Free Agents in the Workplace -- Part II

This is the second in a two part series on the increased use of independent contractors in the environmental field. Part One (available at no charge at www.eponline.com, under Archives, June 2003) focused on the pros and cons of using contract labor in your company. Part Two covers the laws that define an independent contractor and an employee.

Determining worker status is a major challenge for human resource professionals. The question that needs to be determined is whether a worker is a regular employee or an independent contractor. Both federal and state regulations force companies to accurately determine workers' status, which can be a confusing struggle. Many federal laws are often considered in this analysis, including 1) the National Labor Relations Act of 1935, 2) the Fair Labor Standards Act of 1938, 3) the Employee Retirement Income Security Act of 1974 and 4) the Social Security Act of 1935. Misclassification of an independent contractor could result in assessing huge penalties and interest.


Both federal and state regulations force companies to accurately determine workers' status, which can be a confusing struggle.

The Internal Revenue Service (IRS) has a checklist for worker classification, that should be used by companies to help to determine an employee's status. According to the National Association of Temporary Services, contract employment grew 10 times faster than permanent employment from 1982 to 1990, and more than 20 times faster in 1992. This explosive trend in the use of contract workers has caused a crackdown in legislation for independent contractors. The agency leading this initiative is the IRS.

According to the IRS, the general rule is that " an individual is an independent contractor if the employer has the right to control or direct only the result of the work and not the means and methods of accomplishing the results. Independent contractors use their own independent and professional judgment in performing

services." Because of the implication of tax liability, the IRS has established a 20-point checklist (Revenue Ruling 87-41) to determine the status of an independent contractor. However, it is highly controversial and subject to broad interpretation.

The 20 standards used by the IRS to determine the classification of a worker are:

  1. To what degree does the recipient "direct the work?" (Generally, the more detailed the directions, the more likely the worker is an employee and not a contractor.)
  2. Under what conditions can the worker be fired? (An independent contractor should not be fired unless contractual obligations are not met.)
  3. What are the legal obligations of the worker? (An employee may not be legally obligated and not experience any undue repercussions for doing incorrect work or violating company policy or federal, state and local laws, while an independent contractor may incur civil liabilities. The contract would specify the consequences of breach of contract or premature termination.)
  4. Are assistants subject to control by the employer? (Assistants should be employees of the independent contractor, not subject to the employer's control.)
  5. Is the worker paid per time intervals? (An employee-employer relationship is indicated when workers are paid by the hour, day or week. Independent contractors should be paid on a per job basis.)
  6. Does the employer provide training? (Independent contractors are highly skilled professionals who should possess the expertise needed to do a specific task or project. Employer-provided training indicates an employee relationship.)
  7. Is the worker distinguished from the employer's regular employees? (An independent contractor should not be doing normal everyday operational duties. Reference to the contract person in the workplace should indicate an independent status.)
  8. Is the work performed characterized by personal service? (The contract should not indicate that the work be performed personally for any specific individual.)
  9. Does the worker provide continuing services for the employer? (Generally, a service performed regularly for the same employer indicates that an employer-employee relationship may exist.)
  10. Are work hours set by the employer? (Scheduling work is a controlled task and indicates an employer-employee relationship.
  11. Does the employer furnish tools? (An independent contractor normally provides the tools necessary to perform contractual services.)
  12. Is the work performed at the employer's place of business? (Some control is indicated when the worker is near the employer, but it is not concrete. A separate place of business is one characteristic of an independent contractor.)
  13. Has the worker made significant investments in his or her business? (Generally, a business has assets such as facilities, equipment and supplies.)

  14. According to the National Association of Temporary Services, contract employment grew 10 times faster than permanent employment from 1982 to 1990, and more than 20 times faster in 1992.
  15. Is the worker required to submit regular reports? (Regular reporting by the worker is evidence of control. This does not preclude a final report at the conclusion of the project.)
  16. Does the worker devote full time to one employer? (An independent contractor should offer services to multiple clients. Too much concentration on the work of one employer may create a dependence and lead to control by the employer.)
  17. Does the employer designate the order or sequence of work to be performed? (The employer can specify the output, but should not be able to direct or control how an independent contractor does the job.)
  18. Does the employer of the services pay business and traveling expenses? (Whenever possible, the cost of expenses should be covered by the contract. The payment of expenses outside of the contract's scope may be construed as employee expenses.)
  19. Is the worker exposed to normal profit and loss risks associated with operating a business? (If there is evidence that the worker is subject to both suffering losses and reaping profits on a project or job, then the worker is operating a business and is an independent contractor.)
  20. Does the worker provide services to the general public? (An employer-employee relationship exists when the worker performs services exclusively for one employer. Working for multiple clients demonstrates that the worker is operating an independent trade or business.)
  21. Does the worker provide services to more than one employer? (The contract between employer and the worker does not restrict the worker from offering his or her services to other parties.)

Three additional factors that have been considered by the courts to determine worker status include the following: 1) the level of skill required by the worker, 2) the intent of the parties and 3) the prevailing industry practice.

Section 530 of the 1978 Revenue Act provides companies relief from retroactive reclassification by the IRS. An organization can receive relief if it: 1) did not treat the worker as an employee for any period, 2) filed all necessary tax forms consistent with its treatment of the worker and 3) had a "reasonable basis" for treating the worker as an independent contractor. A reasonable basis means that an organization relied on a judicial precedent, technical advice memorandum, private letter ruling or determination letter; had a prior audit that did not result in assessing employment taxes due to the firm's treatment of workers as independent contractors; or relied on long-standing industry practices within which it operates.

State unemployment insurance paid by state agencies is another issue to be considered. If an employee is fired, he or she can receive unemployment compensation. An independent contractor is not eligible for such benefits. Many state employment commissions are responsible for auditing businesses to ensure that employee wages are being reported and taxes are being paid. Should the agency determine that workers who have been classified as independent contractors are really employees, back taxes, penalties and interest will be assessed.


Because of the implication of tax liability, the IRS has established a 20-point checklist to determine the status of an independent contractor.

Avoiding IRS problems is another concern for companies. By downsizing and reengineering, companies are seeking to reduce fixed labor costs. To benefit from using independent contractors, the company's human resource department should be utilized to learn and adhere to federal and state laws regulating the employer-employee relationship. Employers must know legal requirements involving the use of contract labor. It will become increasingly important for human resource managers to classify all workers carefully to protect the organization and workers.

There is one question on the issue of employee versus independent contractor that should always be answered -- "Who controls the worker?" When the answer to this question is concise and clear cut, there will be fewer problems that will have to be dealt with. However, this is a gray area where the employer may run the risk of major tax liabilities. Human resource professionals should consult with tax attorneys and certified public accountants (CPAs) concerning employee classification to avoid penalties or running into problems from the IRS or state unemployment insurance agencies. Contracts should also be drawn up and be carefully reviewed by tax attorneys and CPAs.

With the increase in contract workers creating a new workforce, there will be changes in the future to deal with this type of worker and to modify the present hard line taken by the IRS in defining contract labor. In the interim, however, employers will have to work within the present IRS and state unemployment agencies' guidelines.

The decision on whether or not to use contract laborers has many consequences, so companies should not treat the decision lightly. Companies should weigh each positive against each negative effect to make sure that the rewards outweigh any of the consequences. Contract labor is a useful way to bring down company costs in areas that it does not specialize in; however, the company must take into account all the guidelines and follow them exactly when utilizing a temporary workforce.

References

  • Archer, E.R., "Words of Caution on the temporary workforce," HR Magazine, Sept 1994, pp. 168-167.
    • Barrier, M., "Now You Hire Them, Now You Don't," Nation's Business, Jan 1994, pp30-33.
    • DuRivage, V.L., "New policies for the Part-Time and Contingent Workforce," M.E. Sharpe, Armonk, New York 1992.
    • Fierman, J., "The contingency workforce," Fortune, Jan. 24, 1994, pp. 30-36.
    • Morris, G., "Contract Maintenance Flags Safety, " Chemical Week, Aug 26/Sept 2, 1992 p. 32.
    • Nye, D., "Alternative Staffing Strategies," The Bureau of National Affairs Inc., Salem Ma., 1992.
    • Victor, K., "Explosions on the Job," National Journal, Aug 11, 1990, pp. 1941-1945.
    • Wolfe, M.N., "That's Not an Employee, That's an Independent Contractor," Compensation & Benefits Review, July/ Aug 1996, pp. 60-64.

    This article originally appeared in the July/August 2003 issue of Environmental Protection, Vol. 14, No. 6.

    This article originally appeared in the 07/01/2003 issue of Environmental Protection.

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