Strategies for Minimizing Risks of Worker Misclassification
While the use of independent contractors (IC) can have substantial business advantages given the current economic and political climate, IC relationships have been facing and continue to face increased scrutiny. Both the Internal Revenue Service (IRS) and the Department of Labor (DOL) believe that up to 30 percent of employers are misclassifying their workers. The Government Accountability Office also estimates that misclassification costs the federal government $2.7 billion dollars a year in unpaid unemployment, FICA, FUTA, and other taxes. With the Obamacare mandate that companies with 50 or more “full-time equivalent workers” offer health plans to employees who work the required number of hours per week or else pay stiff penalties, significant temptation exists to reclassify employees as ICs. The risks associated with implementing an IC business model, however, can be significant, and can include:
A. Federal and state DOL wage and hour investigations, testing the IC classification, or seeking unpaid overtime compensation and/or other relief if employee status is found;
B. Private individual and collective/class lawsuits under the Fair Labor Standards Act and state wage and hour laws seeking a finding of employee status, the recovery of unpaid overtime, amounts deducted, liquidated damages, treble damages (under some state laws), and attorneys’ fees;
C. Corporate campaigns by unions seeking to organize IC workers, which are often coupled with multiple misclassification challenges and lawsuits, or unions attempting to intervene in litigation or settlements to exert pressure;
D. Investigations and assessments/fines by federal and state taxing authorities, including the IRS, state Department of Revenue, or other entities for unpaid payroll taxes and unemployment compensation contributions if employee status is found;
E. Class action or individual lawsuits under other employment laws, such as Title VII, ADEA, ADA, FMLA, ERISA, etc., alleging misclassification and entitlement to the benefits/protections typically afforded to employees; and
F. Class actions or individual lawsuits under other state law theories, such as unjust enrichment, fraud, rescission, or improper wage deductions.
PRIMARY TESTS FOR INDEPENDENT CONTRACTOR STATUS
The test used to determine IC status varies depending on the particular law involved, and there are different IC tests that are used. Most of these tests in the litigation context focus, in whole or in part, on the same general factors, including: (1) who controls the manner, method, and means of performance; (2) whether opportunities for profit or loss exist; (3) who provides the equipment and pays expenses; (4) the length of the relationship; (5) whether the services provided are an integral part of the business; and (6) the degree of skill required. Other factors often considered in this analysis include whether benefits are provided; the intent of the parties; and whether the individual is paid on a 1099 or W-2, is free to hire helpers or employees, is able to work elsewhere or have another business, and can or does operate as a separate legal entity.
In contrast, the test used in the unemployment context is much narrower. This test is typically referred to as the “ABC” test. To meet the test, the individual contractor must:
- control the manner, method, and means of performance;
- perform services outside of the usual course of the employer’s business or outside the employer’s place of business; and
- perform services in an independently established trade, business, or occupation. Several states, such as Connecticut, Massachusetts, and New Jersey, have adopted the ABC test for broader use, resulting in a much tougher standard to prevail on IC challenges there.
RECOMMENDED FACTORS AND CONSIDERATIONS TO STRENGTHEN DEFENSIBILITY OF INDEPENDENT CONTRACTOR RELATIONSHIP
It is impossible to determine with certainty how any court or agency may rule when assessing the enforceability of any IC model. With that said, there are numerous steps any contractor using it can and should take to enhance the enforceability of their IC models and minimize their risks of any misclassification liability. Many of these recommended steps have been factors courts have focused on when upholding IC status in recent cases.
More specifically, the following factors/business considerations should be built into any IC model, to the extent possible, to minimize the risks of misclassification liability:
A. Only contract with individuals who are incorporated into a separate legal entity and require proof of good standing for each entity;
B. Where applicable, ensure contractors have multiple projects on which they are working, which will necessarily mean they also employ several helpers or employees for whom they control all terms and conditions of employment;
C. Ensure that the contractor’s relationship with the company is not established for a high degree of permanence by establishing an expiration date in the contract not to exceed one year at the longest;
D. Avoid termination at will language in the contract;
E. Allow the contractor to hire employees to assist him/her with the services and/or perform the services in his/her place without prior approval of the company;
F. Require payment by the job – not time worked – and avoid paying any set salary;
G. Allow the contractor to negotiate contract terms (e.g. rates);
H. Allow the contractor to work elsewhere, have his or her own clients, and advertise his/her own services to others through the use of his/her own business cards or other advertising materials;
I. Allow the contractor to control the economic aspects of his/her job by:
- Requiring significant investment in all equipment necessary to perform the job and no reimbursement of operating expenses or company-provided subsidies, privileges, goods, services, or facilities at a discount or free (i.e. providing an office or office equipment for the contractor to use); and
- Providing opportunity for profit or loss based on managerial skill by allowing the contractor to make his/her services available to the market, accept or refuse work for the company at his/her discretion, and hire employees to perform work with him/her or in his/her place;
J. Avoid any semblance of control over “manner and means” in which services are performed, such as:
(i) Specific work hours or mandated work at company offices;
(ii) Designated break/lunch periods;
(iii) Specific techniques;
(iv) Training programs;
(v) Grooming standards;
(vi) Non-compete provisions; and
(vii) Mandated dress code, uniforms, or use of business cards with the company’s logo.
K. No use of conventional discipline for contractors (breach of contractual obligations may result in contract termination);
L. Allow the contractor to own or obtain an equity interest in the business that can be sold to others without prior company approval for profit or loss; and
M. Not include contractors in employee meetings.
It is important that these and other factors/business considerations be incorporated into a carefully-drafted Independent Contractor Agreement to increase the chances of the IC model being upheld. However, because actual practice is the typical focus of any IC misclassification inquiry, the principles should also be adhered to in practice, as a carefully-drafted agreement will only get you so far.
Chris Caiaccio has been practicing traditional labor relations his entire legal career and currently serves as counsel for Ogletree, Deakins, Nash, Smoak & Stewart, P.C. He has particular expertise representing clients in the construction industry. He regularly advises construction contractors on matters such as union avoidance, double-breasting, project labor agreements, and Davis-Bacon compliance.