© 2012 Winston & Strawn LLP
Employee or Independent Contractor?
Brought to you by Winston & Strawn’s Labor and Employment Relations Practice Group
© 2012 Winston & Strawn LLP
Today’s eLunch Presenters
© 2012 Winston & Strawn LLP
Jennifer Rappoport
Marlén Cortez Morris
Labor and Employment Los Angeles
Labor and Employment Chicago
[email protected]
[email protected]
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Overview
Why engage independent contractors? Risks of misclassification of workers Tests used by courts and enforcement agencies for employee/independent contractor determination Recent IRS initiatives on independent contractor classification Recent enforcement actions New laws regarding independent contractors, and potential penalties that may arise as a result of misclassification Best practices for avoiding misclassification
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Why Use An Independent Contractor?
If worker is treated as an independent contractor:
Paid on a 1099 basis – no employer tax withholding No overtime (unless provided by contract) Provide their own tools and equipment No reimbursement for business expenses (unless provided by contract) Generally not protected by fair employment laws Not covered by workers’ compensation
Allows staffing for specific projects and needs Minimizes recruitment and retention costs, and, in some cases, overhead and supervision costs Opportunity to learn what people can do before hire Provides flexibility to both parties
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Risks of Worker Misclassification
While independent contractors may provide a greater return on investment than hiring new employees in some cases, this approach is not without risk Misclassification issues continue to be front and center in state and federal legislation, enforcement actions by state and federal agencies, DOL and IRS audits, and wage and hour litigation
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Risks of Worker Misclassification
A federal study in 2009 estimated that:
U.S. government loses $2.72 billion a year due to misclassification of employees as independent contractors State governments lose nearly $200 million a year in employment insurance compensation for every 1% of employees who are misclassified
President Obama’s “Misclassification Initiative”
FY 2011: $25 million to increase audits and enforce misclassification FY 2012: $240 million FY 2013: Budget request seeks an additional $14 million
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Risks of Worker Misclassification
Severe penalties for employers Vizcaino v. Microsoft, 120 F.3d 1006 (9th Cir. 1997), cert. denied, 522 U.S. 1098 (1998):
Estrada v. FedEx Ground Package Sys., Inc., 64 Cal. Rptr. 3d 327 (Cal. App. Ct. 2007):
Settlement of $97 million for independent “freelancers” hired under independent contractor written agreements to do production editing, proofreading, formatting, indexing, and software testing
Verdict for drivers found to be employees, $5 million compensation and $13 million in attorneys’ fees
IRS audit of FedEx found the company misclassified package pickup and delivery contractors, and owed $319 million in back taxes and penalties for tax years 2004-2006
Although this was later rescinded after an appeal by FedEx, the IRS did find that the drivers were employees of the company, which could result in tax liability for future years.
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Worker Classification Tests
Courts and different agencies apply different tests in examining whether a worker is an employee or independent contractor
Right-to-control v. entrepreneurial opportunity Economic realities test Hybrid tests
California
ABC test IRS factors
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The Right-to-Control Test
Common law test Factors
the extent of control which, by the agreement, the employer may exercise over the details of the work; whether the worker is engaged in a distinct occupation or business, independent of the business; whether the work, in the locality, is usually performed under the direction of the employer or by a specialist without supervision; the skill required in the particular occupation; whether the employer or worker supplies the instrumentalities, tools, and place of work for the worker; the length of time for which the worker is employed; the method of payment, whether by time or by the project; whether or not the work is part of the regular business of the employer; and whether the parties believe they are creating an employer and employee relationship.
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Right-to-Control v. Entrepreneurial Opportunity
No one factor is determinative, but courts have emphasized the “right to control the manner and means of the worker’s performance of the work.” FedEx Home Delivery v. NLRB, 563 F.3d 492 (D.C. Cir. 2009):
D.C. Circuit expressed dissatisfaction with the “right-tocontrol” test and announced a new element for determining employee classification: entrepreneurial opportunity.
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Economic Realities Test
For purposes of determining whether an individual is an “employee” under the FLSA, the U.S. DOL uses the economic realities test.
The definition of an “employee” under the FLSA is very expansive and broader than the common law test. It has been held to be a matter of “economic realities.”
Ultimate question is whether, as a matter of economic reality, the worker depends on the employer.
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Economic Realities Test
In United States v. Silk, 331 U.S. 704 (1947), the U.S. Supreme Court found the following factors important:
The degree of control exercised by the alleged employer; The extent of the relative investments of the alleged employee and employer; The degree to which the “employee’s” opportunity for profit and loss is determined by the “employer”; The skill and initiative required in performing the job; The permanency of the relationship; and The extent to which services performed by the worker are a key aspect of the regular business of the company
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Economic Realities Test
Immaterial factors to whether there is an employment relationship
The place where work is performed; The absence of a formal employment agreement; Whether an alleged independent contractor is licensed by state/local government; and The time or mode of pay does not control the determination of employee status.
Bottom line: if the worker is controlled by and depends on the employer, the worker is an “employee” rather than an independent contractor
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Hybrid Test
Some courts will use a hybrid test that combines the right-to-control and economic realities tests California
S.G. Borello & Sons, Inc. v. Dep’t of Indus. Relations, 769 P.2d 399 (1989): whether the employer retains the right to control “all meaningful aspects of the business relationship” is the principal test, with an emphasis on the integration of workers into the employers’ overall business operations
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Hybrid Test
Narayan v. EGL, Inc., 616 F.3d 895 (9th Cir. 2010): drivers found to be employees using hybrid test where:
The delivery services provided by the drivers were an essential part of the regular business of the company; The company instructed its drivers on proper conduct when receiving assignments and packages, handling of damaged freight, how to communicate with the dispatch, and when to arrive for work; The company controlled the details of the drivers’ performance as it related to uniforms and vehicles; The work did not require a high level of skill; Many of the relationships were of long duration; and The contracts signed by both parties contained automatic renewal clauses and could be terminated by either party upon 30 days’ notice or breach of the contract.
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ABC Test
For purposes of state unemployment taxes, some states use the ABC Test, which presumes an employment relationship.
California Illinois Others
Since the test presumes employment relationship, to be considered an independent contractor, the employer must meet three criteria:
1) the worker is free from control or direction in the performance of the work; 2) the work is done outside the usual course of the company’s business and is done off the premises of the business; and 3) the worker is customarily engaged in an independent trade, occupation, profession, or business (e.g., operates under a trade name, has own business cards, or works for other companies)
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IRS Test
For purposes of withholding federal income tax, the IRS uses the following factors to determine whether a worker is an employee or an independent contractor Behavioral Control – facts that show whether the business has a right to direct and control, including:
Instructions – an employee is generally told:
When, where, and how to work What tools or equipment to use What workers to hire or assist with the work Where to purchase supplies and services What order or sequence to follow
Training – an employee may be trained to perform services in a particular manner
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IRS Test
Financial Control – facts that show whether the business has a right to control the business aspects of the worker’s job, including:
The extent to which the worker has unreimbursed expenses The extent of the worker’s investment The extent to which the worker makes his/her services available to the relevant market How the business pays the worker The extent to which the worker can realize a profit or loss
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IRS Test
Type of Relationship – facts that show the type of relationship include:
Written contracts describing the relationship the parties intended to create Whether or not the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay The permanency of the relationship Whether the services are provided as a key activity of the business
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Worker Classification Tests
Irrespective of test used, whether a worker is an employee or an independent contractor is a factspecific analysis Label of “employee” or “contractor” not determinative
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Independent Contractor: IRS Initiatives
IRS Employment Tax National Research Project
Employment tax audit of 6,000 randomly selected companies; 2,000 each year for three years beginning in February 2010
In September 2011, the IRS announced its Voluntary Classification Settlement Program (“VCSP”)
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IRS Voluntary Classification Settlement Program
What is it? How does it benefit the IRS? How does it work? Who is eligible? How to apply? Risks of volunteering
Only 540 employers have applied to participate – May 23, 2012 IRS News Release
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Department of Labor Initiatives
Department of Labor’s Misclassification Initiative
Launched in 2010 Targeted wage and hour investigations in industries with the most classification problems Coordination with states on enforcement litigation against multi-state employers
On September 19, 2011, as part of its Misclassification Initiative, the DOL and IRS signed a Memorandum of Understanding (“MOU”) to allow the sharing of information regarding worker misclassification
How it works “We’re standing united to end the practice of misclassifying employees.”- Secretary of Labor Hilda Solis
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DOL Enforcement Actions
In 2011, the DOL’s Wage & Hour Division collected more than $5 million in back wages for minimum wage and overtime violations that resulted from employees being misclassified as independent contractors In 2012, the DOL’s Wage & Hour Division has committed to increasing its investigations by 35%
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State Misclassification Initiatives
13 states have signed memoranda of understanding with the DOL’s Wage & Hour Division to combat misclassification of workers
California Illinois
34 states have formed task forces aimed at combating employee misclassification across all industries
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Recent State Enforcement Actions
Connecticut and Rhode Island
DOL’s Wage & Hour Division is currently conducting a multi-year enforcement initiative focused on the construction industry Since 2008, the Wage & Hour Division’s Connecticut office has conducted 183 investigations of construction industry employers in these two states, recovering nearly $3.3 million in back wages for 1,226 employees, including for misclassification of workers as independent contractors DOL issued 23 Stop-Work orders against subcontractors working on a $26 million HUD project after finding that the firms had misclassified their employees and failed to have adequate workers’ compensation insurance For Fiscal Year ending June 30, 2011, Connecticut’s DOL issued a total of 159 Stop-Work orders to employers who did not comply with the state’s workers’ compensation laws In January and February 2012, Connecticut’s DOL issued Stop-Work orders to 19 construction companies, collecting $250,000 in civil penalties
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Recent State Enforcement Actions
Massachusetts
Aggressive enforcement efforts targeting independent contractor misclassification in a range of industries $3 million settlement with FedEx Ground Restaurant industry also a focus Joint Task Force on the Underground Economy and Employee Misclassification
New York
Recovered nearly $6.5 million
Focus on construction sites, restaurants, and retail establishments
Washington
Focus on hair, nail, and skin care industries
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Recent State Enforcement Actions
Texas
FedEx Ground Sys. Inc. v. Tex. Workforce Comm’n, No. D-1-GN-12002394 (filed in Travis County District Court, Aug. 6, 2012):
In 2008, the Texas Workforce Commission issued a ruling to FedEx that it had to pay unemployment taxes for its drivers. The Commission determined the amount of unpaid unemployment taxes from 2005 to 2010 to be $900,000. On August 6, 2012, FedEx sued the Commission in state court, challenging the Commission’s ruling that FedEx must pay unemployment taxes for its Texas delivery drivers, claiming the delivery drivers are employed instead by independent contractors. FedEx asserts it never had the “right to control” how its contractors or their drivers operated because:
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The drivers are hired by companies that contract with FedEx to deliver packages, not directly with FedEx; Contractors were free to decide when to work, how many vehicles to use, how to load those vehicles, what routes to take, how to juggle competing customer demands, how to deal with excessive volume, and even whether to work at all; FedEx doesn’t pay contractors on a salary or hourly basis, but instead for actual performance of the delivery services; FedEx is not responsible for hiring, training, managing, compensating, or terminating any Texas drivers 29
Recent Proposed Legislation – Federal
Employee Misclassification Prevention Act
Payroll Fraud Prevention Act
Would create a new federal offense for intentional and unintentional contractor misclassification Increased penalties Recordkeeping requirement Notice requirement Increased penalties Recordkeeping requirement Notice requirement
Fair Playing Field Act
Would eliminate the “safe harbor” provision of Section 530 of the Internal Revenue Code
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New Legislation – States
Since 2010, 11 states have passed laws curtailing the use of independent contractors or increasing penalties for misclassification 10 other states had similar laws in place prior to 2010 At least 18 state legislatures have proposed bills intended to limit the use of independent contractors or make misclassification more costly
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New Legislation – States
Illinois, New Jersey, New York
Connecticut, Kansas
Rebuttable presumption of employee status for workers in the trucking and messenger service industries
Vermont
Increased civil penalties and imposition of criminal penalties
Maine
Employee presumption for workers in the construction industry
Per se violation for misclassification
Wisconsin
Recordkeeping requirements Painting, drywall, and construction industries
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New Legislation – States
California Senate Bill 459
Effective January 1, 2012 Key provisions
Increased penalties
“Willful” misclassification Intersect with Private Attorney General Act (“PAGA”)
Notice posting of violation Enforcement
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Avoiding Misclassification
Employers can adopt strategies to minimize risk through how independent contractor relationships are structured and documented Written agreements Corporate policy on engagement of independent contractors Project vs. at-will, long-term, or exclusive contracts Pay for performance vs. time worked Contractor should be invested Train employees who manage independent contractors No unnecessary restrictions on other opportunities
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Questions?
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Thank You.
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