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Just how “independent” is that contractor, really?

July 13, 2011

Your small business is doing better than you’d hoped, and you could use a little help.  But you don’t want to pay workers comp insurance, payroll taxes, or other employee-related costs.  And you want to maintain a little flexibility, in case the business trend suddenly shifts.  What’s an entrepreneur to do?  Hire an independent contractor (IC), of course.

Not so fast.  Legally, many ICs are in fact employees.  And there are several taxing and regulatory agencies, not to mention employees, who would be happy to tell you so – and collect back taxes, minimum and overtime wages, and potential criminal penalties.  Defending against a misclassification claim can be expensive, even if you win.

Because this is such an important topic, here are 11 (H/T to Nigel Tufnel) tidbits to keep in mind when classifying employees or ICs.  And since no one likes a complainer who can’t offer a solution, there are also a few tips for employers who want to limit their liability risk.

1.  Labels mean nothing.  You can call the worker whatever you want.  The worker can even call herself an independent contractor (at least, she can until she sues you for overtime).  It doesn’t matter.  The label an employer (er, principal) applies doesn’t matter, and can be challenged at any time.

2.  Workers are employees until you prove otherwise.  Employers start out of the box losing this battle.  California (and most other) courts presume someone doing work for you is an employee.  You disagree?  Fine.  Prove it.

3.  The test is ridiculously complex and fact-specific.  There are different legal tests for different circumstances (IC for FLSA purposes? for workers comp purposes? for payroll tax purposes? for ERISA? you get the picture), but each of them is incredibly lengthy and difficult to apply.  The leading cases from the US Supreme Court and from California identify no less than twelve separate factors that bear on the employee/IC question.  Each of those cases allow for other factors to be considered, too.  It is incredibly difficult to apply each of those factors prospectively to a particular worker.  It is impossible to predict how a jury will apply them after-the-fact.

4.  The question is virtually always up to the jury.  Did I say fact-specific?  A recent Ninth Circuit case held that the inquiry whether a worker is an employee or IC necessarily requires weighing of facts.  And judges don’t do that, juries do.  There are no summary judgments in employee/IC cases.  You’re going to trial.

5.  If the worker is at will, she’s an employee.  The California case came darn close to saying that workers who can be fired without cause are all employees regardless of how the other factors work out.

6.  Employees are paid by the hour, ICs by the project. This is not a hard and fast rule — none of them are, for that matter — but workers paid by the job are more likely to be considered ICs than workers paid by the hour.

7.  Who brings the tools?  ICs bring their own tools to the job, whether those tools are saws or sketchbooks or stethoscopes.  Employers provide tools for employees to use.  If the worker types on the employer’s computer and makes calls on the employer’s phone, both of which are sitting on the employer’s desk, you’d better believe she is an employee.

8.  Who makes the rules?  Employers tell employees not only what to do, but how to do it.  Show up at 9, don’t leave before 5.  Answer your phone before the third ring.  Wear a uniform.  All those rules indicate an employee.  ICs, on the other hand, deliver results, and it shouldn’t matter how they do it — they can dress in a suit or their pajamas and work from 9-5 or 3-11.

9.  Does the worker work for anyone else?  Exclusivity is a sign of an employment relationship.  If your IC is only working for you, she is probably not an IC.  ICs run their own businesses and work for more than one client.  (Not necessarily at the same time, but definitely over time.)  By the same token, the longer the relationship (especially an exclusive relationship), the more likely the worker is an employee.

10.  Is the worker doing what your business normally does?  ICs are more likely to be brought in to take care of special tasks not normally required for your business.  Thus, the lawyer who represents you in the lawsuit you’re filing is an IC.  But the clerk who helps you with your office filing is not.

11.  Regulators, courts and employees have a vested interest in finding an employment relationship.  Because they are all likely going to get more money from you as a result.  So if you do retain an IC, be cautious about how you do it, and recognize that there are no guarantees.  No matter how careful you are, there is virtually always room for argument.

Tips to avoid misclassification problems:

1.  Use carefully drafted written contracts with all ICs.  Make sure the contracts set out why the relationship is properly principal-contractor rather than employer-employee.  Avoid using words like “employer” and “employee.”  Carefully consider (with another ICs help, like a lawyer or HR consultant) limiting or eliminating an at will relationship — with a 30-day termination notice period, perhaps.  Make sure the contract says the IC will pay her own taxes, obtain her own benefits, and pay her own expenses (subject to reimbursement if you like).

2.  Give the IC room.  Give the IC as much discretion as you can over day-to-day work.  Let her decide when and where to work and what to wear.  Make sure she brings her own equipment.  If the IC wants to hire others to do the job, let her, if you can.  Focus on the result the IC is supposed to deliver rather than how the IC delivers it.

And, last but definitely not least,

3.  Accept the inevitable.  If it’s even a close case whether your new hire is an employee or an IC, consider her an employee.  Pay the taxes and overtime.  Buy the workers comp insurance.  It’s far less than you’ll pay if you have to fight it out — with three years’ worth of overtime and payroll taxes riding on it — down the road.

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From → Wage and hour

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