Are They Independent Contractors or Employees?: The Wrong Answer Could Cost You Millions (December 30, 2002) by Robert J. Tribeck |
The idea of using independent contractors, rather than hiring employees, has been embraced by employers. And with good reason. The use of independent contractors can dramatically reduce costs and headaches associated with hiring employees. However, as one company recently learned, companies must be diligent in insuring that their "independent contractors" are not really employees." A jury recently entered an award against Mary Kay, Inc. for $11.2 million, including $10 million in punitive damages. The award was in a wrongful termination case alleging disability discrimination. Essentially, Mary Kay, Inc. failed to offer an independent sales agent who suffered from a disability (breast cancer) any "reasonable accommodation," as required under the Americans with Disabilities Act ("ADA") and similar state laws. However, the company thought it had a perfect defense: the individual was not an "employee", but was an "independent contractor." In fact, an agreement signed by the individual at the commencement of her relationship with Mary Kay provided that she was an "independent contractor" and she filed her tax returns as a self-employed individual (i.e., an independent contractor). Despite those facts, the individual was deemed to have been an" employee" and, as such, Mary Kay was required to offer her "reasonable accommodation." Having failed to do so, the company was liable, the only question being how much. Obviously, the jury did not respond well to Mary Kay's arguments. While the above case is only one example, and may well get reversed on appeal, the issue should be critical to any company that uses independent contractors. Companies have been successfully sued by individuals they believed were independent contractors for: wrongful termination, workers' compensation, overtime pay, health insurance benefits, and retirement plan benefits, among other things. Moreover, and perhaps even more troubling, the IRS and Department of Labor have each stepped up their review and enforcement in this area, and have issued stiff penalties and required the repayment of taxes, interest, overtime, and backpay by companies that were determined to have misclassified an employee as an independent contractor. The same is true with state agencies, particularly in the area of workers' compensation.
(1) Agreement ? each time a company engages (NOTE: not "hires") an independent contractor, it should do so under a written agreement, specifically identifying the fact that the individual is not an employee, that the individual will be issued a 1099, that they are not covered by workers' compensation, and that the employee is not entitled to health or retirement benefits. (2) Taxes ? companies should never withhold taxes from an independent contractor and must always issue a 1099 (companies are also strongly discouraged from allowing their independent contractors to "hire" the company's accounting department to perform the withholding on their behalf). (3) Supervision/Skill Level ? the level of supervision exercised by a company over an individual purported to be an independent contractor and the level of skill/training possessed by the individual are important factors in determining whether an employment relationship exists -- the higher the supervision level and/or the lower the level of skill/training, the more likely the individual will be classified as an employee. (4) Discipline ? independent contractors are not "disciplined" as employees are; they do not have a "supervisor"; to the extent that an independent contractor fails to perform agreed upon duties appropriately, the "discipline" should be cancellation or re-negotiation of the agreement. (5) Tools ? where applicable, an independent contractor should normally provide the tools of his or her trade. (6) Hours ? independent contractors should not be on set hours or required to punch a timeclock, although the IRS does recognize that some positions mandate work being done during a certain time period. (7) Support ? companies should not offer their own employees to act as assistants or support staff to independent contractors, nor should companies decide who an independent contractor hires as an assistant; the independent contractor (not the company) should pay the assistant. (8) Compensation ? independent contractors are normally paid by the job, rather than bi-weekly; however, some circumstances, particularly long-term assignments, would mandate payment over time but it is recommended that payment be made once a month (rather than bi-weekly as employees are paid). (9) Exclusivity ? if an independent contractor works solely for one company, and is precluded under his or her agreement from working elsewhere, those facts can support a finding of employment status; it is recommended that any agreement containing exclusivity language be reviewed and limited if applicable (i.e., no competitors). (10) Benefits ? no benefits should be provided to independent contractors, including but not limited to, health insurance, participation in retirement plans, company vehicles, computers, business cards, employee identification badges (i.e., the independent contractor's badge should differ); however, where because of business reasons, or as part of the deal with the independent contractor, the use of company resources (i.e., computer, vehicle) is necessary, such factors should be specifically set forth in the written agreement. (11) Records ? the better the records maintained by a company, the easier time they will have with any audit or review by the IRS or Department of Labor; appropriate records would include business cards of the independent contractor, 1099 forms, invoices from the independent contractor. While the use of independent contractors can yield tremendous benefits to employers, there are many risks associated with an improper classification of individuals as independent contractors. Every company that uses independent contractors, or is contemplating their use, should consider and apply each of the above factors to determine whether such individuals are properly treated as independent contractors. Moreover, any agreement with an independent contractor should be reviewed by counsel to help assure that the individual will not be reclassified as an employee. Finally, any inquiry by a federal or state agency, or any complaints by an independent contractor, should be taken seriously and due care should be given in providing any information that may ultimately be used against a company.
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