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Employees vs. Independent Contractors

choice of working as freelancer versus employee

Business owners looking to save money and overhead costs often wish to classify as many workers as possible as independent contractors. Unlike employees, independent contractors are not protected by overtime laws, they are not guaranteed certain benefits, they require less training and supervision, etc. However, employers are not free to characterize workers as either employees or independent contractors as they please. There are specific rules governing whether a worker qualifies as an employee or an independent contractor, and an employer can incur significant penalties for misclassification. Read on for a discussion of employers and independent contractors under Texas law, and reach out to a seasoned Houston business law attorney with additional questions or for help with a Texas business law or real estate matter.

Determining if a Worker is an Employee or Independent Contractor

The definition of an “employee” as opposed to an “independent contractor” can be somewhat nebulous. According to the Texas Workforce Commission (TWC), an employee is anyone who performs service that can be classified as “employment.” Employment, in turn, means:

[A] service performed by an individual for wages under an express or implied contract for hire, unless it is shown to the satisfaction of the Commission that the individual’s performance of the service has been and will continue to be free from control or direction under the contract.

The essential elements to employment are service, wages, direction, and control. Even if an employer does not actually exercise direction and control over a worker, if they reserve the power to do so should they so choose, then they might satisfy the direction and control prong.

Under the federal Fair Labor Standards Act (FLSA), courts utilize an “economic reality” test to evaluate whether a worker is an employee under federal law. Several factors play into whether a worker is an employee, including:

  • The extent to which the services rendered are an integral part of the principal’s business.
  • The permanency of the relationship.
  • The amount of the alleged contractor’s investment in facilities and equipment.
  • The nature and degree of control by the principal.
  • The alleged contractor’s opportunities for profit and loss.
  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  • The degree of independent business organization and operation.

It is not up to either the employer or indeed the employee to decide whether a worker is an employee or an independent contractor. The question is only whether the worker satisfies the statutory definition of “employee.” Employees cannot, for example, agree with employers to be classified as independent contractors when they otherwise fit the definition of an employee.

Dangers of Worker Misclassification

Misclassifying employees as independent contractors can prove to be a costly mistake. Employers may be subject to wage & hour claims from workers misclassified and denied benefits. Workers denied the benefits they are owed under federal and/or state law can sue employers and seek back pay for, for example:

  • Unpaid overtime
  • Minimum wage violations
  • Unpaid meals and rest breaks
  • Additional penalties for knowing and willful violations

Additionally, state and federal taxes on businesses depend, in part, on payments made to employees. Misclassifying workers as independent contractors means misreporting information to the state government and to the Internal Revenue Service (IRS), which is never a wise proposition. For example, the IRS requires employers to withhold contributions to the Federal Insurance Contributions Act (payments for Social Security and Medicare) and income taxes for employees. If an employer fails to properly classify an employee, that means they are not withholding the appropriate taxes payable to the IRS. They may be liable to the IRS for those taxes as well as additional penalties. Likewise, under Texas law, employers are required to pay unemployment taxes based on employees, not independent contractors; employers who misclassify employees may be subject to back taxes, fines, increased taxes, and interest charges.

If you need legal assistance with a Texas business law matter, contact the seasoned and talented Texas business lawyer Leigh Meineke at the Houston offices of Stephens | Domnitz | Meineke PLLC by calling 832-706-0244.

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