What Arizona Employers Need to Know About Classification

Arizona law defines an employee “[w]hen an employer procures work to be done for the employer by a contractor over whose work the employer retains supervision or control, and the work is a part or process in the trade or business of the employer….” A.R.S. § 23-902(B).

Conversely, an independent contractor is defined as “[a] person engaged in work for a business, and who while so engaged is independent of that business in the execution of the work and not subject to the rule or control of the business for which the work is done, but is engaged only in the performance of a definite job or piece of work, and is subordinate to that business only in effecting a result in accordance with that business design.” A.R.S. § 23-902(C).

The Arizona Supreme Court has further defined the “right to control” test to ask whether the employer retains the right to supervise the person or to control the method of reaching the desired result. Home Insurance Co. v. Industrial Comm’n, 123 Ariz. 348, 599 P.2d 801 (1979). To determine the “right to control”, courts look at the totality of the facts and circumstances of each case, examining various indicia of control, including: (1) the duration of the employment; (2) the method of payment; (3) who furnishes necessary equipment; (4) the right to hire and fire; (5) who bears responsibility for workmen’s compensation insurance; (6) the extent to which the employer may exercise control over the details of the work; and (7) whether the work was performed in the usual and regular course of the employer’s business. Id.

On a more practical level, independent contractors are usually found when providing temporary services, while remaining independent and retaining control over their means and methods of providing said services to reach a determined goal, rather than an employee who is and remains under the direction or control of the employer.

Why Does the Classification Matter?

The expenses associated with employees – including taxes, training, promotions, overtime, benefits, unemployment insurance, workers’ compensation insurance, FMLA leave, 401K matches, etc. – are usually far greater than those associated with independent contractors.

The classification is also critical when a worker incurs an on-the-job injury. In general, only employees are covered under Arizona worker’s compensation laws.

Employers may face unexpected liability in the event any worker designations are reclassified. For example, if state (or federal) regulators reclassify workers, the company may be responsible for all back income tax withholdings, workers’ compensation premiums, unemployment insurance taxes, and other mandated benefits. Employers could also face other regulatory penalties.

What Kinds of Documentation Can Be Used to Assist in Classification?

First, Arizona employers should always consider having new hires acknowledge and sign a written employment agreement that identifies the terms and conditions of the relationship, for either employees or independent contractors. A.R.S. § 23-902.

Second, if Arizona employers are hiring independent contractors, they should consider having a signed and dated independent contractor declaration of business status (in lieu of, or in addition to, the employment agreement identified above). In 2016, Arizona adopted House Bill (HB) 2114 in response to worker status lawsuits throughout the country, particularly against gig economy heavyweights such as Uber and Lyft. HB 2114 permits an employer and contractor to create a rebuttable presumption of an independent contractor relationship by prescribing a Declaration of Independent Business Status Form. A.R.S. § 23-1601.

This type of optional declaration will usually state the worker understands they are:

  • An independent contractor, not an employee of the company, and therefore are not entitled to unemployment or other benefits afforded to employees;
  • Are not covered under the company’s workers’ compensation insurance;
  • Are permitted to accept work from other businesses;
  • Are responsible for supplying their own tools and complying with licensing requirements, if any;
  • Are responsible for paying business-related expenses and income taxes; and
  • Are authorized to determine the days and time the work is performed but acknowledge the company may impose quality standards and performance deadlines.

A declaration signed by the worker will serve as evidence they are properly classified as an independent contractor, but the worker will have the opportunity to produce evidence to overcome this rebuttable presumption. A.R.S. § 23-1601(B). However, the failure to execute a declaration of independent business status does not create any presumptions and is not admissible to deny the existence of an independent contractor relationship. A.R.S. § 23-1601(A).

Third, and similarly, Arizona adopted House Bill (HB) 2652 to address the use of smartphone technology by defining “qualified marketplace contractors” who are classified as independent contractors. The qualified marketplace contractor uses another company’s digital platform to connect with third parties that are seeking the contractor’s services. The company providing the digital platform should have a written agreement/declaration like that discussed above.

How Does Federal Law Impact the Classification?

The U.S. Department of Labor (DOL) proposed a new rule in October 2022 which would rescind and replace the 2021 Independent Contractor Rule, which previously emphasized the factors of control and opportunity for profit to determine classification. The new rule would implement a six-factor test – including (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral part of the employer’s business and (6) skill and initiative – and would consider any other factors that may be deemed relevant. The new rule would also include a presumption of classifying a worker as an employee, rather than an independent contractor. After the public comment period ended in December 2022, the DOL scheduled the final rule publication for May 2023.

Employers should keep in mind that compliance with Arizona state law regarding classification does not automatically equal compliance with federal law, especially given the pending rule change.