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Vol. 72, No. 7, July 1999 |
Are Your Independent Contractors
Truly Independent?
While using independent contractors can help businesses
contain employee-related costs, misclassifying employees can
result in significant financial liability.
By Jordan W. Siev & Kirsten
M. Eriksson
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independent contractors to perform work once done by traditional
employees is widely recognized as an effective cost-cutting measure.
Independent contractors, or "temporary" workers, need
not be included in benefit plans, and they carry a lesser tax
liability than regular employees. Also, their numbers can be
easily expanded and contracted to meet changing needs. While
this relationship can be mutually advantageous, it also can subject
the hiring company to significant liability if the independent
contractors should have been classified as employees and awarded
traditional benefits.
Does
this seem like an unlikely scenario? Just look at Time Warner
and Microsoft, two of the best-known companies involved in recent
lawsuits challenging their treatment of certain workers as independent
contractors. Time Warner has been sued by the U.S. Department
of Labor, which is seeking to remove plan fiduciaries and to
require payments to workers excluded from benefit plans. Microsoft
was subjected to an IRS audit and forced to pay back taxes for
improperly classifying workers as independent contractors. The
IRS also could have required interest payments and imposed penalties
on Microsoft. Indeed, between 1988 and 1995, the IRS reclassified
500,000 "free-lancers" as employees, and levied $830
million in back taxes and penalties against various entities.
The danger does not end with the government. After the IRS
audit, Microsoft was faced with an ERISA-based class action lawsuit
by workers who were not treated as employees and who successfully
sought to obtain employee benefits from which they were excluded.
Such claims can result in large payments of back benefits and
steep statutory penalties.
Thus, to avoid the perils faced by Time Warner, Microsoft,
and others, lawyers should ensure that their own business entities
and those they counsel correctly classify workers as independent
contractors. This article examines the factors considered in
determining whether a worker is an independent contractor or
an employee, and provides some practical tips to help protect
businesses from the dangers of misclassification.
Employee or Independent Contractor: The Test
Many state and federal laws that require a determination of
whether a worker is an "employee" use the common law
definition of employee.
The fundamental characteristic of employees under the common
law is that their employer has the right to control the manner
and means by which their work is performed. Obviously, a certain
amount of control by a company is inevitable in all employee
and independent contractor relationships. However, the determinative
factor is whether, under all the circumstances, the company has
the right to control not only what work is to be done, but how
it is to be done. That the company does not actually exercise
this right is irrelevant; all that matters is that the right
exists.
The question of control, while simple in theory, is difficult
to assess in practice. One of the most complete analyses of the
common law test is contained in the IRS training materials, which
are used as a guide in this article. These materials focus on
three categories of evidence - behavioral control, financial
control, and the relationship of the parties. No one category
or factor is determinative and, in many cases, some factors pointing
in both directions will exist. Ultimately, whether a worker is
an employee or an independent contractor will be determined by
balancing all of the factors in light of the relationship as
a whole.
Behavioral Control
Behavioral control - the extent to which a company directs
or controls how the specific tasks are performed by the worker
- focuses on the instruction and training provided by the
company.
Instructions. Two types of instructions are important
- instructions as to what the final work product will be,
and instructions as to how to achieve the desired product. Generally,
the fewer details a company provides as to the completion of
the work, the less control appears to be exerted, and the less
likely that the worker is an employee. Thus, it is likely that
an employer-employee relationship exists if a company provides
instructions as to the details of the work, such as: when to
do the work, where to do the work, what tools or equipment to
use, what workers to hire to assist with the work, where to purchase
supplies or services, what routines or patterns must be used,
or what order or sequence to follow. By contrast, because businesses
often require a uniform end product and a specific delivery date
of that product, instructions concerning matters such as these
are less indicative of control.
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