How to Properly Classify Independent Contractors and Employees in Washington

Published on October 5, 2016

It is a common mistake for employers to misclassify individuals as independent contractors instead of employees. Determining whether someone should be classified as an independent contractor or as an employee is a legal minefield because different laws apply in different contexts. Multiple state agencies audit employers to uncover misclassifications and each agency applies a different test in making its determination. Regardless of the test applied, the presumption is in favor of finding that individuals are employees and not independent contractors.

Whether a worker is classified as an employee or independent contractor is subject to increasing scrutiny in Washington State and around the country. When misclassifications are discovered, the employer faces stiff penalties and liability. For example, the employer must pay back taxes, back wages, insurance premiums, penalties, and interest for all misclassified workers. Therefore, it is essential to examine each independent contractor relationship to determine whether it should instead be classified as an employee relationship so that the employer can avoid potentially significant liability.

One test for independent contractors is in Washington’s Industrial Insurance Act, which is enforced by the Department of Labor and Industries. Generally, individuals may be exempt from being considered employees if they meet all of the following six criteria:

1. The individual must be free from direction and control;
2. The service is either outside the usual course of business for which the service is performed, or the service is performed outside all of the places of business of the enterprise for which the service is performed, or the individual is responsible for the costs of the principal place of business from which the service is performed;
3. The individual is customarily engaged in an independently established trade, occupation, profession, or business, of the same nature as that involved in the contract of service, or the individual has a principal place of business for the business the individual is conducting that is eligible for a business deduction for federal income tax purposes;
4. The individual is required under IRS rules to file a business tax return with the IRS;
5. The individual has an active account and unified business identifier number (UBI) with the Department of Revenue; and
6. The individual maintains their own separate books and records showing business income and expenses of the business.

Washington’s Employment Security Department enforces the Employment Security Act and uses two alternative tests to determine whether someone is an independent contractor or an employee. The first test is:

1. Whether the individual is free from direction or control over performance of the service under the contract and in practice;
2. Such service is either outside the usual course of business for which such service is performed, or such service is performed outside of all the places of business of the enterprises for which such service is performed; and
3. The individual is customarily engaged in an independently established trade, occupation, profession, or business, of the same nature as that involved in the contract of service.

The second test is:

1. Whether the individual is free from direction or control over performance of the service under the contract and in fact;
2. Such service is either outside the usual course of business for which such service is performed, or such service is performed outside of all the places of business of the enterprises for which such service is performed, or the individual is responsible under contract and fact for the costs of the principal place of business from which the service is performed;
3. The individual is customarily engaged in an independently established trade, occupation, profession, or business, of the same nature as that involved in the contract of service, or such individual has a principal place of business for the work the individual is conducting that is eligible for a business deduction for federal income tax purposes;
4.  The individual is responsible for filing a schedule of expenses with the internal revenue service for the type of business the individual is conducting;
5. The individual has an account with the department of revenue and has registered for and received a UBI number; and
6. The individual maintains their own separate books and records showing business income and expenses of the business.

A third test was adopted by the Washington Supreme Court in July 2012 when considering Washington’s Minimum Wage Act. The test considers whether the alleged employee is, as a matter of economic reality, dependent on the business to which he or she renders the service. The factors are:

1. The permanence of the working relationship between the parties;
2. The degree of skill the work entails;
3. The extent of the worker’s investment in equipment or materials;
4. The worker’s opportunity for profit or loss;
5. The degree of the alleged employer’s control over the worker; and
6. Whether the service the worker performs is an integral part of the employer’s business.

As seen from these various tests, there is no single factor that controls whether an individual is an employee or an independent contractor. The multitude of tests leads to confusion for employers and may result in conflicting results and additional liability. For example, employers can be found to have properly classified an independent contractor for purposes of the Employment Security Act and to have misclassified that same individual for purposes of the Minimum Wage Act. To avoid liability for misclassification, employers should have written contracts with their independent contractors identifying that the independent contractors:

• are free from direction/control,
• have their own UBI numbers,
• keep their own books and records,
• are responsible for and pay for their own taxes,
• bear their own costs and expenses,
• perform tasks outside the company’s typical operations (such as a company hiring a graphic designer for its website),
• provide their own tools and materials, and
• are limiting the job to a fixed project instead of an ongoing relationship, among other factors.

The parties must follow these contracts in practice.

Employers should consider the factors in the tests above for every independent contractor relationship. Due to the complexity of the laws, employers are advised to seek legal counsel when classifying an individual as an independent contractor and when facing an audit over classification.

If you find yourself in a questionable situation, please consider contacting any member of Ryan, Swanson & Cleveland, PLLC’s Employment Rights, Benefits and Labor Group.

Britenae Pierce is a member in Ryan, Swanson & Cleveland, PLLC’s Employment Rights, Benefits and Labor Group and can be reached at 206.654.2289 or [email protected].