Independent Contractors? Beware the Pitfalls of Mis-classification
© Bob E. Lype, 2001
An independent contractor is not an employee... or is he? If it's a close question, there are risks to how you classify your independent contractors.
You've heard the old saying: if it walks like a duck, and quacks like a duck, and even looks like a duck, then chances are pretty good that it's a duck. In a sense, the same can be said of your employees – and maybe more importantly, your independent contractors.
In various situations, employers frequently use independent contractors to perform part of their customary work. There are many reasons employers may utilize contract labor instead of their own employees, some of which are financial, such as to avoid having to pay fringe benefits, or workers' comp coverage, or the employer's share of tax withholdings, or overtime. These can be legitimate considerations. But because of the potential savings involved, sometimes employers slip into the trap of classifying their employees as independent contractors – and when they do this improperly, there can be serious financial consequences.
For example, a number of grocery store chains in the northeast were recently sued by workers who were classified as independent contractors, but who claimed they should have been treated as employees. The stores contracted with a couple of "independent companies" which provided laborers to deliver groceries, or to stock shelves and bag groceries. The stores did not recognize the workers as employees. They were paid as little as 75 cents an hour for their work, and they were paid no overtime, even though they often worked as much as 84 hours in a week. A class action lawsuit was filed against the grocery store chains last year.
But not all cases involve blatant examples of worker exploitation. Recently Microsoft agreed to pay $96.9 million to as many as 12,000 mis-classified employees. Microsoft classified the employees as independent contractors or "freelancers." The workers were hired on to perform specific projects, and some of them had been working on their projects for a number of years. Many workers were fully integrated into Microsoft's workforce, working alongside the company's regular employees, under the supervision of the same supervisors, and performing nearly identical functions of regular employees.
Microsoft's troubles began (as they do for many employers) when the IRS performed an audit to determine whether the company was in compliance with federal tax laws. The IRS applied its tests for independent contractors, and it found that the workers in question were really employees – so Microsoft had to pay overdue taxes and issue retroactive W-2 forms. Then the employees, armed with the IRS's decision, filed a class action lawsuit demanding the same pay and benefits which the "employees" had received (medical benefits, pension and retirement benefits, etc.).
Needless to say, mis-classification can have dire financial results for an employer. Often things will start out with something fairly routine and innocuous, such as a supposed "independent contractor" making a claim with the Department of Labor for unpaid overtime. Then suddenly the IRS becomes involved, or a whole group of independent contractors gets wind of the claims. Quickly things can spin out of control, from the employer's perspective.
As noted above, independent contractor status can have a significant impact on an employer's tax obligations, and mis-classifying an employee as a contractor can lead to the employer owing significant back tax obligations. Therefore the IRS guidelines are critical. But in addition, the Department of Labor guidelines will determine whether a so-called contractor should have been paid overtime, or whether he should have received employment benefits. The Department of Labor's guidelines will also determine whether a so-called contractor is an employee for purposes of various employment discrimination laws, including whether the worker was an employee entitled to pursue a claim, or whether the worker should be counted in determining whether the employer has enough employees to trigger coverage. The state's "common law" will usually determine whether a so-called contractor is actually an employee entitled to workers' compensation coverage, or perhaps whether the employer can be held liable for the negligent acts of the worker.
Unfortunately, there are no bright lines in deciding when an independent contractor becomes an employee. As discussed above, there are different "tests," factors and criteria utilized by different government agencies, and courts decide these situations on a case-by-case basis. This can lead to some confusion for employers, as well as inconsistent decisions under factually similar circumstances.
The following factors are based upon a combination of the various "tests" described above. If your business utilizes independent contractors, you should periodically ask these questions about the workers. If the answers do not leave you with a clear sense that the worker is an independent contractor, it would be worthwhile to seek specific legal advice regarding these matters.
- How much skill is required to perform the job? The work of contractors frequently involves a higher degree of skill.
- Where is the work performed? In some cases, a contractor may be able to perform work either at the employer's business or away from it.
- What is the duration of the relationship? If the worker has been on the job a long time, he looks less like a contractor.
- How is he paid? Most often a contractor is paid to achieve a particular result, regardless of how much or how little time is spent. If he is paid by the hour, rather than "by the job," this could mitigate against a contractor relationship.
- Who provides the tools necessary to perform the job? Frequently a true contractor will provide his own tools, and the more you provide the tools of the job, the less the worker looks like a contractor.
- Who decides when and how long the worker works? Once again, a contractor is frequently retained to achieve a result, without specific guidance over exactly how and when the work is done. The more these things are left to the control of the employer, the more the worker looks like an employee.
- Is the worker free to also perform the same tasks for another employer? If so, then he looks more like a contractor and less like an employee.
The overriding factor is one of "control." The more the employer controls the details of how and when the work is performed, the more the worker looks like an employee, rather than a contractor. And it really doesn't matter what the parties call the relationship – a court or government agency will look to the realities of the situation.
Employers should not be afraid to use independent contractors, when warranted. There are valid and legitimate reasons to do so. But employers should carefully consider the impact of their classifications.