WASHINGTON, September 24, 2017 – As our country is looking at immigration reform, tax reform and many other issues that affect employers, it is easy to ignore a large and very significant money issue: the classification of workers. How they are classified can make a huge difference in an employer’s bottom line.
Is a worker an employee, or an independent contractor?
The incentives for employers to embrace the latter category are well understood. It is less expensive, often significantly less expensive, to classify workers as independent contractors.
For independent contractors, employers do not have to withhold income tax, Social Security or Medicare from wages paid. As well, the employer contribution for taxes is not required. Further, employers are not required to provide fringe benefits to independent contractors.
But employers beware: a misclassification can be very costly.
The Internal Revenue Service (IRS), the Department of Labor (DOL) and state governments are cooperating with one another more than ever before on this matter, thus enhancing the ability of the IRS to tax and require employers to pay.
Moreover, besides the IRS, state tax authorities, labor departments, insurance companies, and workers themselves can challenge their current classification. Audits by state agencies frequently occur when “independent contractors” apply for unemployment benefits or Worker’s Compensation.
Workers seeking benefits can file lawsuits against employers who classified them as independent contractors, and many have done so. Workers’ claims can include wrongful discharge, demand for employee benefits such as health, dental and vision insurance, and retirement plan contributions as well. In addition, workers wrongfully classified as non-employees can sue for minimum wages and for overtime pay.
In 2013, cable installation and repair technicians in Florida claimed they were entitled to overtime pay. Their employer claimed that they were not, citing their status as independent contractors. Ultimately the court (Scantland v. Knight) found the technicians were employees, primarily citing the degree of the company’s control over how the work was to be performed as the determining factor.
IRS-initiated legal battles over the classification of employees, and ultimately whether or not the associated taxes must be paid, can be costly to the employer. Fighting and losing a worker re-characterization battle can cripple a business. In addition to the legal costs of defending the existing classification, should a ruling goes south for the company involved, the appropriate taxes must be paid, along with interest and penalties.
The most significant issue in determining the status of a worker is the amount of control the employer exercises; and beyond that, “the right to control” in directing the particulars involved in accomplishing the work. One result is that we see a great deal of analysis involved in the wording of tax court decisions that define who is, and who is not an employee.
In 2014, the Federal 9th Circuit Court of Appeals held that 2300 Federal Express drivers were employees (Alexander v. FedEx Ground) and not independent contractors as Federal Express identified them. The underlying basis for the decision was once again the control component, namely, the fact that Federal Express had the right to control these drivers.
Many employers mistakenly believe that simply having a contract with a worker or workers allows them to classify those workers as independent contractors. Legally, whether a worker is an employee or not depends upon the application of a legal test, not on the existence of a contract.
Domino’s Pizza got hit with a $32 million verdict in Texas in 2013, losing a fight in which the company claimed that their delivery driver was an independent contractor. The driver caused an automobile collision that killed an elderly woman and left her husband permanently brain damaged. Domino’s was sued in this case and defended itself on the basis that the driver involved was not acting as an employee. The court found otherwise.
So what is an independent contractor? The IRS states the general rule is that if the payer has the right to control or direct only the result of the work, and not what will be done and how it will be done, then the worker is not an employee.
But of course, the IRS developed a further list of 20 factors to be considered when classifying workers (Revenue Ruling 87-41). They are as follows:
- Is the worker required to comply with another person’s instructions about when, where and how he or she is to work?
- Is the worker trained by the employer?
- Is the worker an integral part of the employer’s business?
- Services rendered personally. Is the worker required by the employer to render the services personally?
- Hiring, supervising and paying assistants. Is the hiring, supervising and paying of assistants for the worker done by the employer?
- Continuing relationship. Is there a continuing relationship between the worker and the employer?
- Set hours of work. Does the worker have work hours set by the employer?
- Full time required. Does the worker normally work full time for the employer?
- Work done on premises. Is the work performed on the premises of the employer?
- Order or sequence set. Is the order of the work performed by the worker set by the employer?
- Oral or written reports. Is the worker required to submit regular or written reports to the employer?
- Payments by hour, week or month. Is the worker paid by the hour, week or month?
- Payment of expenses. Does the employer ordinarily pay the worker’s business and/or travel expenses?
- Furnishing of tools and materials. Does the employer furnish the worker’s tools, materials and other equipment?
- Significant investment. Has the worker significantly invested in the facilities where the worker performs services?
- Profit or loss. Does the employer pay for the worker’s time, no matter the outcome, protecting the worker from losses or limiting the right to a profit?
- Working for more than one firm at a time. Is the worker only performing services for one employer?
- Making services available to the general public. Does the worker limit services to the employer as opposed to making his or her services available to the general public on a regular and consistent basis?
- Right to discharge. Can the employer discharge the worker?
- Right to terminate. Can the worker quit at any time without incurring liability?
The more “yes” answers to these questions, the more likely a worker is an employee. The list is subjective, but given the increased amount of scrutiny by the government with regard to this issue, it is clear that now more than ever employers should take heed.
Trying to better clarify this issue, that most prolific creator of regulations, the IRS, while indicating the above list is still to be used, condensed the factors to be considered into three categories:
- Behavioral Control. Does the company control or have the right to control what the worker does and how the worker does the job?
- Financial Control. Are the business aspects of the worker’s job controlled by the employer?
- Type of Relationship. Are there written contracts or employee type benefits? Will the relationship continue and is the work performed a key aspect of the business?
The moral of the story: Penny wise can be dollar foolish. If you are an employer, make sure you get it right.
Paul A. Samakow is an attorney licensed in Maryland and Virginia, and has been practicing since 1980. He represents injury victims and routinely battles insurance companies and big businesses that will not accept full responsibility for the harms and losses they cause. He can be reached at any time by calling 1-866-SAMAKOW (1-866-726-2569), via email, or through his website.
His book “The 8 Critical Things Your Auto Accident Attorney Won’t Tell You” can be instantly downloaded, for free, on his website: http://www.samakowlaw.com/book.
Samakow has now also started a small business consulting firm. The website for this business is brand new and Mr. Samakow will be most appreciative of any and all comments. www.thebusinessanswer.com.