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Know the Difference between Independent Contractors and Employees

Portland Independent Contractor Attorney

Vancouver Contingent Worker Lawyer

Today’s workforce is increasingly comprised of independent contractors and contingent workers. An independent contractor is one hired to perform a certain task or tasks outside the control of the hiring party. Contingent workers are those individuals whose services are leased from a staffing company that generally retains the workers as “employees”. The use of such personnel does, indeed, offer an opportunity to cut costs. But a clear understanding of exactly who can qualify for this status and the consequences of miscategorizing such workers is of critical import for all businesses.

Courts have recognized the growing use of independent contractors and contingent workers. They have, however, also recognized the growing abuse of such arrangements. Indeed, the 9th Circuit recently noted “corporations have increasingly adopted the practice of hiring temporary employees or independent contractors as a means of avoiding payment of employee benefits, and thereby increasing their profits.” Courts will not determine the legal relationship between two parties based solely on the invocation of the terms “independent contractor” or “contingent worker.” In this arena substance governs over form. The courts examine many factors including the “economic realities” of a relationship and will look behind the scenes at the actual mechanics of the relationship to determine its true nature.

The traditional employer-employee relationship is characterized by its degree of employer control. The employer preserves the right to control the business activities of the employee. Further, the employee is obligated to follow the employer’s instructions in matters related to accomplishing required work.

An independent contractor, conversely, remains independent of the hirer. In such a relationship, the hiring party does not retain a significant degree of control over the conduct of the hired party. While the hiring party contracts for the performance of a task, the independent contractor, unlike the employee, is in nearly complete control as to how the task is completed. For example, a company might hire someone to install equipment in its office, but it has little control over exactly how that task is achieved.

Contingent workers are usually working in (1) Temporary services; (2) Managed services; (3) Employee leasing; and (4) Pay rolling arrangements. Such workers may be employees of the staffing company/employment agency that provides their services, the company that contracts for their services, or both. Although most hiring parties assume such workers are independent contractors, this is not always the case.

Mischaracterizing employees exposes employers to a number of significant legal liabilities. First, if an employer misclassifies an employee and fails to withhold taxes it faces penalties from the IRS. These include: (1) the full amount of the worker’s income tax that should have been withheld; (2) both the employer’s and employee’s share of the Federal Insurance Contributions Act tax (FICA—essentially, Social Security and Medicare); (3) Federal Unemployment Tax; and (4) a penalty of up to 25% of the total amount due, although this may be mitigated if the failure to pay was due to “reasonable cause and not due to willful neglect.” Alarmingly, penalties may be assessed against both the offending business and its corporate officers.

Second, misclassifying a worker can lead to civil liability. This includes unpaid overtime compensation and withheld ERISA employee benefits. For example, a class of contingent workers recently sued Microsoft to recover benefits that they were denied, particularly valuable stock options. The case settled in December of 2000 for nearly $97 million. Likewise, unlike independent contractors, employees are authorized to bring suit under the numerous discrimination statutes (Title VII, ADEA, ADA…etc.). ERISA and most of the discrimination statutes also provide for an award of attorney’s fees to prevailing plaintiffs.

The Fair Labor Standards Act requires employers to pay overtime and minimum wages to employees, but not to independent contractors. Mischaracterization in an effort to avoid these requirements may lead to liability under the statute. The FLSA provides its own definitions of “employee” and “employ,” such that it likely includes workers excluded by other tests.

Workers’ compensation also turns on whether a worker is considered an “employee.” The downside for characterizing workers as employees in this area is that employers must pay appropriate taxes. However, workers’ compensation is the exclusive remedy for those it covers. Thus, in exchange for paying such taxes employers are protected from further civil liability.

There are also other legal issues that must be examined. The National Labor Relations Act may come into play, or the “work for hire” provisions of the Copyright Act of 1976. That law vests copyright ownership in an employer where an employee acting within the scope of employment prepared the work. While some of these provisions can be contracted around, an understanding of a worker’s status is essential to preserve particular interests and avoid exposures to liability. That is why periodic review of employee policies by an experienced attorney is prudent.

Many tests have been developed by Congress and the courts to determine a worker’s employment status. The crucial element of each, however, is control. Another important factor is the “economic reality” of the particular employment setting. As mentioned earlier, simply declaring the relationship to be that of hirer-independent contractor or employer-employee is not conclusive.

The test used by the IRS is illustrative. Using 20 different factors, the IRS examines the degree of employer control over the worker. Each factor is looked at individually with no single one determinative of the outcome. The first set of factors can be termed “behavioral” control. Factors of behavioral control concern the extent to which the employer maintains control over the tasks to be performed by the worker. Business that provide training and/or detailed instruction about when, where, and how the worker is to perform its tasks are more likely to be “employers.” Similarly, where a business supplies the tools for the work and directs the order in which it is performed, it is more likely to be seen as an employer with employees.

The second set of factors relate to financial control. Evidence that a worker is reimbursed for expenses and is paid by invoice upon completion of the work gives weight to his or her status as an independent contractor. Conversely, an employee paid a salary or by the hour is more likely an employee subject to the employer’s control.

The final set of factors examines the actual relationship of the parties. What are the terms and length of the agreement and what services are being performed? Are those services an integral part of the employer’s business? Is it a long-term relationship? Are the worker’s hours set by the business? Affirmative answers usually indicate employee status.

What Can I Do to Minimize My Liability?
Actions speak louder than words. That is the lesson learned by many unfortunate employers who have sought to disguise their employees as independent contractors or contingent workers. If you treat a worker like an employee, so will investigating agencies and reviewing courts.

Business using independent contractors should have competent counsel audit their employee categorizations. A business wishing to retain independent contractors should be certain that the independent contractors actually operate independently.

If an enterprise wishes to retain contingent workers, efforts should be taken to ensure that the workers remain employees only of the staffing company. This was the problem in the recent Microsoft case. Microsoft incorporated these workers into its general workforce. To avoid such a result, a business should not select, train, supervise, or discipline the contingent workers. While the business may certainly direct complaints or concerns about the performance of a contingent worker to the staffing agency, the staffing company alone should discipline or dismiss the worker.

Finally, managers and counsel must set up a specific plan for how to treat these workers. After careful legal analysis, supervisors will need to be trained to carry out this plan and monitor their employee’s performance.