1. Is Your Independent Contractor Really an Employee?
LI APA Presentation
Is Your Independent Contractor Really an Employee?
Presented By:
Sima A. Ali, Esq. T: C:

2. Introduction

3. Proper Classification: Why It Matters & How To Understand It
Introduction
Proper Classification:
Why It Matters & How To Understand It
Incorrect classification of employees as independent contractors is under intense scrutiny by the IRS and DOL.
The tests set forth by these agencies provide useful guidelines.
Misclassification of employees as independent contractors is increasingly occurring in small to large businesses across the U.S. Whether intentional or not, misclassification circumvents compliance with labor laws and puts employers who properly classify their employees at a disadvantage. Not only does misclassification reduce tax revenues, it negatively impacts employees who are denied overtime pay, worker’s compensation and unemployment insurance as a result of their improper independent contractor status. For this reason, the government does not favor treating workers as independent contractors and incorrect classification of employees as independent contractors is currently under intense scrutiny by the IRS and the Department of Labor (DOL). Thus, employers must take care to ensure they are properly classifying all of their workers.
This presentation describes the state of the law today regarding the legal distinctions between the classification of workers as “employees” and “independent contractors” under laws governing the employment relationship and the consequences of misclassification. There are several complex standards used to determine if an individual is legally an independent contractor. The independent contractor tests set forth below are employed by the DOL and the IRS and provide useful guidelines as to which workers qualify as independent contractors.

4. The DOL Test

5. DOL Test The Fair Labor Standards Act (FLSA) defines “employee” as
The “suffer or permit” standard has broad applicability
Supreme Court construed the FLSA “liberally” for broadest reach
The Fair Labor Standards Act (FLSA) defines “employee” as
“any individual employed by an employer”
and “employ” as
“to suffer or permit to work”
DOL Test
Independent contractors, by definition, are not employees. Thus, labor and employment laws do not cover independent contractors. Whether or not a worker is covered by a particular labor or employment law hinges on the definition of “employee.” The Fair Labor Standards Act (FLSA), defines “employee” as “any individual employed by an employer,” 29 U.S.C. 203(e)(1), and “employ” as “to suffer or permit to work.” 29 U.S.C. 203(g). The “suffer or permit” standard has broad applicability. The Supreme Court has “consistently construed the Act liberally to apply to the furthest reaches consistent with congressional direction, recognizing that broad coverage is essential to accomplish the [Act’s] goal.” Tony & Susan Alamo Found. v. Sec’y of Labor, 471 U.S. 290, 296 (1985) (quoting Mitchell v. Lublin, McGaughy & Assocs., 358 U.S. 207, 211 (1959)).

6. How Tests Have Emerged Over Time
DOL Test
How Tests Have Emerged Over Time 1
Common Law Test
Employer’s right to control most important factor 2
FLSA
Rejects common law test for
broader coverage, “suffer or permit” 3
“Economic Realities” Test
Developed by Supreme Court & Circuit Courts
Over the years, various tests have emerged to define independent contractor and determine whether an employment relationship exists. Before the FLSA was enacted, the common law control test was the prevalent test for determining whether an employment relationship existed. Under this test, the employer’s right to control is the most important factor in determining whether a contractor is actually an employee. However, Congress rejected the common law control test in drafting the FLSA. See Walling v. Portland Terminal Co., 330 U.S. 148, (1947). Instead, the FLSA’s “suffer or permit” standard covers more workers as employees and was designed to broaden the scope of employment relationships as much as possible. See U.S. v. Rosenwasser, 323 U.S. 360, (1945) (“A broader or more comprehensive coverage of employees would be difficult to frame”). 4
DOL Administrator’s Interpretation

7. DOL Test: “Economic Realities” Test
the extent to which the work performed is an integral part of the employer’s business;
the worker’s opportunity for profit or loss depending on his or her managerial skill;
the extent of the relative investments of the employer and the worker;
whether the work performed requires special skills and initiative
the permanency of the relationship; and
the degree of control exercised or retained by the employer.
After the FLSA was enacted, the Supreme Court and Circuit Courts of Appeals developed a multi-factor “economic realities” test to determine whether a worker is an employee or an independent contractor under the FLSA.
An “entity ‘suffers or permits’ an individual to work if, as a matter of economic reality, the individual is dependent on the entity.” Antenor v. D & S Farms, 88 F.3d 925, 929 (11th Cir. 1996). The “economic realties” factors include: (1) the extent to which the work performed is an integral part of the employer’s business; (2) the worker’s opportunity for profit or loss depending on his or her managerial skill; (3) the extent of the relative investments of the employer and the worker; (4) whether the work performed requires special skills and initiative; (5) the permanency of the relationship; and (6) the degree of control exercised or retained by the employer.

8. The “Economic Realities” Test Is Now the Prevailing Test
FMLA
Age Discrimination
in Employment Act
WARN
Americans with Disabilities Act
The “economic realities” test is now the prevailing test for determining employee status under the Family and Medical Leave Act (FMLA) and the Worker Adjustment and Retraining Act (WARN) and is often applied by courts in determining independent contractor status in civil rights cases under Title VII of the Civil Rights Act, the Age Discrimination in Employment Act and the Americans with Disabilities Act.
Title VII of Civil Rights Act

9. DOL Test
The “Economic Realities” Test makes it more difficult to classify a worker as an independent contractor
In addition to considering the issue of control, it takes into account the degree to which workers are economically dependent on employer’s business.
In applying the “economic realities” factors, courts have described independent contractors as those workers with economic independence who operate a business of their own. In contrast, workers who are economically dependent on the employer, regardless of skill level, are employees covered by the FLSA. See, e.g., Hopkins v. Cornerstone Am., 545 F.3d 338, 343 (5th Cir. 2008). The “economic realities” test makes it more difficult to classify a worker as an independent contractor because, in addition to considering the issue of control, it takes into account the degree to which the workers are economically dependent on the employer’s business. For example, an employee who invests all his or her time in one business and provides services to only one “customer,” the employer, is economically dependent upon that work. In contrast, an independent contractor is in business for him or herself and has a large customer base.

10. DOL Administrator’s Interpretation
DOL Test
DOL Administrator’s Interpretation
Downplays significance of employee’s exertion of control
Stresses that no single factor should be weighed to ascertain whether a worker is ultimately dependent
On July 15, 2015, the U.S. Department of Labor (DOL) issued an administrator’s interpretation regarding the application of the FLSA with respect to the misclassification of workers as independent contractors. In the interpretation, the administrator formally accepted the “economic realities” test as the DOL’s preferred approach to determining whether a worker is an employee or an independent contractor. The interpretation downplays the significance of the employer’s exertion of control over the worker and stresses that no single factor should be overemphasized. Instead, the factors should simply be weighed to ascertain whether, as a matter of economic reality, a worker is ultimately dependent on the business for continued employment. Thus, the prevailing “economic realities” test expands the scope of employment and narrows the definition of independent contractor. Moreover, the FLSA’s broad definition of “employ” as “to suffer or permit to work,” and the Act’s intended increase of coverage for workers must be considered when applying the “economic realities” factors to determine whether a worker is an employee or an independent contractor.

11. IRS Test

12. Considers the degree of the right to control in 3 categories.
IRS Test
Considers the degree of the right to control in 3 categories.
behavioral control;
financial control; and
type of relationship.
The IRS looks at a number of factors in order to determine whether a worker qualifies as an independent contractor, all of which involve the element of control. The IRS test considers the degree of the right to control in the following three categories: (1) behavioral control; (2) financial control; and (3) type of relationship.

13. IRS Test 1
Behavioral control - whether the employer has the right to control how the work is performed
The first factor hinges on whether the employer has the right to control how the work is performed. Training, evaluation systems and detailed instructions about how to perform the job are all indicators that the worker is working under the direction of the employer and is thus likely an employee. For example, if a company provides training for the worker, requires the worker to perform the job during set hours at the company’s premises and requires the worker to perform the work in a certain sequence and according to particular instructions, the worker is probably an employee.

14. IRS Test 2
Financial Control - aspects of the job such as worker’s compensation and reimbursement for expenses
If the worker is paid according to time increments, provided with tools and supplies by the employer and has his or her business expenses reimbursed, the worker is likely an employee.
Conversely, independent contractors are usually paid per job completed, use their own equipment and consider business expenses to be part of their overhead.
The second factor refers to control of the financial aspects of the job such as the handling of the worker’s compensation and reimbursement for expenses. If the worker is paid according to time increments, provided with tools and supplies by the employer and has his or her business expenses reimbursed, the worker is likely an employee. Conversely, independent contractors are usually paid per job completed, use their own equipment and consider business expenses to be part of their overhead.

15. IRS Test 3
Type of Relationship – the way in which the company and the worker perceive their relationship
Indefinitely versus set project or period of time
Key aspect of the business, on-site, integrated into operations
Signed an employment
agreement or received
benefits
The third factor involves the way in which the company and the worker perceive their relationship. If there is an expectation that the worker will provide his or her services to the company indefinitely, rather than for a set project or a specified period of time, the worker is more likely to be an employee. Further, if the work performed is a key aspect of the employer’s business and the worker performs his or her work on-site daily and is integrated into the business operations, the worker is probably an employee. Finally, if the worker has signed an employment agreement or receives employee benefits such as health insurance, retirement benefits or paid vacation, the worker likely has an employee status.

16. IRS Test
[SCALE IMAGE]
Businesses must weigh all of these factors in order to determine whether a worker is an employee or an independent contractor. No set number of factors makes the worker qualify for independent contractor status and no one factor is dispositive. Instead, the employer must simply look at the relationship in its entirety, weigh the various factors and determine whether or not the employer ultimately controls the services the worker performs.

17. Consequences of Misclassification

18. Consequences of Misclassification
Unintentional
Pay employer’s one-half of employee’s FICA taxes
Either 20% or 40% of employee’s share of FICA tax
Either 1.5% or 3% of compensation paid to reclassified employee
Intentional
Criminal prosecution;
Fines up to $10,000 and;
Liable for the full amount of reclassified worker’s income taxes, offset by what worker paid IRS.
If you erroneously classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be liable for fees, back taxes and wages for that worker, including overtime and other benefits. When employers intentionally misclassify workers as independent contractors to avoid paying them required wages under the FLSA, they can face criminal prosecution and fines up to $10,000 and will be liable for the full amount of the reclassified worker’s income taxes, offset by what the employee paid the IRS. For unintentional violations, the IRS may require your business to pay (1) the employer’s one-half of the employee’s FICA taxes, (2) either 20% or 40% of the employee’s share of the FICA tax, and (3) either 1.5% or 3% of the compensation paid to the reclassified employee. 26 U.S.C. § 3509(a)-(b). The higher amounts are triggered if you did not issue IRS Form 1099 for the worker. However, if you have a reasonable basis for failing to treat a worker as an employee, you may be relieved from liability to pay employment taxes if you file all required federal information returns on a basis that is consistent with your treatment of the worker. See Publication 1976, Section 530 Employment Tax Relief Requirements.
Higher amounts are triggered if you did not issue IRS Form 1099
Reasonable basis may relieve you from liability to pay taxes

19. Consequences of Misclassification!
Having a worker sign an independent contractor agreement will not automatically create such status if the worker does not meet the requirements of the tests described above.
Document each of the factors used in coming up with your determination of independent contractor status. !
It is important to recognize that having a worker sign an independent contractor agreement will not automatically create such status if the worker does not meet the requirements of the tests described above. Enhanced steps are being taken to increase employer accountability and combat misclassification through ramped up IRS and DOL investigations of businesses, both large and small, for-profit and not-for-profit. Therefore, after careful application of the relevant tests, if you decide that a worker is indeed an independent contractor it is crucial to document each of the factors used in coming up with the determination.

20. Independent Contractor or Employee Checklist

21. Checklist
Company can direct and control how the worker does the job. -Employee
Company provides extensive training for the worker.
-Employee
Company requires worker to personally perform services and precludes her from delegating work or hiring assistants.
No set hours under which the work must be performed.
-Independent Contractor

22. Checklist Work must be performed on the company’s premises. -Employee
Worker advertises her services and has multiple customers.
-Independent Contractor
Worker is paid according to time increments as opposed to jobs completed.
-Employee
Worker uses her own equipment and considers expenses for supplies to be part of her overhead.

23. Checklist Worker has her business expenses reimbursed by company.
–Employee
Worker is free to seek out other business opportunities Independent contractor
Worker is expected to continue her services for the company indefinitely.
-Employee
Worker receives insurance, retirement benefits or paid time off.
**** No one factor is dispositive when analyzing employee/independent contractor status ****

24. Tips for Using Independent Contractors

25. Tips
Issue a Form 1099 for all independent contractors. This is a requirement, as every auditor will need to see your 1099s.
When advertising for independent contractors, avoid using phrases such as salary, wages, or steady work.
Use contractors who normally advertise their services in some manner. Keep on file any business cards, circulars, or even telephone directory ads.
Avoid requiring the IC to work specific hours. A self-employed individual should have the opportunity to select when and where he will work in relation to all his customers.
Don’t ask the contractor to work at your office or provide them with equipment unless it’s absolutely necessary.

26. Tips
Do not directly reimburse contractors for any expenses they might have, for gasoline, meals, tools, supplies, etc. Such expenses should stand as part of the contractor's set fees.
Don't include contractors under the insurance coverage for workers' compensation, health insurance, or other benefits that are provided for employees.
If possible, pay independent contractors on a per-job basis rather than by the hour, day, or week.
Always ask for an invoice before paying an IC for any work performed. If possible, make checks payable to a company rather than to an individual.

27. Tips
Pay for the IC out of accounts payable. They should not be on the company payroll.
Have a written Independent Contractor agreement. This can demonstrate the validity of an independent contractor relationship, but it isn't conclusive evidence of one.
Don’t exert too much control or supervision over a contractor. Don’t include the IC in employee activities and don’t require the IC to attend regular meetings or conference calls.
Hire contractors who have different clients. Do not limit the worker’s ability to work for other companies.
Don’t give a contractor your employee handbook or ever refer to them as an employee of your business.

28. Questions? Thank You! Sima A. Ali, Esq. T: 631.423.3440C: