The employee/independent contractor misclassification question above was asked as part of a Q&A in a nationally published guide to Texas employment laws and rules. The answer was “Generally, no.” from a labor and employment law firm with several Texas offices. That question has arisen many times from health care providers and businesses in my practice so I will respond to the question in the title of this blog article with the answer “Yes” and explain the role of the Texas state agencies in misclassification.
Misclassification occurs when an employer incorrectly identifies a worker as an independent contractor rather than as an employee. Under Texas law, an independent contractor means a person who contracts to perform work or provide a service for the benefit of another and who ordinarily:
- Acts as the employer of any employees of the contractor by paying wages, directing activities and performing other similar functions characteristic of an employer-employee relationship;
- Is free to determine the manner in which the work or service is performed including the hours of labor of or method of payment to any employee;
- Is required to furnish or have his employees, if any, furnish necessary tools, supplies or materials to perform the work or the service; and
- Possesses the skills required for the specific work or service. (Texas Labor Code, Sec. 406.121(2))
An employee means each person in the service of another under a contract of hire, whether express or implied, or oral or written. (Texas Labor Code, Sec. 401.012)
The Texas Labor Code (“Code”) contains sections on wages and unemployment compensation taxes. The Texas Workforce Commission (TWC) administers the Code’s sections on wages and unemployment compensation and is a taxing authority. TWC’s responsibilities include: (a) imposing the state unemployment tax on employers of Texas employees; (b) keeping track of all wages paid, reports submitted and taxes paid by employers; and (c) determining the individual employer’s tax rates. TWC remits the taxes to the Texas unemployment insurance trust fund that is used to pay unemployment benefits to eligible claimants.
TWC audits selected employers’ tax accounts to determine their compliance with the wage reporting and unemployment tax laws. On unreported wages and unpaid taxes, TWC may impose interest and penalties, file notice of assessment and liens, freeze bank accounts, force an employer to pay a bond in order to continue employing workers in Texas, file an injunction, and/or place an employer in receivership.
A TWC tax audit may begin because an employer is misclassifying its workers. Such an audit may involve the entire workforce. The audit involves review of an employer’s payroll records to discover misclassified workers whose wages should have been reported and taxed. If it discovers that workers were misclassified or that taxes were unpaid, TWC will inform the Internal Revenue Service (IRS) which may lead to an IRS audit. Recently, several Texas licensed professional counselor (LPC) groups were audited by TWC and assessed taxes, interest and penalties for misclassifying LPC interns (LPC-I) as independent contractors.
In 1998, TWC adopted a 20-factor official guideline for determining worker classification for unemployment tax purposes. An independent contractor is a person whose services do not meet TWC’s guideline’s factors. The TWC guideline is similar to the IRS 20-factor test for misclassification (the IRS replaced the 20-factor test with an 11-factor test organized into three main groupings of behavioral control, financial control and type of relationship). The TWC 20-factor guideline follows the common law direction and control test:
…a worker is an employee if the purchaser of that worker’s 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. Control need not actually be exercised; rather, if the service recipient has the right to control, employment may be shown.
TWC Form C-8, Employment Status – A Comparative Approach, contains the TWC 20-factor guideline for employment classification. Form C-8 is available on the Internet in PDF format at http://www.texasworkforce.org/ui/tax/forms/c8.pdf. A copy in printed form may be obtained from TWC, Tax Department, 101 E. 15th Street, Austin, Texas 78778. Form C-8 states:
Depending upon the type of business and the services performed, not all of the twenty common law factors may apply. In addition, the weight assigned to a specific factor may vary depending upon the facts of the case.
If an employment relationship exists, it does not matter that the employee is called something different, such as: agent, contract labor, subcontractor or independent contractor.
TWC takes the position that the agency is not bound by any particular ruling that the IRS makes under federal law. TWC follows the Code regardless of any IRS safe harbor for misclassification.
Since we are discussing independent contractors in Texas, it is important that you know about “new hire reporting” in Texas. Under the State Directory of New Hires Act, Texas Family Code, Sections 234.101 – 234.104, Texas employers must report all new hires and rehired employees within 20 calendar days of their first day of work to the Texas Attorney General Child Support Division. Employers that knowingly fail to report new hires are liable for a $25 penalty per unreported employee, and a penalty of $500 for conspiring with a newly hired employee to fail to make such report. The reports are used primarily for tracking parents who owe back child support and for reducing fraud under various social programs, including unemployment benefits. TWC conducts a cross-match of its wage reports with the new hire database of the Child Support Division. If an employer is found to have misclassified a new hire as a non-employee and failed to report the new hire, the $25 penalty applies. Texas Family Code, Sec. 234.101(1) defines “employee” to include independent contractors for new hire reporting purposes.
TWC and the U. S. Department of Labor have a memorandum of understanding to address misclassification and its adverse effects on federal and Texas unemployment benefit programs, minimum wage, overtime compensation, family and medical leave and safe workplaces.
There are complex and doubtful cases involving classification of workers as employees or independent contractors. Always consult a knowledgeable attorney for advice in these matters.