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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

sing 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.

In Wisconsin, Most Workers Are "Employees" Tips to Protect an Employer

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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