The Arizona Worker Classification Explained
Employers in Arizona should be familiar with the legal distinction between employees and independent contractors. The basic legal distinction is that employees work under the control of employers, while independent contractors are not controlled by others in their work duties. Arizona follows the economic realities test for independent contractors. In determining whether your worker is an independent contractor, Arizona courts look to the intention of the parties and the right of control over the employee. The Arizona Supreme Court developed the core test for independent contractors in Arizona in AMP Am. v. Industrial Comm’n of Arizona . AMP Am developed an 11-point test that has since been truncated by subsequent cases. Although AMP Am did not use the term "independent contractor," the test is used extensively in lawsuits when the issue of worker classification is raised. The AMP Am test (as subsequently trimmed) focuses mainly on: A worksheet based upon the AMP Am test is available on http://www.azag.gov/civil_rights/violations/worker_class.html. As the worksheet indicates, this test is not a rigid set of factors for a court to weigh. Rather, the test merely provides some guidance on how Arizona courts have determined whether an entity may be liable for the acts of its alleged independent contractors.
Arizona’s Legal Definition of an Independent Contractor
According to Arizona Revised Statutes § 23-902, the legal definition of an independent contractor (IC) is limited to its usage for unemployment compensation, not for does the term apply to other applications of Arizona law. However, for the purposes of unemployment compensation, a person who performs services for an employer under an agreement with respect to the hiring of the person is considered an employee unless the individual performing the service is free from control or direction over the performance of the services. This means that if you have contracted with someone to perform a service for your business, but you maintain some control over his or her work, that person may actually be an employee, and not an independent contractor.
Under Arizona’s unemployment compensation statute, the burden of proof is on the "putative employer"—the party that claims an individual is an independent contractor—to prove that the person is, indeed, an IC. The statute spells out a six-factor test for proving such, which include examination of whether the worker is or is not able to work for others at the same time that he or she is working with the alleged employer.
It is essential that anyone who classifies workers as independent contractors or employees have a thorough understanding of what constitutes each. Although the burden of proof is on the client to distinguish them from one another, it is still the responsibility of the business that hires them to do its due diligence in determining the proper classification. If the client fails to take such steps, he or she could face reassessment of workers that had been classified as ICs, as well as be liable for back taxes, penalties and interest that the employers are responsible for.
The Arizona ABC Test for Independent Contractors
The ABC Test is a common legal test for determining independent contractor status. In Arizona, the test is a key factor in distinguishing between covered and non-covered workers under Arizona’s §23-901(5)(a). Under the test, an individual is an independent contractor only if they satisfy all three components.
The employer must not control or direct the individual in connection with the performance of the service, both under the contract of services and in fact. Arizona courts have stated that if the employer has the right to control the means and manner of the work done by the worker, then the courts will find that the individual who performed the service is not an independent contractor.
The service is either outside the usual course of business for the business of the employer or, if within that course of business, performed outside of all the places of business of the employer. While the statute does not provide any guidance or additional explanation, courts have interpreted the term "usual course of business" to mean what the business is engaged in as its primary purpose and is not satisfied merely because the contract in question is one of an incidental nature to the business.
The individual is engaged in an independently established trade, occupation, profession or business. The term "independently established" is defined as being done for pecuniary gain by a person who holds him or herself out to be in business for himself or herself, and is customarily engaged in that business. Customarily engaged signifies a continuous or recurring activity for which the individual is or intends to be paid.
Common Misclassification Issues and Solutions
One common mistake relates to the level of control that an employer is allowed to exert over a worker. The more control one has over how the worker is paid, when the worker is paid, how the work is actually done, and so forth, the more likely it is that worker is actually an employee and not an independent contractor. Consider, for instance, the following scenario: a ditch digging company hires someone to dig ditches and fills out a W-9 form for the company’s tax records. The company tells the worker when to work, where to work, what tools to use, and refuses to allow the ditch digging person to have a side job. Can such a worker really be called an independent contractor? Arizona courts have been clear – no.
Another frequent mistake is to hire someone as a free lance worker to generate sales and then tell that worker not to hire his own sales team without permission. An independent contractor would have a team of workers and would not be required to submit to the will of the employer about such things.
Legal consequences of misclassification can be severe. As discussed in another portion of this site, such misclassification can result in serious fines and consequences from DOL, the IRS and for unemployment insurance tax. If those agencies find that an employer has misclassified workers, they can impose tax and penalties up to two years’ worth of taxes owed, back taxes and interest, and fines per worker and per tax period. These liabilities can add up very quickly, and sort of a "death of a thousand cuts" approach to a problem may not be the best strategy for a company that improperly classifies workers.
Financial consequences can also be severe. One consequence is tax fraud. When a company fails to pay employment taxes on money it pays to someone else, that amount of money essentially becomes taxable income to that worker. If DOL discovers this, it can impose all of the taxes that would have been due in that situation. The IRS may also impose penalties for fraud. It can be particularly devastating because the worker now faces hundreds of thousands of dollars of tax obligations and may not be aware that additional tax liability belongs to the employer.
Rights and Protections for Independent Contractors
Employment laws in Arizona offer independent contractors a surprising amount of protections. Legislation passed over the last couple of decades has established wage, health and safety, and other protections for independent contractors.
In terms of worker’s compensation, unless you have a good reason or your independent contractor has agreed to be self-insured, your business must carry worker’s compensation insurance. Contractors are not excluded from OSHA regulations, either. Safety standards must be followed on any jobsite, including an independent contractor jobsite. Arizona law also protects contracting wages . As long as you’re living up to your obligations under the law, including making timely payments for services rendered, your contractor should have no need to file complaints related to contract payments.
Arizona prohibits discrimination against independent contractors. If a company is in a position to hire employees but chooses to hire contractors, it would be improper to discriminate on that basis. If an employer routinely hires for the same positions as contractors, it would be risky for the company in a hiring or furlough situation to terminate those contracts based on race, gender, age or national origin. It can be a slippery slope, however, because it would be very tempting to fill relevant vacancies with independent contractors instead of paying to maintain full-time employees on the payroll.
Steps to Compliance with Arizona Laws
To ensure that your business is in compliance with Arizona’s independent contractor laws, it is helpful to meet the following criteria:
Maintain Records: Even if you have a clear agreement in contract form, Arizona law requires businesses to maintain sufficient employment records. To this end, in order to be classified as an independent contractor, the worker must:
Have a Contract: An independent contractor agreement that lays out the nature of the relationship and the duties and obligations of the parties will also go a long way toward ensuring compliance. This will limit confusion and provide a clear record of what the relationship entails. Such an agreement should include the following:
Retain Control: The best way to avoid confusion about the existence of an employment relationship is to maintain more control over the work to be performed by your independent contractor. (Conveniently, this is also why independent contractors are often preferred to temporary or private employees – they require less oversight.) Although businesses must allow independent contractors to exercise some degree of control over how the work is performed, you should still avoid providing significant oversight and maintaining day-to-day control. Likewise, the work materials and tools should be provided by the contractor and not the employer, and the employer should avoid making remuneration contingent on the work produced rather than the time spent performing the work.
In the unfortunate event that your business has engaged in misclassification, Arizona law recommends holding a formal "conferencing" between the employer and the Department of Economic Security, Administration and Enforcement (DESAAE) during which the agency will help to bring your business into compliance. Repeated violators of Arizona’s independent contractor laws may be liable for back payment of unemployment insurance on behalf of the misclassified workers.
Recent Developments and Arizona Laws
Recent amendments to Arizona’s federal and state temporary labor laws expanded the protections for temporary employees. These changes were passed as an effort to give greater control to administrative authorities over the temporary labor staffing industries. With these changes, more temporary workers can bring wage claims, and the private right of action has also been extended. Below are the significant changes.
The changes amended the definitions to broaden the application of the Fair Labor Standards Act, which as a result means more temporary employees are now covered under the act. The amendments define a "joint employment relationship" more inclusively. An employee which works for multiple employers falls within the jurisdiction of the Act if one of the employers satisfies the definition of employer. For example, if an employee works for company A, but company A doesn’t satisfy the definition of employer, the amendments broaden the definition so that company B will now fall under the Act. In other words, if a joint employment arrangement exists in which two or more employers each exercise direct or indirect control over an employee, the Act now covers all those employers.
Amendments to the protections of the Arizona Equal Pay law require the state to identify the employer when a labor recruiter is involved. Under this provision, the law now includes "labor recruiter" in the definition of employer. The identity of the labor recruiter must be disclosed by a job posting. Prior to the changes, the law had limited the prohibition of wage differentials based upon gender, race, or ethnicity to "employer" defined as the contractor, subcontractor, or employer of election. The explanation was that the two different identities for the purposes of demands for equal pay meant when both employers were before the court, the court also had the power to issue an injunction against both companies. In all, because of the amendment, the law now covers some forty-six labor recruiters.
As of August 2019, Arizona Senate Bill 1396 also increases the recordkeeping requirements and fines on employers who do not comply with substantive wage-payment provisions. The amendments require contractors to pay reasonable compensation due to the recruitment, hiring, and employment of temporary employees. A temporary worker is defined as any who performs work for an employer for less than 6 months.
The bill also requires the written notice of the temporary work agreement, which must be provided at the time of employment or offered prior to the commencement of work in the same language as the contract. The contract must contain: (1) if a placement fee recoups for services under the temporary worker agreement; (2) the rate of pay; (3) the basis of compensation; and (4) whether the employer has the right to terminate the temporary work agreement without prior notice.
The amendments also require employers to maintain records relating to the place of employment of both the employer and the temporary worker. This requirement is intended to "ensure clarity in the employment relationship." The amendments create a right of action against the temporary worker’s employer.
Seeking Guidance and Advice in Arizona
Worker classification issues are legally complicated. Fortunately, businesses in Arizona have several options when seeking legal advice regarding their business concerns. The first step towards ensuring legal compliance is connecting with an attorney who is experienced in this area. An attorney experienced in employment issues can help you avoid costly mistakes. You want to make sure that the attorney you retain is experienced in Arizona labor law so that he or she can advise you on how to handle your business practices in compliance with Arizona law. When considering which retained attorney to seek from, consider asking the lawyer some of the following questions: If you are unsure where to begin your search , you can obtain the name of a qualified labor lawyer in your area by searching the Internet or you can go to any State Bar Association’s website. Many times State Bar Associations will list attorneys who are speacialized in a particular area of the law and also list the prices charged by each attorney.(for example: the State Bar Association of Arizona provides a listing of attorneys who are qualified on specific areas of law.) However, even if you have already received a checklist of employees from another source (e.g., the State or IRS), you may still want to speak to a lawyer to confirm your checklist is exhaustive and/or to make sure you understand the legal terms used on the checklist.