Personnel
Independent Contractor or Employee? The Pitfalls of Employer Misclassification
By taking a second look at how you are classifying your Independent Contractors, you can determine whether or not you are in line with the Department of Labor’s requirements and avoid any costly penalties.
Steven B. Horowitz
Here is a hypothetical for everyone to consider: You are the owner of a garbage company, XYZ Sanitation, Inc. Like most business owners, your payroll tax burden is substantial, and is one of the factors that is significantly reducing (or eliminating) your profit margin. As part of your strategy to reduce this tax burden, you make the business decision to approach some, or all of your employees, telling them that effective immediately you will not withhold taxes from their paychecks, and will instead list them as “Independent Contractors” on your records. Or maybe a single employee or group of employees approaches you, and requests that you pay them as “Independent Contractors” and not withhold taxes from their paychecks (as a proposed benefit to both you and them).
New Developments
When it comes to wage and hour matters, everyone is usually doing “something” wrong that may end up costing a business tens of thousands of dollars, if not substantially more. The Department of Labor (DOL) (both Federal and the State in which you conduct your business) has enacted a number of laws related to the money that workers of your business are to receive. Recently, two developments have arisen in the Federal Sector that requires every employer in the refuse collection and recycling industry to reassess how they operate their business. The first is that the DOL and the Internal Revenue Service (IRS) have targeted Employer Misclassification of Independent Contractors as a top enforcement priority. In addition to this enforcement mandate by the DOL and IRS, the DOL has also taken steps to enact Rules that would require companies to carry out a written analysis of a worker’s status, and to also disclose that status to the worker and keep a record of the analysis in its files. The DOL’s proposed 2011 budget also seeks increased spending on enforcement, and for grants to States to help them deal with these misclassification issues as it relates to unemployment insurance programs.
Second, the Senate, through Senator Sherrod Brown (D-Ohio), has introduced a bill (“Employee Misclassification Protection Act” or “EMPA”) that would crack down on this classification of workers as Independent Contractors, when these workers are actually employees. The bill would also affirmatively state that such misclassifications would be a violation of the Fair Labor Standards Act (FLSA) (which misclassification of workers alone is not currently a violation of), and would increase penalties for companies that misclassify workers.
Why a new interest in this misclassification issue? The answer is simple: we are living in an age of deficits of trillions of dollars. By misclassifying employees, the Federal government is being denied taxes (i.e., revenue). Additionally, Independent Contractors are currently denied items such as minimum wage, overtime, workers’ compensation, unemployment and retirement benefits. Therefore, any means with which the Federal government can use to obtain additional money into the Treasury in an attempt to deal with this deficit is going to be pursued and aggressively enforced.
Establishing Employee/Employer Relationships
The classification types used by the refuse collection and recycling companies in this industry remain relatively constant. In addition to the officers, directors and clerical individuals used by companies, refuse collection typically focuses on drivers, helpers/lifters, mechanics and welders. Recycling operations will also employ classifications such as pickers, sorters, machine operators (including bailers and hi-lo operators) and generic laborers.
If the individuals that are paid by your company are listed as “employees”, then at a minimum they should be receiving $7.25 (the minimum wage rate in the United States), time and one-half for all hours worked over 40 (overtime) and the appropriate taxes withheld from their remuneration. If you are doing this, you can stop reading this article.
However, for those of you that have individuals that are paid as “Independent Contractors”, this is where you need to start reviewing your corporate policies and procedures. The DOL uses the “Duck Theory”: if it walks like a duck, and acts like a duck, it’s a duck. In this regard, the relationship of employer and employee exists when the person or persons for whom the services are performed have the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also to the details and means by which the result is accomplished (i.e., as to how it shall be done). If an employer/employee relationship exists, the designation or description of the relationship by the parties as anything other than that of employer and employee is immaterial. Thus, it is of no consequence that the employee is designated as a partner, agent, independent contractor, etc. No one is controlling; rather, the Courts will look to the overall context of the relationship. There have been 20 factors/elements that have been identified as being indicative as whether an employer/employee relationship has been established:
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Instructions: A worker who is required to comply with other persons’ instructions about when, where and how they are to work is ordinarily an employee. This factor is satisfied when management has the right to require compliance with instructions.
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Training: This goes beyond merely requiring an experienced worker to work with the worker but extends to requiring the worker to attend meetings, or wanting certain services performed in a particular method or manner.
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Integration: This shows that the worker is subject to direction and control when the worker’s services are integrated into the business operations.
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Services Rendered Personally: Services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.
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Hiring/Supervising/Paying Assistance: If management for whom the services are performed hire, supervise and pay assistance, that factor generally shows control over the workers on the job.
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Continuing Relationship: A continuing relationship between the worker and management for whom the services are performed indicates that an employer/employee relationship exists. This applies to work that is performed at frequently reoccurring although irregular intervals.
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Set Hours of Work: The establishment of set hours of work by management for whom the services are to be performed is a factor indicating control.
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Full-Time Required: If the worker must devote substantially full-time to the business of the employer for whom the services are performed, such indicates control over the worker. Conversely, an independent contractor is free to work when and for whom he or she chooses.
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Doing Work on Employer’s Premises: If the work is performed on management’s premises, that factor suggests control over the worker, especially if the work could be done elsewhere. While work done off the premises indicates some freedom from control, this fact by itself does not mean that the worker is not an employee. This is due to the fact that control over the place of work is indicated when the management has the right to compel the worker to travel a designated route, to canvas a territory within a certain time, or to work at specified places as required.
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Order of Sequence Set: When the worker is not free to follow the worker’s own pattern of work, but must follow the established routines and schedules of management, the worker is deemed an employee.
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Oral or Written Reports: A requirement that the worker submit regular or written reports to management indicates a degree of control.
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Payment by Hour/Week/Month: This generally shows an employer/employee relationship; however, payment made by the job or on straight commission generally indicates that the worker is an independent contractor.
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Payment of Business and/or Travel Expenses: If management ordinarily pays the worker’s business and/or travel expenses, the worker is ordinarily an employee.
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Furnishing of Tools and Materials: When management furnishes tools and other equipment, an employer/employee relationship is presumed.
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Significant Investment: When the worker invests in facilities that are used by the worker (i.e., paying a fair market rent to the management), there ordinarily is an independent contractor relationship. Conversely, a lack of investment indicates an employer/employee relationship.
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Realization of Profit/Loss: If the worker has the risk of realizing a profit or loss as a result of that worker’s services, then there is an independent contractor status, but the worker who cannot is an employee.
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Working for More than One Firm at a Time: This factor is indicative of independent contractor status.
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Making Service Available to the General Public: This factor is indicative of independent contractor status.
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Right to Discharge: The right to discharge a co-worker is a factor indicating that the worker is an employee.
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Right to Terminate: If the worker has the right to end his or her relationship with the person for whom the services are performed at any time without incurring liability, that factor indicates an employer/employee relationship.
These 20 factors are significant in that they represent a blending of Labor and IRS laws. However, in so stating, each of the 20 elements can be boiled down to one simple word: control. The more control that an employer is able to impose on an Independent Contractor, the more likely that an Independent Contractor will be ultimately deemed to be an employee. Therefore, if the employer uses a packer/roll-off driver as an Independent Contractor, but the Employer sets times for start/finish of the route, provides the truck for the driver to perform the work in, the driver performs driving duties only for this particular company (or primarily for this particular company), then the driver is misclassified, and should be made an employee as soon as possible. Conversely, many transfer/recycling stations use tractor/trailer drivers who own and operate their own equipment for hauling of materials to landfills, etc. The likelihood of a tractor/trailer driver being considered an Independent Contractor is increased if the tractor/trailer driver has formed his or her own company, files a separate tax return, owns the tractor/trailer, pays the appropriate workers’ compensation and withholds the appropriate FICA/FUTA taxes. Problems in this tractor/trailer scenario arise when the driver is operating the tractor/trailer of a company that is owned by the collection/recycling entity.
Risks and Penalties
Currently, under DOL/IRS guidelines, a company may be subjected to substantial unanticipated risks and penalties for the misclassification of a worker as an Independent Contractor. These risks and penalties include retroactive unemployment insurance contributions (FUTA) and social security (FICA); back payroll taxes, interest and penalties, wage and hour obligations for failure to pay overtime, and potential liability to third-parties for acts of the worker that occured within the scope of their duties to the company. In addition to the liabilities listed above, the new EMPA Statute would further require civil penalties ranging from $1,001 to $5,000 per employee for any misclassified employees, and would subject employers to additional audits by the Federal government. The Statute also seeks to require employers to provide written notice to each individual hired as an Independent Contractor making them aware of their status as an Independent Contractor, directing the employee to the DOL Web site (which would provide additional information of their rights), provide the address and telephone number of the local DOL Regional Office, and any other notifications as may be required by the DOL. From a legal perspective, the failure by the employer to satisfy the EMPA Statute’s record keeping and notice requirements will create a presumption that any individuals listed as an Independent Contractor are actually employees. This will shift to every Employer the burden to prove that someone is not an employee, a significant burden to accomplish.
Minimizing the Penalties
What should companies do to minimize the penalties and liability if they erroneously treat workers as Independent Contractors? The answer here is simple: the employer must “unscramble the egg” and retroactively re-compute the compensation paid to this individual for the work that they performed, and make the appropriate tax/contribution payments. At a minimum, an employer should immediately adjust their pay practices to reflect that the worker is actually an employee moving forward. Additionally, it is never too late to draft a thorough Independent Contractor Agreement (which specifically refers to the 20 components listed previously) in order to support the analysis that a worker is an Independent Contractor. However, keep in mind the “Duck” theory that was referred to previously. Federal agencies will not look at the mere letters on a page when it comes to classifying a worker. Rather, they will look at the actual performance of the worker in making a determination of Independent Contractor/employee status.
Most importantly, when in doubt, a Labor and Employment Law Professional should be consulted for purposes of examining and, if necessary, adjusting a worker classification practice to ensure compliance with the existing (and future) Federal and State laws.
Steven B. Horowitz is the founding member of the firm of Horowitz Law Group, LLC, and limits his practice to the representation of management in labor and employment matters. Steven’s expertise in employment law includes litigating State and Federal cases on behalf of employers involving, but not limited to, Title VII, the ADA, the ADEA, OHSA compliance, the Fair Labor Standards Act, ERISA, the Davis Beacon Act, various State Laws Against Discrimination, CEPA, Wage an Hour, and the prevailing Wage Act; and preparing personnel handbooks and policies involving issues such as drug and alcohol testing, absenteeism and leave of absence. He lectures frequently at Waste Expo on employment-related issues and is consistently selected as one of the Top One Hundred Labor Attorneys in the United States by the Labor Relations Institute. Steven can be reached at (973) 226-1500 or via e-mail at [email protected].