Is Your Business at Risk for a Determination That Your Independent Contractors Are Actually Employees?
You’ve built your business on the model that people doing work are independent contractors rather than employees. Everything has been going fine until one day when you sit down at your desk to find a letter from a federal or state agency. It might be the Internal Revenue Service, the Ohio Bureau of Worker’s Compensation, the Kentucky Division of Unemployment Insurance, or the Indiana Department of Workforce Development. Regardless of the sender, the punch-line is the same: the agency in its infinite wisdom has determined that your independent contractors are in fact your employees. At the stroke of a pen, the agency has created the foundation demand you make back payment for all the obligations you would have had if your contractors were on your company payroll going back however many years the statute of limitations allows. Imagine if you suddenly had to pay several years worth of payroll taxes, workers’ compensation premiums, and unemployment insurance premiums, plus penalties and interest! How would that affect your bottom line? Would you even be able to stay in business? Under-budgeted agencies are turning increasingly to these tactics in an effort to obtain revenue for operating expenses. Will your company be next?
Fortunately, you can take pro-active steps to avoid these dire consequences. The IRS and courts use a list of 20 factors as an aid in determining whether a worker is an employee or an independent contractor. The test is not a math problem; you need to do more than prevail on 11 of the 20 factors. On the contrary, the test is rather subjective and that’s part of the problem. You need to prepare in advance to make sure you land on the independent contractor side when the agency evaluates each individual factor. The factors are discussed below.
(1) Do you direct or control the manner or method by which instructions are given to the person performing services?
A worker who is required to comply with another person’s instructions about when, where, and how he is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions. On the other hand, constraints imposed by your customer’s demands and government regulations do not determine the employment relationship. Your efforts to monitor, evaluate, and improve the results of ends of the worker's performance do not make the worker an employee. Work by independent contractors is often performed to the exacting specifications of your customer.
(2) Do you require the person performing services to undergo particular training?
The “training factor” refers to an experienced worker giving guidance to new workers to demonstrate how the instructions must be followed. For example, people who are required by the company to attend more training than was mandated by the government have been deemed employees. People who arrange for their own training tend to be deemed independent contractors. Familiarizing a person with a customer’s needs does not constitute training. Likewise, explaining the paperwork the independent contractor needed to complete in order to get paid does not constitute “training.”
(3) Are the services performed by the individual integrated into the regular functioning of your business?
The “integration factor” refers to whether a business could continue without the contribution of the person’s services. Integral services are more likely to be subject to the business’ control.
(4) Do you require that services be provided by a particular individual?
If the services must be rendered personally, presumably the person for whom the services are performed is interested in the methods used to accomplish the work as well as in the results. If your independent contractor has the power to hire a substitute to actually perform the services, that power strongly tends to show an independent contractor relationship.
(5) Do you hire, supervise, or pay the wages of the individual performing services?
This factor tends to state the obvious. Supervision tends to show an employee relationship. Where the company does not confer benefits such as paid leave, health insurance, life insurance, or retirement benefits, this suggests an independent contractor relationship.
(6) Is there a continuing relationship between you and the person performing services which contemplates continuing or recurring work, regardless of whether that work would be full- or part-time?
A continuing relationship between the worker and the person for whom the services are performed tends to indicate an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals. Conversely, contracts of a set length often indicate independent contractor status.
(7) Do you require the individual to perform services during established hours?
The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control. The absence of set hours or a minimum number of hours tends to indicate an independent contractor relationship.
(8) Do you require the individual performing services to be devoted on a full-time basis to your business?
If the worker must devote substantially full time to your business, that requirement tends to show an employee relationship because you have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he chooses.
(9) Do you require the individual to perform services on your premises?
The performance of work on the premises of the company suggests control over the worker, especially if the work could be done elsewhere. Where the person has no specific work location, a finding of an independent contractor relationship is more likely.
(10) Do you require the individual performing services to follow the order of work that you have established?
If a worker must perform services in the order or sequence you set, that requirement suggests employer control. An employee is typically not free to follow his own pattern of work but must follow the established routines and schedules of the company.
(11) Do you require the individual performing services to make oral or written progress reports?
A requirement that the worker submit regular or written reports to the person for whom the services are performed indicates a degree of control typically present in an employee relationship.
(12) Do you make payments to the individual for services on an hourly, weekly, or monthly basis?
Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission, on the other hand, generally indicates that the worker is an independent contractor. The independent contractor status is also indicated when the company does not withhold taxes or benefits on behalf of the worker.
(13) Do you pay expenses for the person performing services?
If the company pays the worker’s business and/or traveling expenses, the worker is ordinarily deemed an employee.
(14) Do you furnish the tools and materials for use by the person to perform services?
If the company furnishes significant tools, materials, and other equipment, that fact tends to show the existence of an employer-employee relationship. Where a worker furnishes his own tools, that fact tends to support the existence of an independent contractor relationship.
(15) Has the person performing services invested in the facilities used to perform services?
If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees, that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship.
(16) Does the person performing services realize a profit or suffer a loss as a result of the performance of the services?
A worker who can realize a profit or suffer a loss as a result of the worker’s services is generally an independent contractor; the worker who cannot is an employee. This factor reflects the shift in emphasis away from the subjective inquiry about “control” toward something that can be measured. Courts focus on whether the worker has an entrepreneurial stake in his work. This factor is powerful because independent contractors tend to be entrepreneurs; employees tend to have less ability to affect the income they generate.
(17) Does the person perform services for two or more employers simultaneously?
If a worker performs services for two or more companies at the same time, that factor generally indicates that the worker is an independent contractor. If the independent contractor agreement prohibits the worker from providing services to others, that fact will lean toward a finding of an employee relationship.
(18) Does the person performing services make the services available to the general public?
The fact that a worker makes his services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
Workers who are paid by the job, chose their own work hours, have the right to refuse assignments, and can work for others, are typically deemed independent contractors. If the worker operates as a partnership, limited liability company, or a corporation, that fact will also weigh in favor of an independent contractor finding.
(19) Do you have a right to discharge the individual performing services?
The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer’s instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
(20) Does the person performing services have the right to end the individual’s relationship with the employer without incurring liability pursuant to an employment contract or agreement?
This is the flip side of Factor #19. If the worker has the right to end his relationship with the company any time he wishes without incurring liability, that factor indicates an employer-employee relationship. A worker who breaches an independent contractor agreement, however, is subject to contractual liability for damages.
As you can see, these factors can be very subjective. Whether one factor weighs in favor of a finding of an employee or independent contractor relationship can depend on which side of the bed the auditor woke up on. Remember, the agency is motivated to find the existence of an employee relationship because that relationship will generate revenue. Accordingly, it is imperative that the company develop a strategy to make it difficult to support a finding of an employee relationship and to implement that strategy immediately. If you wait till one of your independent contractors files for unemployment benefits or an agency picks your name out of a hat for an audit, it may be too late to put the positive spin on your business model. When that seemingly innocuous government questionnaire arrives in the mail, handle it with utmost care and at the highest level. Because the test is subjective and no one factor is controlling, a careless answer or ambiguous word choice could make it easy for the government to brand your independent contractors as employees.
If you would like more information about these issues, please contact Scott Thomas. Scott has secured victories for firm clients in Ohio, Kentucky, Indiana, New York and Pennsylvania against claims by state and federal agencies that the client’s independent contractors were employees. He has assisted clients in developing proactive strategies to strengthen the company’s shield against such accusations. He welcomes the opportunity to work with you on your case. His direct line is 859.578.3862. You can email him at [email protected]. If there is a particular topic you would like to see addressed in a blog, please send Scott an email with your ideas.
Hemmer DeFrank Wessels, PLLC serves clients throughout Kentucky, Ohio, Indiana and New York, including the cities of Cincinnati, Covington, Florence, Ft. Wright, Newport, Erlanger, Independence, Highland Heights, Park Hills; and the communities of Greater Cincinnati, Northern Kentucky, Kenton County, Boone County, Campbell County, Grant County, Hamilton County, Clermont County, Warren County and Butler County.