Independent Contractor or Employee: Agencies are cracking down on retailers - Oct 2015
By Bradford G. Harvey
Agrowing portion of the workforce is classified as independent contractors, rather than employees, and both the employer and the worker often prefer this classification. The government and plaintiffs’ attorneys, however, beg to differ and have made the issue of independent contractor misclassification a multi-million dollar, and perhaps multi-billion dollar, business.
This issue should be of particular concern for the flooring installation industry, given its tendency to rely on independent contractors. Floor Focus’ 2015 Retailer Survey found that 78% of independent flooring retailers work as independent contractors, and a recent U.S. Government Accountability Office (GAO) survey found that 85% of independent contractors “appeared content with their employment type.” Despite the contentment of workers self-described as independent contractors, the IRS has declared that “the misclassification of employees as independent contractors is a nationwide problem affecting millions of workers that continues to grow and contribute to the Tax Gap.”
There are substantial risks involved with potential misclassification, and the battle is being waged on many different fronts. Retailers need to be aware of the applicable tests for independent contractor status and actively reduce risks when they use independent contractors or reclassify workers as employees.
RISKS OF MISCLASSIFICATION
There are advantages to classifying workers as independent contractors, including potentially lower costs, staffing flexibility and less susceptibility to lawsuits. Moreover, if the employer is happy and the workers are happy, as the GAO reports, one may wonder what the problem is. Although it may be tempting to classify employees as independent contractors, retailers should be aware that there are a myriad of risks in doing so.
• Unpaid minimum wages, overtime, and liquidated damages under the Fair Labor Standards Act (FLSA), which may be difficult to contain given the lack of clear records of hours worked.
• Unpaid federal taxes based on lack of W-2 withholdings.
• Unpaid state unemployment compensation insurance withholdings.
• Unpaid state workers’ compensation insurance withholdings.
• Unreimbursed employee expenses.
• Failure to provide benefits to which employees would be entitled.
• Coverage under the Affordable Care Act.
• Targeting by unions seeking to bring independent contractors under coverage of the National Labor Relations Act (NLRA) as employees.
• Due diligence concerns when a business is being bought or sold.
DEPARTMENT OF LABOR CHALLENGES
The Department of Labor (DOL) has been tightening the screws on employers misclassifying workers as independent contractors for several years now. In September 2011 the DOL launched a Misclassification Initiative to target wage and hour violations that would apply under FLSA if independent contractors were properly classified as employees. Also in September 2011, the DOL entered into a Memorandum of Understanding with the IRS by which the agencies share information and work together to reduce misclassification.
In 2012 and 2013, the DOL hired 300 additional investigators, and in the fiscal year 2014, the Wage and Hour Division conducted investigations resulting in $79 million in back wages for more than 109,000 workers.
This July, the DOL issued an Administrator’s Interpretation addressing what it believes to be a growing problem of employees being misclassified as independent contractors. In order to combat the “problematic trend” of misclassification, the Interpretation applies the FLSA’s broad definitions of employment—under which “most workers are employees”—along with the “economic realities” test, which is to be analyzed in light of the FLSA’s intended expansive coverage for workers. Because of the DOL’s crackdown on misclassification, employers should be careful before slapping the label of independent contractors on its workers.
In this Administrator’s Interpretation, the DOL rejects the common law “control test,” which essentially looks to whether the employer exercised extensive control over the employee’s work. Instead, the FLSA definition of employ—“to suffer or permit to work”—and the “economic realities” test are used to provide broader coverage. This test is premised on the idea that independent contractors enjoy economic independence through the management of their own business, whereas employees financially depend on their employers.
There are six factors of the economic realities test. These factors are not to be applied mechanically, or as a checklist, but in relation to one another in order to determine whether the worker exercises economic independence and is in business for himself. Keep in mind that the DOL’s goal is to broaden the scope of employment, so the “economic realities” test is liberally construed to give broad coverage to employees.
The extent to which the work performed is an integral part of the employer’s business: If a worker’s job duties are integral to the business, then the worker more likely will be economically dependent on the employer. Generally, courts find this factor to be of great weight. Why would a business hire an independent contractor to perform work that can be completed by its own employees? Note that the work can be integral to the business even if it is only one component of the business and even if is not performed on the employer’s premises.
The Administrator’s Interpretation provides the example of a construction company that frames residential homes. A carpenter would be an integral part of the construction company because carpentry is an essential role to providing that service. Conversely, a software developer who created software to assist the construction company in tracking its bids, scheduling project and crews, and tracking material orders is not performing work that is integral to the business.
The worker’s opportunity for profit or loss depending on his or her managerial skill: An independent contractor’s opportunity for loss or profit largely turns on his or her managerial skills relating to decisions concerning whether to hire employees, what equipment or materials to purchase, whether to advertise, and how to market and develop the business. On the other hand, an employee’s opportunity for loss or profit depends on the employer’s management of the employee’s work hours and work assignments. Although an employee may be free to work extra hours to increase his or her income, the employee has no decision-making authority concerning advertising, marketing, or other aspects connected to the ultimate profitability of a business.
To illustrate this point, consider a worker who provides installation services for carpet retailers. The worker performs assignments only as determined by the carpet retailer and does not independently schedule assignments, solicit business from other clients, advertise his or her services or endeavor to reduce costs. The worker does regularly agree to work additional hours or job assignments in order to earn more. This worker does not exercise managerial skill that affects his or her profit or loss. And the worker’s earnings may fluctuate on the availability of work and willingness to work more, but the lack of managerial skill indicates that the relationship is one between an employer and employee.
The extent of the relative investments of the employer and the worker: For a worker’s business to exist independently of an employer’s, a worker must invest in his or her business, and, accordingly, undertake some risk of loss. Installers who invest in their own tools and equipment are not necessarily independent contractors. The worker’s investment is not considered in isolation, but relative to the employer’s. If the worker’s investment is minor compared to the employer’s investment, then the worker likely is economically dependent on the employer.
For instance, if an installer invests $1,000 in tools but the employer spends $100,000 on advertising, operating expenses and materials, then the installer’s minor investment in tools does not indicate economic independence.
Whether the work performed requires special skills and initiative: A worker’s business skills, not technical skills, are relevant to the determination of independent contractor status. Technical skills do not indicate that workers are in business for themselves. Rather, a worker must use business judgment and initiative to establish and maintain economic independence.
For these reasons, a worker’s ability to install flooring is not indicative of independent contractor status, because these skills do not demonstrate business skills, judgment or initiative. Installing flooring requires technical skills that can be accomplished by an employee. However, the management of an installment business, including decisions to market services, order additional materials and hire workers, requires business skills and initiative, which are significant to the classification of a worker as an independent contractor.
The permanency or indefiniteness of the relationship: A definite, short-term contract suggests that the worker is an independent contractor. Independent contractors are engaged to complete a task, often by a specified deadline. On the other hand, employer-employee relationships usually are more indefinite (for instance, an at-will employee). But again, this factor is not conclusive, and the overarching theme of “economic independence” influences this assessment. Indefiniteness due to “operational characteristics intrinsic to the industry” (e.g., seasonal workers or part-time workers) relates more to the nature of the profession and not to the employee’s business skills and judgment.
Consider an installer who has worked intermittently with several different flooring retailers, markets his services, negotiates rates for each job and turns down work for any reason. This installer exemplifies the lack of a permanent or indefinite relationship with any one retailer. Alternatively, receiving work from only one retailer, completing all of the work the retailer allocates to the worker and performing the work to the specifications of the employer indicates an employer-employee relationship.
The degree of control exercised or retained by the employer: Although the Administrator’s Interpretation does not apply the common law control test, the economic realities test still factors in the degree of control exercised by the employer. But be aware that the IRS still applies the control test and will find that an individual is an employee if the employer has the right to control or direct the result of the work and what will be done and how it will be done.
Still, to be an independent contractor under the economic realities test, an individual must control meaningful aspects of the work. Control over what work to perform and how to perform the work evidences the running of a business. Nevertheless, an employer’s lack of direct control over an employee or an employee’s flexible work schedule are insignificant to the analysis when the employee fails to exercise control over decisions relating to the management of a business.
For example, an installer who controls all aspects of the installation of flooring at the worksite is not an independent contractor if he relies on the retailer to make decisions concerning marketing, what jobs to take, what equipment to purchase and other major business decisions. Again, showing economic independence is key. If an installer not only controls the work at the worksite, but also takes on as many or as few clients as he wishes and negotiates his own wage rate and schedule, then the “control” factor will weigh in favor of him being found as an independent contractor.
CHALLENGES FROM THE IRS
State and federal agencies want workers to be classified as employees largely for financial reasons. More employees translates to more tax and insurance money. In 2006, for example, the GAO estimated that independent contractor misclassification cost the federal government $2.72 billion in revenue that year, and the U.S. Treasury Department estimated that a provision in President Obama’s 2013 budget to prevent misclassification would produce $8.32 billion in additional revenue over a decade.
Classification as employees also makes it more difficult for workers to hide their income to escape paying income taxes. As a result, the IRS has been chasing the money by more closely scrutinizing independent misclassification.
In 2011 the IRS announced a Voluntary Classification Settlement Program (VCSP) to limit past tax exposure. The VCSP does nothing to limit exposure in other areas, though, and has not been widely used. And in 2014 the IRS launched a campaign to promote its SS-8 program, by which workers may initiate an IRS review of their classification.
While the IRS refers to a 20-factor “common law” test, it has grouped these factors into several categories.
Behavioral: Does the employer control or have the right to control what the worker does and how the worker does the job? An employee is generally subject to the employer’s instructions on when, where and how to work.
Financial: Does the employer control the business aspects of the worker’s job? These include, as examples, how the worker is paid, whether expenses are reimbursed and who provides tools and equipment.
Type of Relationship: Are there written contracts or employee benefits? Will the relationship continue, and is the work a key aspect of the business?
Section 530 of the Revenue Act of 1978 also offers a “safe harbor” provision for liability for past employment taxes if specific requirements are met.
Reporting Consistency: The employer must have filed all required federal tax returns consistent with its past treatment.
Substantive Consistency: The employer must have treated the workers and any similar workers all as independent contractors.
Reasonable Basis: The employer had a reasonable basis for not treating the workers as employees, such as a court case or an IRS ruling or audit.
Note, though, that Section 530 relief only applies to liability of the employer for past employment taxes, and not other areas of exposure or future classification of the worker.
CHALLENGES FROM STATE AGENCIES
The DOL and IRS also have bolstered state agencies’ efforts to crack down on independent contractor misclassification. The 2012, 2013 and 2014 federal budgets have included $10 million for the DOL to distribute to state agencies to increase enforcement efforts. And as of May 2015, 21 states had signed Memoranda of Understanding to work with the DOL as part of its Misclassification Initiative. At least 37 states have signed Questionable Employment Tax Practices (QETP) program memoranda of agreement with the IRS as well.
State agencies’ enforcement efforts have in some cases focused on flooring installers. The New Jersey DOL has focused on auditing the independent contractor classification of flooring installers. And the state of Washington, in listing “examples of directing and controlling the work” that would make a worker an employee, describes as its first example: “A flooring retail store contracts with an owner-operated flooring installation business to install vinyl flooring and carpeting in its customer’s house. The store’s sales representative comes to the house during the installation and tells the installer to use the rep’s tool and where to put the seams.”
Independent contractor misclassification can deprive states of unemployment compensation and workers’ compensation insurance premiums. Many states employ what is referred to as the “ABC” test, which considers whether three requirements are met: (A) the individual is free from control and direction with the performance of duties; (B) services are performed either outside the usual course of business for which such services are performed or outside all places of business of the company for which the services are performed; and (C) the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the services.
CHALLENGES THROUGH PRIVATE LAWSUITS
The plaintiffs’ class action bar has taken note of the trend toward disallowing independent contractor classification and increasingly has filed class action lawsuits. These cases seek damages based on such theories as unpaid overtime, unreimbursed expenses and deprived benefits.
Earlier this year Lowe’s entered into a $6.5 million class action settlement based on claims that it has misclassified home improvement installers as independent contractors. And just last month a California federal court certified a class action against Uber Technologies that threatens its core business model. Also, Federal Express has entered into a $227 million proposed class action settlement (not yet finalized) in a lawsuit asserting independent contractor misclassification.
MAINTAINING INDEPENDENT STATUS
Even the DOL and the IRS would concede that not all workers are employees or need to be labeled as such. Still, retailers need to consider the factors of the tests outlined above before deciding whether to classify an installer as an employee or independent contractor. If retailers want to continue using installers who will satisfy the definition of independent contractor, then there are certain precautions and steps that a retailer should take in order to avoid an employer-employee relationship. Because all of the circumstances surrounding the relationship will be analyzed, not one single factor will establish economic independence.
Deciding whom to hire: Hire independent contractors who have incorporated their own business. Although not determinative, it places the corporation between the hiring business and the worker—you pay the worker’s corporation, which pays the worker. Also, do not hire the same independent contractor for every project. Although you may have a favorite installer, try to spread the work around to others.
Let the contractor act like a contractor: If an installer collects a fee from a homeowner and gives the carpet company that sold the carpet a referral fee, this structure will look more like an independent contractor arrangement than if the carpet company collects money from the homeowner and then dispatches the installer to whom it pays a fee.
The installer should be free to work for other flooring retailers or home improvement companies, and the installer should have its own identity, rather than just wearing the uniforms of the carpet company and driving a van with the carpet company’s logo.
Developing a contract: Do not require the contractor to complete an employee application. The contractor should complete Form W-9, Request for Taxpayer Identification Number and Certification.
Develop a written agreement with an assigned specific scope of work for a specific duration, and do not give the independent contractor new work after the original project is completed without signing a new agreement. Require payment to be rendered upon completion of a certain task or job, and do not pay by the hour, week or month unless a flat fee is agreed to be paid at regular intervals.
Do not pay contractor expenses. Businesses pay their own expenses. Contractors should factor expenses into the cost of the entire job.
Work to be performed: Do not have contractors perform similar work to that of employees or perform routine work. Contractor work should not be close to core business operations or else it may be considered “integral” to the business.
Overseeing the work: Do not greatly limit an independent contractor’s role in any hiring, disciplinary action or termination decisions, and do not supervise how the work is done in any detail. Do not allow the independent contractor to work at your office unless the nature of the services requires it, and do not establish the independent contractor’s working hours.
Maintaining records: Keep records concerning the independent contractor determination process. Maintain records of business licenses, business cards and work plans that show engagements of limited duration and correspondence from the contractor, and retain records of all transactions with the contractor, including contractor’s invoices for billing.
Companies should periodically check to make sure workers have not moved across the line from independent contractor to employee. Review the contract and confirm that the independent contractor is working within the scope of the contract, soliciting work from other businesses and exercising independent business judgment. A retailer should give a worker enough space so that he maintains economic independence.
For some companies, the greater control allowed under an employee relationship may be a better fit. If that is the case, simply having an independent contractor agreement and issuing a Form-1099 will not make the issue go away. You can call a shark a guppy, but it can still bite. The employer should classify its workers properly to manage legal risks while serving its business needs. If an employer needs to reclassify certain workers, it should consider how it does so in order not to further increase risks. As always, consult with legal counsel for guidance on your particular circumstances.
FLOORING INSTALLER CASES
The flooring installer industry has not been immune from scrutiny. Several recent cases provide insight as to the risks involved and key factors in analyzing independent contractor status.
Copyright 2015 Floor Focus