Employment Classification: Trap for the unwary

LAW
Werner Sabo, FAIA, CSI, and James K. Zahn, FAIA, CSI
Design professionals face a pair of issues regarding how employees are designated, each with two different potential consequences.

Employees or independent contractors?
The first issue is whether a particular person is an “employee” or an “independent contractor.” Many firms hire architects or engineers (or unlicensed draftspersons) for short-duration projects. Rather than consider them full-time employees, the firm pays them a certain amount on a periodic basis, but without offering any benefits or making Federal Insurance Contributions Act (FICA) deductions. These people are considered “independent contractors” who will be responsible for their own taxes, insurance, and so forth.

This has obvious advantages for the firm, since it can end the relationship without worry over unemployment compensation. The firm also does not need to pay overtime. The question is, however, whether the Internal Revenue Service (IRS) or other governmental agencies would see the relationship the same way.

Generally, it does not matter what the relationship is called; rather, what matters is the substance—how the parties actually relate to each other and how they work together. There are several factors that need to be looked at:

1. Does the firm control or have the right to control what workers do and how their job is done? (This includes whether the worker is in the office using the firm’s computers and software or whether the worker can decide to work from his or her own office.)
2. Are the business aspects of the job controlled by the firm? (This includes things like reimbursable expenses, whether the worker is paid when employees are paid, who provides supplies and tools, and so forth.)
3. What are the terms of the relationship? That is, is the worker doing work on more than one project? Is the worker performing a key aspect of the business?

These factors are not necessarily exhaustive, and no single factor is determinative. Rather, the overall relationship must be examined to decide whether an “independent contractor” is in reality an employee. If it turns out the person is considered an employee, the firm will likely face tax consequences that could be substantial. The employee would also be eligible for unemployment compensation if terminated and might be entitled to overtime for past work. Firms that use independent contractors as design professionals should periodically review each situation with a qualified certified public accountant (CPA) or attorney to avoid potential problems.

Personnel descriptions
Design firms often bill out their personnel by job description. For instance, an architectural firm might send out a monthly invoice to its client for hourly services with listing such as:

Architect, 4 hours, $400.00.

An engineer might bill out

Mary Jones, Engineer, $600.00.

This is all fine and well if these individuals actually have the appropriate professional license. Often, they do not. Individuals who are not licensed are sometimes incorrectly designated as “architects” or “engineers.” In most states, this would violate the licensing act. Worse, the client could audit the bills and, upon discovering he or she is paying for an architect when the individual is not one, would demand a return of some or all of the prior fees. This would be highly embarrassing for the firm and might result in the loss of a client as well as substantial money.

There are solutions to this problem. The most obvious is to assign a billing rate for individuals, as opposed to job classifications. For fixed-fee projects, billings should be broken down not by hours, but by percentage of completion of each task. Finally, the firm should verify the license status of each employee to ensure it is correctly representing that status to its clients. This can often be done easily online via each state’s licensing site.

Werner Sabo, FAIA, CSI, and James K. Zahn, FAIA, CSI, are architects, attorneys, and partners in the Chicago law firm of Sabo & Zahn. Both are resource members of the American Institute of Architects’ (AIA’s) National Documents Committee. They can be reached, respectively, at wsabo@sabozahn.com and jzahn@sabozahn.com.