[Due to the fact that many businesses will soon be ramping up for the upcoming sales season, coupled with the fact that April 15 arrives even sooner, I have received many requests for advice regarding employee-independent contractor classification. This article is a reprint of an article analyzing the issue.]
The Internal Revenue Service, and its state counterpart, The Commissioner of Labor, continue to aggressively pursue reclassification of independent contractors as employees. For fireworks display companies that rely upon technicians to temporarily supplement its full-time technical staff, an assessment by federal and state agencies can put a company out of business given the significant dollars involved. The same conclusion is also valid for businesses that rely upon seasonal sales staff to market consumer fireworks.
In general, the reviewing agency employs a common law test of control to determine whether a worker is an employee or an independent contractor. Under this test, a worker is an employee if the user of the worker’s services has the right to direct and control the manner and details of the worker’s performance. In ascertaining the level of direction and control relating to a specific worker, the IRS routinely considers a wide variety of factors. However, (a) none of these factors, in and of itself, are dispositive, (b) some factors do not apply to certain occupations and (c) the level of importance assigned to a particular factor may vary depending upon the occupation.
The factors are:
1. Significant Investment. The absence of investment in the facilities used by a worker indicates dependence upon the employer; whereas the investment by a worker in the facilities used by him in performing services for the employer is indicative of independent contractor status. For most businesses, this is the most significant control factor to the IRS in assessing whether a particular worker is an employee or an independent contractor.
Analysis: This factor is of lesser importance in the context of technicians retained solely to perform fireworks displays since, invariably, the display site is far removed from the employer’s facility. The same is true for workers that sell consumer fireworks at locations other than the employer’s facility. Also, independent contractors maintain their own business facility with a separate address. It is suggested that the written service agreement signed by the independent contractor include the independent contractor’s full business address (preferably, either in the opening paragraph or at the signature line).
2. Realization of Profit or Loss. For most businesses, this factor is the second most important control factor to the IRS in determining whether or not a particular worker is an employee or an independent contractor. If the worker is not able to realize a profit or, as the case may be, suffer a loss, the worker may be classified as an employee. Conversely, independent contractor status exists where the worker is able to realize a profit or, as the case may be, suffer a loss. The opportunity for profit or loss can be established by a variety of factors, such as: (i) continuing and recurring liabilities or obligations, with success or failure depending on the relationship of revenues to expenses; (ii) the worker’s services establish or affect that worker’s own business reputation, as opposed to the reputation of the employer; and (iii) the worker maintains an office, owns equipment and materials, or other work facilities.
Analysis: Whenever possible, the worker should be compensated strictly in accordance with the terms of a written agreement negotiated by the parties. Agree to pay a lump sum or commission, and avoid performance bonuses. Also, the worker is to be responsible for compensating any assistants. Once again, it is suggested that the written service agreement signed by the independent contractor include the independent contractor’s full business address (either in the opening paragraph or at the signature line).
3. Services Rendered Personally. When the services are rendered personally a presumption is made that the employer is interested in both the methods and the results. The employer may also be interested in the identity of the workers. Each of these facts evidences an employer-employee relationship.
Analysis: Independent contractors, by nature, do not work personally for one employer; instead they market themselves to, and presumably select the highest bidder and, oftentimes, serve more than one employer at the same time. Once again, businesses that are heavily dependent upon seasonal ‘volunteer’ labor should be aware of the trap of having a worker deemed to have rendered services personally. Under all circumstances, ensure that the written service agreement that you have the independent contractor sign expressly disavows the creation of an employer-employee relationship. The written agreement should also contain a provision that the parties understand that the worker is intended to be an independent contractor for all purposes.
4. Working For More Than One Employer. As a general rule, the more employers that an individual works for at the same time, the more likely independent contractor status is present.
Analysis: Conditions that restrict a worker’s ability to perform for another employer are to be avoided. For example, precluding a worker from working in a particular geographical area and/or barring the worker from performing the same work for a specified period of time. These types of restrictions may be deemed covenants not to compete and are to be avoided at all costs. As a general rule, the worker should remain free to accept work from other employers.
5. Services Available to the General Public. Where the worker’s services are made available to the general public (i.e., advertising, business phone number and listing), a finding of independent contractor status is likely.
Analysis: This factor is self-explanatory. Once again, avoid any restrictions upon the worker’s availability to solicit and perform work for another employer. Indeed, it may prove helpful to expressly acknowledge in the agreement itself that the independent contractor works for others.
6. Employer Right to Discharge. Generally, the person possessing the right to discharge a worker is an employer. By contrast, an independent contractor cannot be fired provided the results achieved satisfy the contract specifications.
Analysis: The right to hire does not necessarily create the right to fire. Where the employer can fire at will, an at-will employer-employee relationship may exist.
7. Employee Right to Termination. An ‘at will’ employee may terminate the employment relationship at any time without incurring liability (a contract employee may have agreed obligations and liabilities); whereas, an independent contractor is obligated to complete the agreed task and is liable for an incomplete job.
Analysis: This is the reverse of an employer’s right to discharge. An ‘at will’ worker’s freedom to terminate signifies an employee-employer relationship. By contrast, an independent contractor exposes oneself to a claim of breach of contract upon termination without cause.
8. Assistants. A worker’s ability to hire and pay assistants is highly probative of independent contractor status.
Analysis: Many display companies ascertain technician availability by using a prepared form, or rely upon trade publications in which technicians advertise their availability and services. While the employer may prefer to know the identity of the other assistants that the worker will employ, the less involved the employer is in the selection process the more likely that the IRS will find that an independent contractor relationship exists. The fact that the employer may require all technicians to possess valid COF’s does not, in and of itself, give rise to a finding of an employer-employee relationship. However, as a general rule, the determination of fitness of a particular individual should be left to the worker so as to preserve independence. Similarly, the worker retained by the employer should be solely responsible for determining how and when to pay his assistants. To summarize, the employer should avoid interfering with a worker’s entitlement to hire assistants, as well as avoid having any input into the selection of substitute or replacement staff. Indeed, the fact that the employer has no knowledge of the occurrence of substitution or replacement infers an independent contractor relationship. Also, ensure that the worker is solely responsible for all state, Federal, Social Security and unemployment taxes on the income the worker earned under the written service agreement, as well as on the earnings paid to any assistant the worker may hire.
9. Directions. A worker that is required to comply with instructions about when, where and how to work is, generally, an employee. The element of control exists since the employer can require compliance with directions. The directions can be either oral or in the form of manuals or written procedures that describe the desired result to be achieved. By contrast, an independent contractor is responsible only for the end result.
Analysis: The less involvement that the employer has regarding the execution of the display or, as the case may be, the sale of fireworks, after the worker accepts delivery of the fireworks, the less likely an employer-employee relationship will be found. Generally, when technicians that are hired use their own independent discretion and judgment regarding, among other matters, the delivery, set up and execution of the display, an independent contractor relationship exists. The government agent should recognize that, oftentimes, the display is to be set up in a particular manner to achieve the end result, and that the display itself invariably begins after dark; and the existence of these factors should not weigh against a finding of independent contractor status. Similarly, when salespeople that are hired to use their own independent discretion and judgment regarding activities surrounding the subsequent sales of fireworks, and related matters, an independent contractor relationship generally exists.
10. Provision of Tools and Materials. Where the tools and materials are furnished by the employer a finding of an employer-employee relationship may arise; by contrast, an independent contractor provides the needed tools and materials.
Analysis: To the extent feasible, require the worker to provide tools and materials. With respect to the practice of display companies of furnishing racks, mortars, sand, shells, etc., it is suggested that the written service agreement expressly indicate that the provision of tools and materials does not indicate that the parties desire to enter into an employer-employee relationship. Since no one factor is dispositive, the realization that it may be impossible for display companies to completely overcome this factor (display companies regularly provide racks, mortar tubes, sand, wiring, electronic firing boards, etc.) does not warrant an automatic finding of an employee-employer relationship. Also, avoid providing the worker with company clothing or uniform, such as t-shirts and caps, and requiring the worker to wear it while working for the employer; otherwise the general public is given the impression that the worker is an employee. Nothing prevents an employer from agreeing to provide clothing as part of the written service agreement, or as a gift.
11. Training. A worker may be deemed an employee when (i) an experienced employee is assigned to work with the person for purposes of training, or (ii) attendance at training meetings is mandatory. By contrast, an independent contractor customarily receives no training by the employer.
Analysis: In essence, you get what you pay for. Presumably, the more experienced the worker the less training that is required. Avoid training technicians, or assisting them in obtaining a certificate of fitness; instead, retain qualified technicians who have completed their training, or obtained their certificate of fitness, elsewhere. Businesses that rely upon seasonal ‘volunteers’ encounter a dilemma. While ‘volunteers’ are by name cheap labor, invariably, volunteer workers need training and supervision, exposing the employer to a finding of an employer-employee relationship.
12. Full-Time Requirement. Where a worker is required to devote full-time to the business of the employer and, as a consequence, is restricted from performing other gainful work, the element of control over that worker’s time is present. Accordingly, a determination of an employer-employee relationship may occur.
Analysis: The employer should permit the worker to freely decline any work (without providing a reason), and to freely work for competing companies.
13. Set Hours of Work. The establishment of set hours of work by the employer indicates control; whereas an independent contractor normally determines the hours of work.
Analysis: The absence of a requirement to be available at a particular time or date evidences an independent contractor relationship. Accordingly, to the extent feasible, do not require work at set times or the submission of time reports. The fact that a display is scheduled to commence at a set time is of no consequence, since an independent contractor is responsible only for the end result (i.e., a display that is ready to start at a predetermined date, time and place).
14. Work on Employer’s Premises. Where an employer has the right to compel a worker to travel a designated route, or to work at a designated place, the element of control over the place of work is present. Accordingly, a determination of an employer-employee relationship may occur.
Analysis: Let the worker select the travel route, recognizing that transportation routes available for hazardous materials is already governed by statute. Indeed, the fact that travel routes are subject to regulation argues against a finding of an employee-employer relationship in those instances where the employer and the worker select the same travel route.
15. Order of Sequence. Where the employer determines the order of sequence of the services to be performed by the worker the element of control is present, and an employer-employee relationship may exist. By contrast, an independent contractor is free to establish and follow any sequence in the course of performing services that achieves the agreed result.
Analysis: Arguably, an accepted method of setting up a fireworks display exists. Thus, the fact that the worker may employ the same order of sequence does not, in and of itself, necessarily prompt a finding of independent contractor status.
16. Reports. If the worker is required to submit regular oral or written status reports to the employer, the element of control is present.
Analysis: To maintain independent contractor status, have the worker create, on its own business stationary, a statement or invoice detailing all of the materials used as well as the work performed. Avoid written interim status reports.
17. Payment by Hour, Week or Month. Where the worker is paid regular amounts at stated intervals, such as by the hour, week or month, an employer-employee relationship may exist. By contrast, payments made by the job or on a straight commission basis generally indicate independent contractor status.
Analysis: The employer should avoid setting the price for the services to be rendered by the worker; rather, let the worker (e.g. lead technician, salesperson) negotiate the price with the employer with the understanding that the worker remains responsible for compensating his assistants, if any. Also, the employer should base the final negotiated price upon the job as opposed to the time expended by the worker and his crew or, as the case may be, the salesperson and his sales force; avoid unit measurements (hourly, daily, weekly) as the method of calculating compensation. It is also valuable to have the worker provide the employer with an invoice that is not on a form of the employer. Importantly, the company should furnish all workers that it considers to be independent contractors with 1099s, where appropriate, and none of these workers should be permitted to receive a bonus, sick leave, paid vacations or a pension.
18. Payment of Expenses. The more expenses the employer pays, the more likely that an employer-employee relationship exists.
Analysis: As opposed to agreeing to pay the expense, the employer should consider having the worker include these expenses as part of the negotiated price. Also, reimbursed expenses should be made on a voluntary case-by-case basis so as to avoid the implication that the payment by the employer is a regular part of doing business. To summarize, the worker should be responsible for the businesses expenses incurred in performing under the written service agreement.
19. Continuing Relationship. The existence of a continuing relationship between the worker and the employer is another factor indicating an employer-employee relationship.
Analysis: The employer should avoid being over-reliant upon any one worker. However, the employer should not compromise safety in order to avoid a finding of a continuing relationship. Given the hazardous nature of the work, the need to retain qualified workers necessarily limits an employer’s ability to hire. Generally speaking, this is a weak factor.
20. Integration. The IRS may analyze the extent of the integration of the worker’s services as compared to the total business operation to determine the degree of control and direction that may be present.
Analysis: This factor is rather esoteric. However, it suggests that the employer should attempt to retain fresh workers rather than rely upon the same individuals year after year. As a general rule, independent contractors have little, if any, influence regarding the operation of the employer’s business.
In conclusion, the issue of whether or not a particular person is an independent contractor or an employee depends upon a review of many factors. No one factor or set of factors is necessarily controlling one way or the other. Instead, the determination depends upon an overall review of the facts and circumstances on a case-by-case basis. The employer who relies upon detailed written service agreements, and consistently adheres to the terms contained in it, is best served. Nevertheless, the reviewing agency is not bound by the parties’ agreement, and even a well-drafted agreement cannot convert an employee into an independent contractor. The most important guideline in drafting a written service agreement is that is accurately describes the exact nature of the business relationship to be cre
