3rd party inspection services

FAQ: Inspection Company Employee or Independent Contractor; Does It Matter When Engaging a 3rd Party Inspection Services Firm?

Facility owners frequently rely upon 3rd-party quality assurance (QA) verification of all forms of steel and concrete fabrication, coatings application, non-destructive testing (NDT), and cathodic protection (CP) system installation and maintenance.  While specific reasons for engaging 3rd-party QA services vary, in general, facility owners want to know that their projects are being constructed in shops and in the field in accordance with their contract documents.  At a minimum, these 3rd-party service providers are engaged to observe, document and report on contractor conformance to the governing specification.  Some 3rd-party QA (inspection) firms rely on independent contractors to fulfill these obligations.  The question frequently asked is, “Does it matter if an inspection firm relies upon their own employees or independent contractors when contracted to provide 3rd party QA services?” 

To answer this question, it is necessary to establish the difference between an employee and an independent contractor.  Both the federal Internal Revenue Service (IRS) and the Department of Labor (DOL) have regulatory jurisdiction in this area.  The key to determining whether an inspector is an employee or independent contractor is largely based on the degree of control the inspection firm has over the inspector’s actions.     

Internal Revenue Service (IRS) Perspective

There are 20 factors used as guidelines by the IRS to determine whether a (inspection) firm has enough control over a worker (inspector), for the worker to be considered an employee.  If the inspector in question has the potential to make a profit or suffer a real economic loss, if the inspector has a significant personal investment in the equipment relied upon to conduct the work, if the inspector works for multiple firms at the same time, and if the inspector offers these services to the general public, then the inspector may be an independent contractor.  However, if the inspection firm offers any of the following, the inspector is probably an employee.

  • Training – If the inspection firm trains the inspector to do the work in a particular way, they likely aren’t independent contractors. Independent contractors are already trained. 
  • Integration – If the inspection services being performed are an integral part of the inspection firm’s business, the inspectors likely aren’t independent contractors.
  • Continuing relationship – If there is an ongoing relationship (services are performed frequently, even if irregularly) between the inspector and the inspection firm, they likely aren’t independent contractors.
  • Setting work hours – If the inspection services firm sets the inspector’s hours, they likely aren’t independent contractors.  Independent contractors are masters of their own time. 
  • Full-time work – If the inspector spends all of his or her time on an inspection firm’s job, they likely aren’t independent contractors.  Independent contractors choose when and where they will work.
  • Reports – If the inspector must provide reports accounting for his or her actions (e.g. time sheets, daily inspection reports) to the inspection firm, it demonstrates a lack of independence, and they likely aren’t independent contractors.
  • Tools and materials – If the inspection firm provides the inspector with equipment (e.g. safety) and instrumentation (e.g. to ensure its proper calibration) necessary to conduct the work, they likely aren’t independent contractors.

There are other factors [for a full description see https://www.irs.gov/newsroom/understanding-employee-vs-contractor-designation] but the 7 items listed above are very enlightening.  The general rule is that an inspector is an independent contractor if the inspection firm only has the right to control or direct the result of the work, and not what will be done, when it will be done, or how it will be done.  It’s unlikely that this conforms with the facility owner’s expectations when hiring a 3rd party inspection firm.   If a facility owner expects the 3rd-party inspection firm to act on their behalf and ensure the inspector is trained, properly equipped with calibrated instrumentation and safety gear, and fulfills the contracted scope of services, the inspection firm cannot rely upon independent contractors.  If they do, they are in likely violation of IRS regulations by virtue of the control they are exercising over the inspector’s work. 

Department of Labor (DOL) Perspective

The DOL (hour and wage division) provides guidance for compliance with the Fair Labor Standard Act (FLSA).  Like the IRS, there is no single rule or test to determine whether an employee or an independent contractor relationship exists.  Rather, the totality of the activity or situation controls the classification. According to the DOL, the key considerations include:

  • The extent to which the services rendered are an integral part of the principal’s business.
  • The permanency of the relationship.
  • The amount of the alleged contractor’s investment in facilities and equipment.
  • The nature and degree of control by the principal.
  • The alleged contractor’s opportunities for profit and loss.
  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  • The degree of independent business organization and operation.

Like the IRS, there are other factors the DOL may use in determining the nature of employer-employee relationship [for a full description see https://www.dol.gov/whd/regs/compliance/whdfs13.htm] but the 7 items listed above are once again very enlightening, and in alignment with the IRS.  The conclusion is similar; if a facility owner expects the 3rd-party inspection firm to act on their behalf and ensure the inspector is trained, properly equipped with calibrated instrumentation and safety gear, and fulfills the contracted scope of services, the inspection firm cannot rely upon independent contractors.  If they do, they are in likely violation of DOL regulations by virtue of the control exercised over the individual. 

Industry Standards

There are consensus-based industry standards that provide further guidance in this area. One example is SSPC QP 5 “Standard Procedure for Evaluating the Qualifications of Coating and Lining Inspection Companies.” 

As suggested by SSPC on their website “Consistency and accountability at all levels of the inspection service let owners know that their project is not just being inspected, it is also reviewed and supported by the inspection company itself” (emphasis added).  The QP 5 standard defines a Coating and Lining Inspection Company as “An independent company that is not involved in the manufacture of coating materials or coating application equipment, or the application process, whose primary function is to inspect the application process and the quality of the applied film” (emphasis added).  Since inspection services, by SSPC definition, must be an integral part of the firm’s business, by both IRS and DOL guidance, any inspectors must be employees and not independent contractors. 

Similarly, the qualification requirements, quality management system, standard operating procedures, and inspection personnel requirements outlined in QP 5 require the certified inspection firm to exercise control or direct and be accountable for much more than just the result of the inspector’s work, including but not limited to what will be done and how it will be done.  To conform with these SSPC requirements, and the IRS and DOL regulations, it’s inconceivable how the certified inspection firm could rely upon independent contractors.   

Economic Incentive   

An underlying question is “Why would an inspection services firm rely upon independent contractors to fulfill its inspection service obligations?”  It comes down to a matter of economics.  A report was released from the University of California Berkeley Labor Center on March 11, 2019 found that “While there are legitimate circumstances where classifying workers as independent contractors is appropriate, it is clear that some employers misclassify workers as a way to reduce their labor costs by avoiding payroll taxes and payments for unemployment insurance and workers compensation.” “Misclassification also allows employers to transfer some of their operating costs and legal risks to workers, which may result in lower earnings overall for misclassified workers” the report states.

[see http://laborcenter.berkeley.edu/misclassification-in-california-a-snapshot-of-the-janitorial-services-construction-and-trucking-industries/]  

Conclusions

Regardless of how the inspection firm classifies them, someone is an employee if a company controls what they do, if the inspectors work is linked to the inspection firm’s primary business, or if the inspector does not have an independent business performing that work.  By IRS and DOL criteria, a company that employs independent contractors cannot control nor direct the work that will be done or how it should be completed.  Facility owners that engage 3rd-party QA (inspection) firms to perform critical services such as verification of welding, coating, NDT and CP system performance on their assets should ensure the inspection firms engage employees who are properly trained and equipped to do the job, and whose work is actively monitored, managed and supported by the inspection firm.  Otherwise, facility owners may unwittingly contract with inspection companies that engage independent contractors that are in likely violation of IRS and DOL regulations.  Alternatively, the inspection firms are not training, properly equipping, directing and overseeing the work of the inspector (in order to protect their independent contractor status), which may be putting the facility owner’s asset at risk and jeopardizing the safety of the public at large. 

Reputable inspection firms should be committed to following the IRS and DOL rules, which means hiring true employees to ensure that the firm can hire, train, equip, direct, supervise, and audit inspectors to provide clients with 3rd-party inspection services and help mitigate client risks – while providing appropriate insurance protection and paying appropriate payroll taxes for the employee.

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