Recently, Governor Edward G Rendell signed into law a bill that could have a devastating impact on your business.  I’m not talking about a health care law, a tax law or an anti-discrimination law.  I’m referring to House Bill 400.

“What’s House Bill 400 have to do with me?” you ask.  House Bill 400, otherwise known as the Construction Workplace Misclassification Act, now clearly defines an Independent Contractor for the Construction Industry and specifies penalties for non-compliance, or misclassification.  The bill was approved on October 13, 2010 and takes effect on February 10, 2011. Now is the time to make sure you’re obeying the law.

Let’s back up a bit…    In a previous blog, Worker Compensation Insurance: Do You Need It?, we talked about classifying workers as either Employees or Independent Contractors and how it can be a challenge to make a determination.  We referenced the “IRS Test” and suggested you familiarize yourself with the rules so as to not be subject to penalties for misclassifying your workers.

We now have a clearer picture of what an Independent Contractor actually is.

Does This New Bill Impact My Business?

First, let’s look at who falls under this new law.  The law is intended for the Construction Industry.  Under the law, “Construction” is defined: “Erection, Reconstruction, Demolition, Alteration, Modification, Custom Fabrication, Building, Assembling, Site Preparation and Repair Work done on any Real Property or Premises under Contract, whether or not the work is for a Public Body and paid for from Public Funds.”

It might be a bit unclear as to whether your specific business falls under this definition, but it does seem to encompass a large variety of operations.

Second, let’s look at what is now considered an Independent Contractor.  A worker, “for purposes of Workers Compensation, Unemployment Compensation and Improper Classification of Employees,” is an Independent Contractor ONLY IF:

1) The individual has a written contract to perform such services

2) The individual is free from control or direction over performance of such services both under the contract of service and in fact.

3) As to such services, the individual is customarily engaged in an independently established trade, occupation, profession or business.

The law seems to indicate that all three of these must exist for a worker to be classified as an Independent Contractor.

Further, there are specific guidelines as to how we can prove number “3″ above.  In order to be an Independent Contractor, the individual must essentially demonstrate they have their own business.  They can do that by meeting the following criteria: (An individual has their own business ONLY IF)

1) The individual possesses the essential tools, equipment and other assets necessary to perform the services independent of the person for whom the services are performed

2) The individual’s arrangement with the person for whom the services are performed is such that the individual shall realize a profit or suffer a loss as a result of performing the services

3) The individual performs the services through a business in which the individual has a proprietary interest

4) The individual maintains a business location that is separate from the location of the person for whom the services are being performed

5) The individual either: (a) performs or has performed the same or similar services for another person while free from direction or control over performance of the services, or (b) holds himself/herself out to other persons as available and able to perform the same or similar services while free from direction or control over performance of the services

6) The individual maintains liability insurance during the term of the contract of at least $50,000

In other words, the individual must have their own tools, must have a financial stake in the work, must work or be able to work for others, must have their own business location and must have their own liability insurance.

What are the Penalties?

There you have it, a clear way to determine whether someone is an Employee or an Independent Contractor.  But, so what?

Let me finish this blog by detailing the penalties you might incur by misclassifying your workers.

Penalties may be up to $1,000 per violation for the first violation.  Note that each misclassified worker is considered a separate violation.  Further, each subsequent violation will be up to $2,500.

In addition, if it can be determined that an employer intentionally misclassified a worker, a court can issue a stop-work order, which would prevent the employer from using that misclassified worker.  If misclassified workers make up a majority of your workforce at a particular site, you can be issued a stop-work order for your entire operations at that site.  Violating the stop-work order can incur a fine of $1,000 per day.

Moreover, anyone who knowingly contracts with an employer that is knowingly intending to misclassify employees can be subject to these same penalties.  Ouch!

To read the bill in it’s entirety, go to www.legis.state.pa.us and search for H400.

Who Must Purchase Workers Compensation Insurance?

The Workers Compensation section of the PA Department Labor & Industries’s (DL&I) website says, “If you employ workers in Pennsylvania, you must have worker’s compensation insurance - Its the law.”

That seems clear enough but how do you know if the person you are employing is actually an employee or a subcontractor?

Before I answer that question, I must point out that the PA DL&I website goes on to further describe who does and does not need coverage, as well as provides examples of the penalities incurred for employers who fail to provide coverage even though they should have. Also the PA Insurance Department website has a nice piece of information titled “Your Guide to Workers Compensation Insurance.” If you’re in business in Pennsylvania, I suggest you check it out.

The IRS Test

The best way to answer the question as to whether you have an employee or a subcontractor is by using the “IRS Test“. Basically, a subcontractor is defined by the IRS as a person whom you have the “right to control or direct only the result of the work and not the means and methods of accomplishing the results.” Whereas a worker is an employee if you “can control what will be done and how it will be done.”

The IRS test consists of three main catagories to review regarding how to classify your worker: behavior control, financial control and relationship of the parties.

Behavioral Control – This section deals with whether you demonstrate a “right to direct or control how the worker does the work.” Examples are type of or level of instruction and/or training afforded to your worker

Financial Control – This section deals with “whether there is a right to direct or control the business part of the work.” Examples are whether there is significant investment in the work or who is responsible for a majority of the expenses incurred.

Relationship of the Parties – This section deals with “how the business and the worker perceive their relationship.” Examples are employee beneftis and written contracts.

In many cases, the control you demonstrate over a worker, along with your relationship with that worker, can determine how to classify them. Take a look at Publication 1779, “Independent Contractor or Employee”. The document details the three catagories, as well as lays out several questions you can answer to help you better understand how to classify your workers. How you answer the questions in this publication can go a long way in determining whether you need to purchase a workers compensation policy.

In conclusion, determining whether a worker is a subcontractor or an employee can be difficult task. Each situation is unique and a local insurance agent is always a good source to answer questions or help with navigating any of the aforementioned websites. Are you sure if your business has contractors or employees?