Are They Really Independent Contractors?

(The following information was derived from BLR HR Updates May 21 and 22, 2008)

These days, organizations frequently try to increase their workforce flexibility and decrease their benefit costs by hiring independent contractors to do required work.

All well and good … unless a court later determines that while you’re calling such workers independent, you’re really treating them as employees. In that case, and as names as famous as Microsoft have learned the hard way, penalties can be severe.

Often the issue revolves around how much control employers exercise over these workers’ job activities. The more control, the more likely the worker is actually an employee.

This point was highlighted recently in a case described by attorney Michael Curtis on the website, Mondaq.com. The case helps in understanding the reasoning that must be used in determining how “independent” workers are. (Curtis is with the California law firm of Thelen Reid Brown Raysman and Steiner LLP).

The facts were these:
Threatened with unionization of his drivers, a cab company owner contended that they were independent contractors and, thus, not a collective bargaining entity, because:
–They paid a fixed rental fee for the cabs.
–They didn’t have to account for fees or tips.
–They had no set work hours or minimum work requirements.
–They received no benefits and no tax or social security was withheld from pay.
–Lease agreements openly stated that the drivers were independent contractors.

Independent contractors, right? Not so fast. The court held that while all the above was true, the drivers also suffered a “lack of entrepreneurial freedom” (i.e. the chance to make money on their own).

The evidence:
–Drivers could only use cabs to respond to the cab company’s dispatches.
–They were prohibited from distributing private business cards and could not accept calls for service on their cell phones.
–They had to comply with company policy on how they drove and dressed, and they were subject to company discipline.
–They had to carry ads in their cabs that generated revenue for the company, but not for the drivers.
–Drivers were required to take more training than was legally mandated.

Taken together, those facts indicated that the company had a significant amount of control. This led the court to conclude that the cabbies did not have entrepreneurial freedom. And that, said the court, meant they were employees.

What the DOL Says
The U.S. Department of Labor (DOL) states that, under the Fair Labor Standards Act (FLSA), the employer-employee relationship is tested by “economic reality” rather than “technical concepts.” So just words in a leasing agreement, or a “little bit of independence” isn’t enough to classify someone as an independent contractor.

Furthermore, the U.S. Supreme Court has, on a number of occasions, indicated that there is no single test for determining whether an individual is an independent contractor under the FLSA. It’s instead the total activity or situation that defines. Besides the control and entrepreneurial freedom issues mentioned above, courts consider:

– The extent to which the services rendered are part of the principal’s business
– The permanency of the relationship
– The amount of the alleged contractor’s investment in facilities and equipment
– The amount of initiative, judgment, or foresight required
– The degree of independent business organization and operation

Bottom line on all of this: Before you seek the advantages of calling your workers independent contractors, consider their total situation carefully. And remember, it’s not what you call them that may count in the end.

The U.S. Department of Labor (DOL) points out the following particular problem areas for employers when it comes to determining whether a worker is an employee and, thus, is eligible for protections under the Fair Labor Standards Act (FLSA), or is an independent contractor, and therefore not covered under the FLSA. (And note that when DOL identifies problem areas, that usually means they’re keeping a keen eye on anyone in these situations.)

1. Construction. DOL notes that in the construction industry, many builders hire “so-called independent contractors,” who in reality should be considered employees because they do not meet the government’s tests for independence.

2. Franchises. Franchise arrangements can pose problems in the independent contractor arena as well. Depending on the level of control the franchisor has over the franchisee, workers may be considered to be employed.

3. Volunteers. A person employed by a for-profit organization cannot “volunteer” to perform the same services he or she performs as an employee. (Of course, DOL says, individuals may volunteer their services to religious, public service, and nonprofit organizations without contemplation of pay, and not be considered employees of such organizations.)

4. Trainees. Trainees, interns, or students may also be employees, depending on the circumstances of their activities for the employer. Are they doing the same work that regular employees do, as opposed to tasks that help them learn? They might then be considered employees.

5. Homeworkers. People who perform work in their own homes are often improperly considered to be independent contractors. FLSA covers such home workers as employees, and they are entitled to all benefits of the law.

HR Discussion:
One category not listed above that should be considered is sales. Many employers errantly believe that sales people can be classified as independent contractors. In most cases it comes down to an issue of control. If an employer demands total loyalty, and by that we mean prohibiting the sales person from selling other products it’s a good bet that sales person isn’t a qualified independent contractor.

Please contact the A Plus Benefits Human Resource Department if you have any concerns that you might have employees that are misclassified. A Department of Labor audit that occurs because of misclassification is time consuming and potentially very expensive.

It is our desire to assist our clients with being in full compliance with Department of Labor regulations. It is our goal to help you get back to business.

Randall Barker is the VP of Human Resources for A Plus Benefits, Inc.

From time to the Human Resources Department here at A Plus Benefits receives an inquiry concerning how a client might classify one of their employees as an independent contractor in order to avoid paying overtime wages. Generally this happens when the client wants to have the employee perform some kind of work that is different from the employees regular job on an after hours basis.

The short answer is….it is all but impossible to accomplish. A more “smart alec” answer is - you can indeed call a duck a horse – but the duck is still a duck no matter what you do. So, you can call an employee an independent contractor but the employee is in fact just an employee and would have to jump through a lot of hoops in order to qualify as an independent contractor. It is all but impossible to accomplish.

Below are some important factors to know about Independent Contractors.

Legal Exemptions
Independent contractors relieve employers of a variety of legal compliance issues, as the following examples illustrate:

• Independent contractors do not count toward the employee thresholds used for determining employer coverage under most federal employment statutes.

• Employers have no obligation to pay federal and state unemployment insurance, Social Security, and Medicare taxes on behalf of independent contractors.

• Employee protections under the Fair Labor Standards Act, ERISA, the Family and Medical Leave Act, the National Labor Relations Act, and federal nondiscrimination statutes do not apply to independent contractors.

• Employers often do not have to pay state workers’ compensation premiums on behalf of independent contractors.

As a result, using independent contractors can save employers substantial money. However, improperly classifying employees as independent contractors carries substantial penalties. As a result, employers need to make sure that a worker meets the requisite tests for independent contractor status. These tests and exceptions to the tests are discussed below.

Common-Law Test
IRS examines 20 factors—derived from court rulings or common law—to determine whether someone qualifies as an independent contractor or an employee for purposes of federal income, Social Security, Medicare, and unemployment taxes.

Similar factors for determining employee or independent contractor status apply under:

• the National Labor Relations Act, which specifically exempts independent contractors from its employee protections (29 U.S.C. § 152(3));

• the Occupational Safety and Health Act (OSHA Standard Interpretation Letter “Information on Temporary Workers, Particularly Those in the Electronic Assembly Industry,” 4/30/96); and

• most federal discrimination laws, including Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act, and the Age Discrimination in Employment Act.

The IRS test often is termed the “right-to-control test” because each factor is designed to evaluate who controls how work is performed. Under IRS rules and common-law doctrine, independent contractors control the manner and means by which contracted services, products, or results are achieved. The more control a company exercises over how, when, where, and by whom work is performed, the more likely the workers are employees, not independent contractors.

A worker does not have to meet all 20 criteria to qualify as an employee or independent contractor, and no single factor is decisive in determining a worker’s status. The individual circumstances of each case determine the weight IRS assigns different factors.

NOTE: Employers uncertain about how to classify a worker can request an IRS determination by filing Form SS-8, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” However, some tax specialists caution that IRS usually classifies workers as employees whenever their status is not clear-cut. In addition, employers that request an IRS determination lose certain protections against liability for misclassification.

20 Factors
The 20 factors used to evaluate right to control and the validity of independent contractor classifications include:

• Level of instruction. If the company directs when, where, and how work is done, this control indicates a possible employment relationship.

• Amount of training. Requesting workers to undergo company-provided training suggests an employment relationship since the company is directing the methods by which work is accomplished.

• Degree of business integration. Workers whose services are integrated into business operations or significantly affect business success are likely to be considered employees.

• Extent of personal services. Companies that insist on a particular person performing the work assert a degree of control that suggests an employment relationship. In contrast, independent contractors typically are free to assign work to anyone.

• Control of assistants. If a company hires, supervises, and pays a worker’s assistants, this control indicates a possible employment relationship. If the worker retains control over hiring, supervising, and paying helpers, this arrangement suggests an independent contractor relationship.

• Continuity of relationship. A continuous relationship between a company and a worker indicates a possible employment relationship. However, an independent contractor arrangement can involve an ongoing relationship for multiple, sequential projects.

• Flexibility of schedule. People whose hours or days of work are dictated by a company are apt to qualify as its employees.

• Demands for full-time work. Full-time work gives a company control over most of a person’s time, which supports a finding of an employment relationship.

• Need for on-site services. Requiring someone to work on company premises—particularly if the work can be performed elsewhere—indicates a possible employment relationship.

• Sequence of work. If a company requires work to be performed in specific order or sequence, this control suggests an employment relationship.

• Requirements for reports. If a worker regularly must provide written or oral reports on the status of a project, this arrangement indicates a possible employment relationship.

• Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of employment relationships, unless the payments simply are a convenient way of distributing a lump-sum fee. Payment on commission or project completion is more characteristic of independent contractor relationships.

• Payment of business or travel expenses. Independent contractors typically bear the cost of travel or business expenses, and most contractors set their fees high enough to cover these costs. Direct reimbursement of travel and other business costs by a company suggests an employment relationship.

• Provision of tools and materials. Workers who perform most of their work using company-provided equipment, tools, and materials are more likely to be considered employees. Work largely done using independently obtained supplies or tools supports an independent contractor finding.

• Investment in facilities. Independent contractors typically invest in and maintain their own work facilities. In contrast, most employees rely on their employer to provide work facilities.

• Realization of profit or loss. Workers who receive predetermined earnings and have little chance to realize significant profit or loss through their work generally are employees.

• Work for multiple companies. People who simultaneously provide services for several unrelated companies are likely to qualify as independent contractors.

• Availability to public. If a worker regularly makes services available to the general public, this supports an independent contractor determination.

• Control over discharge. A company’s unilateral right to discharge a worker suggests an employment relationship. In contrast, a company’s ability to terminate independent contractor relationships generally depends on contract terms.

• Right of termination. Most employees unilaterally can terminate their work for a company without liability. Independent contractors cannot terminate services without liability, except as allowed under their contracts.

Economic Reality Test
Independent contractors are not covered by FLSA’s minimum wage and overtime protections for employees. Court interpretations have established an “economic reality test” for determining whether someone is an employee or independent contractor under FLSA.

Rather than examine who controls how work is performed, the economic reality test evaluates whether a worker is economically dependent on a company’s business. The greater the economic dependence, the more likely the worker qualifies as an employee protected by FLSA.

Similar to the common law test, the economic reality test focuses on the degree of control exercised by the employer as an essential factor in determining whether an employer-employee relationship exists. While no single factor is controlling or decisive in determining whether an employment relationship exists, the facts and circumstances that courts and federal enforcement officials examine in deciding whether an individual is an employee or an independent contractor are:

• the degree to which the employer controls or directs the manner in which work is performed,

• whether the worker’s opportunity for profit or loss depends on his or her managerial skills,

• whether the worker’s duties are performed for the employer on an ongoing or permanent basis,

• whether the service performed by the worker is an integral part of the employer’s business,

• the extent of the worker’s investment in equipment or materials needed to perform the job, and

• the degree to which the worker is engaged primarily for the benefit of the employer.

Worker’s Compensation
In many states the Worker’s Compensation Insurance Laws have been written to make a business that has hired an independent contractor responsible for work place injuries if the business has not verified that the independent contractor has his own worker’s compensation policy.

This is another was to ascertain if a person is in fact an independent contractor. If upon being quizzed about worker’s compensation, the employee who is acting like an independent contractor seems to know nothing about worker’s compensation insurance and his need to have a policy as an independent contractor – any government investigator or auditor is going to see through the smoke and mirrors that the business has attempted to use to qualify someone who is in fact not an independent contractor as an independent contractor.

Are there penalties for misclassifying employees as independent contractors?
There are penalties for misclassifying employees. If the IRS finds your independent contractor was really an employee, it may assess you:

An amount equal to 1.5% of wages (3% if no information return was filed) if you erroneously treated a worker as an independent for income tax withholding purposes. (The worker is still liable for 100% of his/her income tax bill) [IRC Sec. 3509 (a)(1), (b)].

20% of the worker’s share of Federal Insurance Contribution Act (FICA) tax that you should have withheld (40% if you failed to file an information return) if you erroneously treated a worker as an independent for FICA tax purposes [IRC Sec. 3509(a)(2), (b)].

A civil penalty equal to 100% of the total amount of tax evaded or not collected, if the IRS finds your misclassification was an attempt to evade or defeat employment taxes. The responsible person must receive written notice by mail or in person [IRC Sec. 6672]. There may also be a criminal penalty of a $100,000 fine ($500,000 in the case of a corporation) and/or five years in prison [IRC Sec. 7201].

Up to $50 per Form W-2 you should have filed but didn’t (maximum penalty, $250,000 per calendar year) because you treated the worker as independent.

A civil penalty of $50 per W-2, if the IRS finds you willfully failed to furnish correct W-2s to employees [IRC Sec. 6674]; there’s also a criminal penalty consisting of a $1,000 fine and/or one year in prison for willful failure to furnish W-2s as required [IRC Sec. 7204].

Interest on past-due tax payments (although IRS’s Proposed Regulations would allow an interest-free adjustment if you failed to file Form 941 for a given quarter solely because you improperly failed to treat any individuals as employees for that quarter (and therefore failed to pay over any withheld income tax or employer-employee FICA tax) [26 CFR 31.6205-1].

When in doubt
We encourage any client of A Plus Benefits who has a question about independent contractors and employees to call us for direction. We are committed to keeping you far from the danger line that can be crossed when an employee is improperly allowed to work as an independent contractor.

Randall Barker is the VP of Human Resources for A Plus Benefits, Inc.Read Randall’s previous HR Update.

Read Randall’s previous .

Q: Do I have to pay overtime to a nonexempt employee who is working two different jobs? If so, how do I calculate it?

A: According to the federal Fair Labor Standards Act (FLSA), employers must pay overtime to nonexempt employees for all hours worked over 40 in a single workweek, even if the employee is working two separate jobs for the same organization.

A common example is the employee who offers to provide custodial duties in the evening after his regular shift is over. The organization knows the individual and is confident that he will do a great job – plus the organization knows the employee needs additional income and this seems a great way to help both the organization and the employee.

However, this apparent win-win situation can create a huge problem if the employee’s pay is not calculated according to Department of Labor regulations.

Calculating overtime can be a little tricky when an employee works two or more jobs for which the employee is paid different hourly rates since overtime must be based on the employee’s “regular rate of pay.”

Typically, the employee’s regular rate of pay when he works two jobs (or more) is calculated as the weighted average of the different rates. For example, the regular rate of an employee who works 35 hours per week at $15 per hour as a machine operator ($525), and works 10 hours that same week at $7 per hour cutting the grass outside the plant ($70), is $595 divided by 45 hours, or $13.22 per hour.

35 hours x $15 + 10 hours x $7 = $525 / 45 hours = $13.22 (regular rate of pay)$525 (regular earnings) + 5hours x $6.61 ($6.61 is the premium rate for 5 hours of overtime – that base rate has already been included) This week’s pay would be $558.05.Thus, the overtime rate for this employee is one and one-half times $13.22, or $19.83 per hour, regardless of which job the employee performs during the extra hours. The employee’s regular and overtime rates will vary from week to week with the number of hours spent performing each job.

Thus, the overtime rate for this employee is one and one-half times $13.22, or $19.83 per hour, regardless of which job the employee performs during the extra hours. The employee’s regular and overtime rates will vary from week to week with the number of hours spent performing each job.Thus, the overtime rate for this employee is one and one-half times $13.22, or $19.83 per hour, regardless of which job the employee performs during the extra hours. The employee’s regular and overtime rates will vary from week to week with the number of hours spent performing each job.Alternatively, an employer and employee may agree, before the work is performed, that the overtime rate will be based on the regular rate that applies to the type of work performed during the hours in excess of forty (it is a good idea to memorialize this agreement with a signed document prior to having the work performed). Therefore, if an employee spends 35 hours in a week working as a machine operator at $15 per hour, and five hours a week cutting the grass at $7 per hour, the overtime rate for any additional hours spent cutting the grass is $10.50 per hour. Conversely, the overtime rate for any additional hours spent working as a machine operator is $22.50. This method of computation is available for hourly employees only and does not apply to nonexempt salaried employees.

A “red flag warning” – do not use the alternate method of calculating overtime unless you have a written agreement with the employee to pay the overtime premium on the rate of pay connected to the work done after 40 hours. A Plus Benefits will not calculate overtime using the alternate method unless a written agreement between the employee and employer is submitted with the payroll reports. A Plus will require new documentation (a new signed and dated agreement) for each week that the alternate method is used. If an organization is audited by the Department of Labor and claims to have used the alternate method of calculating overtime but does not have a written agreement for each week that the alternate method was used, the Department of Labor will require the organization to pay each employee affected back-pay along with some penalties and interest.

The overtime requirements, instituted in 1938 to prevent employers from taking advantage of employees, can turn what seems to be a “win-win” situation (allowing your employees to perform a necessary job and earn extra money) into a penalty for employers. As a result, some employers hire independent contractors to do these jobs (i.e. custodial work) at straight time rates instead of paying their own employees the overtime.

Beware – claiming that your employee was an independent contractor while performing additional work will surely result in fines and penalties if your organization is audited by the Department of Labor, be aware that the Department of Labor does not have a long term payment program - if an organization is found guilty of overtime violations the organization is generally expected to cut a check for any back-pay as well as interest, fines, and penalties within several days of the audit’s completion.

Our next HR Update will examine the subject of independent contractors and the hurdles that need to me cleared in order for a person to legally be an independent contractor.

Randall Barker is the VP of Human Resource for A Plus Benefits, Inc.

Read randall’s previous HR Update.

I continue to hear people mention how difficult it is to find employees in the current hiring environment. This seems particularly true when business owners feel they need compete with larger organizations like HP, Simplot, or Micron.

I was visiting with a friend this morning and we were talking about working with the big guys and he mentioned several things that caused me to think about the benefits associated with working for one of the little guys. Seriously, how many big company jobs allow an employee to work on two, three or more very different tasks on any given afternoon? How many big company opportunities include constant change and significant job flexibility? When I was working for Intel two years ago I spent my entire day boxed in a cubicle working on a very specific job. I had little interaction with co-workers unless it was over the phone and even less task flexibility. I was there to do a very finite job day in and day out.

It was this experience that convinced me that regardless of the health plans, stock options, and a good salary I wanted something different. Among other things, I wanted change, I wanted more responsibility and I wanted to feel like my contribution meant something. Fortunately I found that opportunity and by working for small businesses, so have many others. Small business owners can attract key talent by highlighting their flexibility when working with employees versus their much larger counterparts. Focus on the benefits of working in a smaller, more adaptable company and you’ll be in good shape.

Jake Lunt is the General Manager of Idaho operations for A Plus Benefits, Inc.

Many business owners are faced with the challenge of paying non-exempt employees for time while traveling. The laws requiring compensation for travel time under the Fair Labor Standards Act (FLSA) can be very confusing. The compensation an employee is eligible to receive depends on the mode of travel as well as when the travel takes place.

Employees are not eligible for compensation for the time spent traveling between home and work. This also means that employees who are away on business are not eligible for compensation for time spent traveling between a hotel and the worksite or home and the airport.

Any other travel done by employees for business purposes should be compensated as follows:

*Any travel time during normal working hours (between 8:30am-5:30pm on any day of the week) will be paid at the regular hourly rate and be subject to overtime.

*Any travel time spent as the driver of an automobile, regardless of whether the travel time is during normal working hours will be paid at the regular hourly rate and be subject to overtime.

*Travel time spent as the passenger in an automobile outside of normal working hours will be paid one-half (1/2) the regular hourly rate and this time will not be factored into overtime calculations.

For employees who choose a mode of transportation different from the one authorized (such as driving rather than flying) only the estimated travel time for the authorized mode of transportation is eligible for compensation.

For example, if a non-exempt employee chooses to drive rather than fly from Salt Lake City, UT to Boise, ID the employee will only be compensated for the one hour it would normally take to fly.

Some other rules to remember:

*If an employee is traveling between time zones, the point of departure should be used to determine whether or not the travel is during normal working hours.

*Travel time should be calculated by rounding up to the nearest quarter hour.

*Meal periods should be deducted from travel compensation.

*Employees are responsible for accurately tracking and reporting their travel time.

If you have non-exempt employees who are traveling for business, it is important to make sure you understand the laws and speak with your HR representative about exceptions. Please let us know if you have any questions regarding the compensation of your employees.

Samantha Bushard is an HR employee for the Idaho office of A Plus Benefits, Inc.