You might call them independent contractors, but are they employees instead? For employers and workers alike, misclassification of workers has important state and federal consequences. As the U.S. Department of Labor points out, misclassified employees can lose benefits and protections such as family and medical leave, overtime pay, minimum wage and unemployment insurance. Further, such misclassifications reduce payments to the U.S. Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers compensation funds.

Colorado has entered into a Memorandum of Understanding with the Labor Department regarding joint efforts to cut down on worker misclassifications. Nearly three years into this memorandum, the intent is to enable the Labor Department to share information with the Colorado Department of Labor and Employment and coordinate enforcement efforts in order to help compliant employers compete fairly with noncompliant ones, and to ensure that employees receive the protections to which they are entitled under federal and state law.

In Colorado, the guidelines for whether or not a person should be deemed an employee are built around a two-part test. First, an individual will be considered an employee unless he or she is free from control and direction in the performance of the service, both under the contract for performance of service and in fact. Second, before an individual may be considered an independent contractor it must be shown that he or she is customarily engaged in an independent trade, occupation, profession or business related to the service performed. By itself, a written contract that calls a person an independent contractor is not determinative of the actual relationship in the eyes of the federal and state labor departments.

The Colorado Supreme Court decided two cases this year addressing this issue. In those cases, the court held that “determining whether an individual is an employee requires an expansive inquiry into the dynamics of the relationship between the putative employee and the employer” and stated that courts in Colorado must apply “a totality of the circumstances test…”

In other words, decisions must be made on a case-by-case basis, and many factors must be considered in deciding whether the employer exercises sufficient control and direction over a worker for that individual to be considered an employee instead of an independent contractor.

The Internal Revenue Service evaluates three broad categories of evidence regarding the degree of control or independence to determine whether a person is an employee or an independent contractor:

Degree of behavioral control. This includes the type and extent of instructions given, the system in place for evaluating the work (evaluation of final product only versus step-by-step evaluation throughout the process), and the amount of training, if any, provided to the worker by the putative employer. More control by the putative employer makes it more likely that a worker will be deemed an employee.

Degree of financial control. This includes the investment the worker makes in the tools necessary to complete the work, reimbursement of the worker’s expenses, the worker’s risk of loss or potential for profit, the worker’s availability to other potential clients in the market, and the method by which the worker is paid. If a putative employer buys the tools, reimburses the worker’s expenses, keeps the worker from working for others, and pays the worker on a regular hourly or weekly basis, such considerations would suggest the worker is an employee instead of an independent contractor.

Type of relationship. This includes the existence (or not) of a written contract, the degree of employee benefits provided, the permanency of the relationship and the extent to which the services provided by the worker are an ongoing key activity of the business.

Businesses and workers alike must understand that a broad review of the factual realities of their working relationships will determine whether workers are considered employees or independent contractors, and a written “independent contractor” agreement, by itself, will not be determinative. Making the wrong decision about how a worker is classified can lead to considerable headaches, not to mention financial liabilities, in the future, so you should take precautions to avoid costly misclassifications.

Daniel W. Jones, an attorney for Coan, Payton & Payne LLC at the Greeley office, can be reached at djones@cp2law.com or 970-339-3500.