Subs or Gig Workers?

Every contractor understands the advantage of using independent contractors rather than hiring employees: No FICA or FUTA, no workers’ comp, no sick leave, no overtime. Using gig workers cuts at least 30% off labor costs. Great choice!

But you probably detect problems lurking here. I’ll explain by offering a little history.

Statutory Employees

A hundred years ago, employees injured on the job could sue their employer. Recovery often took years. Meanwhile, employees went without medical treatment and without essential rehab. Early in the 20th century, state legislatures stepped in, enacting the first workers’ compensation laws. Workers’ comp took away the right to sue an employer for negligence and gave back compensation for on-the-job injuries, regardless of fault.

From that day, nearly all employers, including construction contractors and subs, had to buy workers’ comp coverage for employees. A sub who didn’t buy workers’ comp coverage made the next contractor up the chain liable for coverage. Usually, that made the prime contractor’s carrier liable for injury to a sub’s employee. The prime contractor became the “statutory employer”.

That solved one problem. Injured employees always got workers’ comp benefits. But it created another problem. Workers’ comp carriers for the prime could be exposed to claims from every sub on the job. The remedy should be obvious. Prime contractors learned to insist that subs and sub-subs carry workers’ comp insurance on their employees.

Enter the Gig Worker

Remember where we started: Contractors save 30% on labor cost by using independent contractors. Now the problem: Where contractors and subs are licensed, about half the licensees claim to have no employees. Since only employees are covered by workers’ comp, about half the trades on your job may have no workers’ comp coverage. If true, that could make you the statutory employer.

Being a statutory employer cuts two ways. First, you’re not going to get sued. Workers’ compensation is the exclusive remedy when an employee is injured on the job. Second, your cost of workers’ comp coverage is going to jump the next time there’s an audit.

How to Protect Yourself

1. Trade certificates of insurance with subs before work starts. Certificates of insurance confirm that coverage is in effect and will show coverage limits. The sub’s policy limits should match limits in your coverage.
2. Be alert for subs who rely on gig workers and claim few or no employees. That could be misclassification, employees passed off as independent contractors. You become the statutory employer for misclassified workers. If the tradespeople are true gig workers, you’re not the statutory employer. Fine. But those tradespeople are not covered by worker’s comp. That means you’re likely to be sued for any injury on the job.
3. Use written subcontracts. Have each sub sign an agreement before work starts. A signed agreement is the best evidence that work is being done by an independent contractor, not an employee. In that agreement, include a clause that requires subs and sub-subs to carry workers’ comp insurance on employees. Include an indemnification agreement. If you’re found liable as the statutory employer, you can recover against the sub.

If you’re not using written subcontracts or if your subcontracts don’t require subs to carry insurance, have a look at ConstructionContract Writer. The trial version is free.

 

Employee or Subcontractor?

Every contractor understands the advantage of getting work done with subs rather than employees. Employees come with headaches like payroll taxes (F.I.C.A., F.U.T.A., S.U.I), employee insurance, fringe benefits and overtime. Collectively, those add about one-third to labor cost. With subcontractors, you simply write a check payable to the sub. No withholding tax. No fringe benefits. No overtime.

So why would any contractor have employees?

The simple answer is that many don’t. That’s known as paper contracting. For details, see my blog post.

But there’s another reason, usually referred to as employee classification. States and the I.R.S. have rules about who qualifies as a sub (an independent contractor) and who has to be paid as an employee.

What makes a sub?

Simply labeling someone a subcontractor doesn’t work. In fact, no single test settles the matter. States and the I.R.S. apply their own rules. But all would agree that most employees:

• Work under employer control and can be laid off.
• Comply with work hours and the sequence of work set by the employer.
• Can’t substitute someone else to do the work.
• Are paid by the hour, week or month rather than by the job.
• Use the employer’s tools and get reimbursed for expenses.

Subcontractors are in business for themselves. They:

• Promote their services and have a business address.
• Usually work under contract for several prime contractors.
• Work for a contract price and cover their own job expenses.
• Have to redo unsatisfactory work at their own expense.
• Stand to make a profit or suffer a loss on the job.

What’s the risk of misclassification?
Make a mistake about who’s a sub and who isn’t and you could get hit from two directions. The employee could file I.R.S. Form 8919 to collect unpaid Social Security and Medicare Tax on wages. Then your state and the I.R.S. could claim a tax lien for failure to withhold. The I.R.S. can be a pit bull when collecting delinquent payroll tax – including seizure of personal assets.

If you’re concerned that subs on your jobs could be classified as employees, here’s a case in point.

Bernie Kurio had worked for several years as a Houston drywall contractor before he got caught up in an I.R.S. sweep. An audit of Bernie’s books resulted in an assessment of $89,063 for failure to withhold payroll taxes. Bernie’s protest of the assessment was denied by the I.R.S. regional commissioner. But that wasn’t where it ended.

Bernie appealed to U.S. District court. Surprise! He won. The tax lien was discharged. The court’s decision makes good reading for every contractor concerned about employee classification. Here are the facts that won the case.

When Bernie landed a drywall job, he called several hanger team leaders. The team with the best price per square foot got the work. Hangers, tapers, floaters, sanders and truckers used their own tools and equipment. Bernie controlled only the result, not the hours or who did the work. Drywall crews understood they were independent contractors and – here’s the key point – most reported earnings on their Schedule C.

Bernie’s case, Kurio v. United States, dates from 1970 and has been followed ever since. Stay within the facts of the Kurio decision and you should have no trouble with either state or federal authorities.

Use written subcontracts to end any debate about employee classification:

• Payment will be by the job.
• You control only the finished product.
• Subs are responsible for their own taxes.

Construction Contract Writer makes that easy. The trial version is free.

Construction Subcontract Flow-Down

Every construction contractor and subcontractor has heard the term flow-down. A few probably feel they were washed away by flow-down. I don’t think that’s necessary and will suggest a better way.

Flow-down is what general contractors do in subcontracts. They incorporate into a subcontract all the terms of the prime contract – usually by stapling the prime contract to the subcontract. That saves a lot of typing. It also offers a (false) sense of security to general contractors. In theory, flow-down obligates the sub to do everything for the sub’s portion of the work that the general contractor has to do under the prime contract.

So if the owner has a legitimate complaint about a sub’s work, and if the prime contractor is obligated to make repairs, the sub has the same obligation. That’s perfect symmetry and should protect general contractors. Flow-down is great for general contractors. Right?

Well, not quite.

Courts don’t like flow-down for several reasons. First, it’s an adhesion contract between parties with different levels of bargaining power. Second, flow-down binds subcontractors to terms they may not have read, probably don’t understand and make no sense whatsoever in the context of a particular subcontract. Worse, the stapled prime contract may have terms completely inconsistent with the signed subcontract.

The result: Courts simply don’t enforce flow-down as general contractors expect. Instead, flow-down binds a “subcontractor only as to prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontractor." (2007 NY Slip Op 2981)

What does that include? Your guess is as good as mine. But I think some would insist it doesn’t go much beyond what appears on the plans and in the specs. That trashes most of the prime contract: payment, liens, delay, insurance, extra work, termination, call-backs, claims, warranty, statute of limitations, indemnification, and a host of other common trouble spots.

If you’re a general contractor, staple-based flow-down can be poison.

But don’t misunderstand. Courts aren’t saying that subcontractors can’t be bound by terms in the prime contract. They can. But those terms better be in the subcontract and over the signature of the subcontractor.

Fortunately, that’s relatively easy today. Just get a digital copy of the prime contract. Replace every occurrence of “owner” with “contractor” and every occurrence of “contractor” with “subcontractor.” That’s a real flow-down subcontract and should be enforced by every court in the land.

But read the subcontract carefully before getting a signature. Add anything that applies to subcontracts only (i.e. payment terms, release of retainage) and eliminate anything that doesn’t apply (i.e. notices and disclosures). Then make the changes required by state law. Many states have special rules for subcontracts.

If you write both prime contracts and subcontracts, Craftsman’s Construction Contract Writer makes flow-down easy. When the prime contract is done and signed, just click to turn that prime contract into a perfectly valid flow-down subcontract covering all the same issues – automatically deleting what doesn’t apply, adding what’s unique to subcontracts and accounting for any special state requirements.