Reed Smith –
With the first quarter of 2015 behind us, many companies are already deeply engaged in social media campaigns. Many of these campaigns include the engagement of professional bloggers or other persons with social media influence to promote corporate brands through social media.
These individuals are typically classified as independent contractors, but are they really employees? This article describes the risks and rewards of classifying bloggers (and any other workers) as independent contractors instead of employees, and ways to manage that risk.
Background: What Is an Independent Contractor?
Broadly speaking, a worker may be classified as either an “employee” (an individual to whom statutory wage payment and other legal protections apply) or an independent contractor (to whom such protections generally do not apply). Although the vast majority of the U.S. workforce falls into the former category, independent contractors serve an important function in the economy and offer businesses many upsides over employees.
To take advantage of these benefits without risking the downsides, including “misclassification” litigation and other pitfalls, it is important for companies to understand the differences between employees and independent contractors from a legal standpoint.
Typically, a company should engage independent contractors for a discrete period of time to perform a task or series of tasks outside the scope of expertise of the regular, employee-workforce. Unlike employees, contractors should not complete employment applications or W-4 forms, and they should not receive the company’s employee handbook.
In addition, contractors should not be shackled by the same restraints that encumber employees: companies should ensure that their independent contractors remain free from direct supervision and control, may negotiate their own rates, retain latitude to perform their assigned task(s) in any manner and on any schedule they choose (so long as their work product is delivered by company-required deadlines), and are permitted to perform work for multiple businesses at any given time. Where applicable, independent contractors also should provide their own tools, transportation, and the like.
Despite these general principles, determining whether a worker is properly classified as a contractor warrants a forum- and fact-specific analysis, as is more fully discussed below.
Benefits of the Independent Contractor Relationship
If properly implemented, an independent contractor relationship will be mutually beneficial for both the contractor and the engaging company.
For the independent contractor, the relationship offers greater flexibility and control over one’s work. There are also tax benefits: independent contractors can deduct more work-related expenses than employees, and their pay is not subject to the same withholdings as traditional employees. Although independent contractors must pay federal and state taxes, they do so on their own, typically by making estimated tax payments throughout the year.
For the engaging company, the benefits are equally, if not more, significant. The costs of independent contractor engagement pale in comparison with those associated with employee hiring and retention. For instance, the company is not required to contribute to unemployment insurance funds, provide expensive benefits (e.g., medical insurance), or allow participation in retirement, profit sharing, and similar plans. Independent contractor engagement also generally comes free from the risk of potentially costly employment litigation (e.g., discrimination, harassment, retaliation).
Moreover, engaging independent contractors has the added benefit of allowing employers to increase their workforce without the costs and commitments associated with hiring additional employees – an advantage that is particularly beneficial for companies with seasonal and other fluctuating workload needs.
How To Determine if a Worker is Properly Classified an Independent Contractor
While the benefits of independent contractor relationships are substantial, the consequences of misclassifying employees as independent contractors can be dire. Unfortunately, determining whether a worker is properly classified as an independent contractor as opposed to an employee is not as simple as it may sound.
The answer is often driven not only by the specific circumstances surrounding an independent contractor’s engagement, but also by the particular forum of the engagement. In recent years, a smattering of disparate (and in some respects, inconsistent) tests have emerged – among federal and state courts, as well as various regulatory and administrative agencies (e.g., the U.S. Department of Labor and the IRS). The IRS, for example, uses a 20-factor test to evaluate proper independent contractor classification. On the other hand, many state agencies, in determining a contractor’s employment status for purposes of workers’ compensation and unemployment insurance eligibility, utilize three- and five-pronged approaches.
The tests coming out of the court system are no less varied. To illustrate, whereas all courts evaluating an independent contractor’s claim for wages under the federal Fair Labor Standards Act (FLSA) apply what is dubbed the “economic reality” test, the courts do not define or apply that test uniformly. For example, federal courts in the Third Circuit examine six factors:
(1) the degree of the alleged employer’s right to control the manner in which the work is to be performed; (2) the alleged employee’s opportunity for profit or loss depending upon his or her managerial skill; (3) the alleged employee’s investment in equipment or materials required to perform assigned tasks, or the employment of helpers to perform those tasks; (4) whether the services rendered require special skills; (5) the degree of permanence of the working relationship; and (6) whether the services rendered are an integral part of the alleged employer’s business.
By contrast, courts in other Circuits, including the Second Circuit, examine only five factors.
State courts assessing independent contractors’ entitlement to protection under state wage and hour statutes also take varied approaches. Of significant note is the New Jersey Supreme Court’s recent adoption of the so-called “ABC” test, which presumes that a worker is an employee, and not an independent contractor, unless the engaging entity can demonstrate all of the following:
(A) that the worker is free from the entity’s control or direction over the performance of the service, both by contract and in fact, (B) that the service provided is outside the usual course of business for which such service is performed, or that such service is performed outside of all the places of business of the entity; and (C) that the worker in question is customarily engaged in an independently established trade, occupation, profession or business.
The court’s ruling means that a worker in New Jersey may be properly classified as an independent contractor under federal law, but improperly classified under state law.
Similar contradictions exist at the state and federal agency level as well.
Does an Independent Contractor Agreement Protect Your Company?
One of the more common myths shrouding the independent contractor relationship is that a written agreement that officially labels a worker as an independent contractor, rather than an employee, will shield a company from misclassification liability. That assumption is incorrect. One principle on which all courts and agencies appear to agree is that it is not the contractual label, but rather the actual relationship between the worker and the engaging entity, that controls.
That said, it is still a good idea to have an independent contractor sign a contract that clearly defines his or her non-employee status. Even though such a contract will not be dispositive, it will help by providing persuasive evidence of both parties’ intent.
The Risks of Independent Contractor Misclassification
Despite the benefits for both parties associated with designated independent contractor arrangements, there are numerous risks (which are compounded by the uncertainty associated with the many different, and often inconsistent, tests used to evaluate proper independent contractor classification). Companies that engage contractors face the peril of independent contractor-initiated litigation in which an independent contractor claims “misclassification” and seeks the greater wage and other benefits afforded to regular employees.
In addition, there is the potential for costly audits by pension authorities and state and federal tax and fair employment agencies. In some cases, if one agency makes a misclassification determination, other agencies will jump on board to commence their own investigations, which can also result in independent contractors initiating their own private civil actions. In short, there can be a real domino effect.
To add further insult to injury, there has been a significant surge recently in regulatory scrutiny in this area. Indeed, 19 separate state governments are currently joined in a U.S. Department of Labor initiative designed to combat independent contractor misclassification. Not surprisingly, there has also been a recent uptick in private misclassification lawsuits under the FLSA and other federal, as well as state, employment laws.
How to Best Protect Your Organization
Given all the above, we offer three tips to help companies continue to benefit from independent contractor engagements while minimizing the associated misclassification risks:
First, be realistic about the nature of your working relationships. Do not allow the benefits of independent contractor designation to cloud an honest evaluation of the propriety of such designation. In borderline cases, consider erring on the side of employee – rather than independent contractor – designation; doing so will often prove more beneficial in the long run, as the costs and inconvenience associated with defending a misclassification audit or lawsuit often will dwarf the short-term savings and other upsides of any independent contractor engagement.
Second, clearly communicate – in a writing signed by both parties – the mutual understanding as to an independent contractor’s non-employee status, spelling out clearly all that that entails (i.e., no rights to statutory and other benefits that are afforded to employees). As noted, although this type of contract will not be conclusive in the event of a challenge, it may provide helpful evidence in the event of litigation, and it may even dissuade the worker from pursuing a claim in the first place.
Third, if you have concern that any of your independent contractors has been misclassified, work with experienced counsel to help you evaluate immediately. Thereafter, you may be able to reclassify voluntarily without involvement by governmental agencies. Sometimes, depending on the level of perceived risk and the scope of perceived misclassification, you may decide to consider voluntary self-reporting to such agencies, especially to the IRS. Doing so could save you the expenses and other headaches of defending adversarial audits down the road.
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