

Another common misconception is that if someone is a salaried employee, they are not entitled to overtime pay. That is not true; salaried employees are entitled to overtime pay unless they are exempt. The most common exemptions are listed below, but I caution you that you will need the help of a qualified attorney to truly determine if someone who works for you is truly exempt. The most common exemptions are:

  • Executive
  • Professional
  • Computer Employee
  • Highly Compensated Employee
  • Creative Professional
  • Administrative - It is important to note that your understanding of administrative may be different than the law's definition. In the Law's eyes, an administrator that is exempt would have full discretion in the day-to-day operations of their job. It is considered more of a managerial category for mid to upper management. For example, they can hire and fire employees. A receptionist or an assistant would not fall into the administrative category.


Consequences of Misclassifying your Workforce

What are the consequences for misclassifying an employee as an independent contractor or subcontractor? There are a lot of possible bad outcomes, but below is a list of the most common legal land minds you could hit:

  • Payroll and Federal tax violations
  • IRS audits
  • Department of Labor (DOL) investigation
  • Wage and overtime lawsuits
    • All your current and former employees being notified to make their claims in the wage and overtime lawsuit against you.
  • Being assessed interest and penalties
  • Paying tens of thousands of dollars to your attorney to handle your defense.


Real-Life Examples from Past Clients

One of my past clients had a disgruntled employee who called the US Department of Labor asking questions about paying them. Because of this call, the DOL (Department of Labor) decided to open a formal investigation into my client's business and found that about 20 employees had been paid incorrectly. The DOL then came up with a calculation for the amount each employee was owed and ordered my client to pay that amount. In addition, the DOL reached out to each employee, informing them of the money owed to them. The most annoying part was that, even if the employees never responded to the DOL or never went to pick up the money, the DOL still kept all the money.

In another case, one of my clients let each employee choose whether or not they wanted to be classified as an independent contractor or an employee. Most of the employees decided to be classified as independent contractors. One of these employees, let's call him Bob, ended up getting injured on the job and contacting a lawyer. That lawyer figured out that Bob was owed overtime and filed a lawsuit against my client. In addition, notice was sent out to over 50 of Bob's employees. Each employee was given the opportunity to join the lawsuit, putting my client at risk of a six-figure damage calculation and payout. 

I do not say these things to scare you; I just want you to realize the risk you are taking if you get the classification wrong. I never wanted to know so much about employment law, but I have been forced to learn it over the years. Some of the costliest lawsuits my firm has handled have been employment lawsuits. Trust me when I say it is 100% worth your limited and valuable time to figure out your employee classification properly and make sure your business is protected on the front end. 


About the Author:

Published author, award-winning lawyer, devoted wife and mother to three girls, and Owner and seasoned Managing Partner of The Cromeens Law Firm (TCLF), Karalynn Cromeens is a true jack of all trades. Karalynn is the Co-Founder of Morrell Masonry Supply and Owner of The Subcontractor Institute, an easy-access online educational platform for contractors. In addition to TCLF, and The Subcontractor Institute, she is also the Host of the rapidly growing educational construction podcast, Quit Getting Screwed - making cost-free industry insight available to contractors across the country. In 2021, Karalynn published two Amazon Best-Selling books - Quit Getting Screwed: Understanding and Negotiating the Subcontract and, in September, Quit Getting Stiffed: A Texas Contractor's Guide to Liens & Collections.  

In the seventeen years she has practiced construction, real estate, and business law, Karalynn has reviewed and explained thousands of subcontracts. For years, she has tried saving companies that have signed problematic subcontracts and lost out on being paid for their work. Unfortunately, it was too late by the time they came to her; she could do nothing to help. She hated seeing clients lose money—sometimes their entire business—over language they did not understand and laws they did not know about. Watching these situations play out day after day was the driving force behind her two books, The Subcontractor Institute, and the firm's accessibility efforts. Providing education to contractors on a national level has become Karalynn's personal mission, and she is always doing what she can to help make it a reality.