Employee/Independent Contractor
You got your reading cut out for you....Dragonbrn!
Courts and agencies use various tests to determine whether an individual is an independent contractor or an employee. An employer's incorrect assessment that a worker is an independent contractor may result in unexpected contract, tax, wage and benefit liabilities. This fact is dramatically illustrated by a recent decision of the United States Court of Appeals for the Ninth Circuit, Vizcaino v. Microsoft, 97 F.3d 1187 (9th Cir. 1996) (rehearing en banc, granted, 1997 US App. 2319 [9th Cir. February 10, 1997).
The Microsoft litigation arose after an IRS investigation into the company's compliance with applicable tax laws.
Applying the common law test described below, the IRS "concluded that Microsoft's freelancers were not independent contractors but employees for withholding and employment tax purposes, and that Microsoft would thereafter be required to pay withholding taxes and the employer's portion of Federal Insurance Contribution Act [FICA) tax." Id. at 1190 (footnote omitted). Plaintiffs, former freelance employees, sued Microsoft, seeking various employment benefits, including the right to participate in Microsoft's Savings Plus Plan ("SPP") and Microsoft's Employee Stock Purchase Plan ("ESPP"). Writing for a divided panel, Judge Reinhardt held the employees were covered by both the SPP and the ESPP.
Here are your identifiable tests Dragonbrn...
A. Common Law Test
B. Economic Realities Test
C. Hybrid Test
D. Remedial Legislation Test
YOU GOT YOUR READING CUT OUT FOR YOU! Good Luck! NYSLaw.
A. The Common Law Test
Many statutes and regulations are based on the "common law" test. Under the common law test, an employment relationship will be found if the employer exercises (a) "control" or (b) has the "right of control" over the individual's performance of the job and how the individual accomplishes the job. The greater the control exercised over the terms and conditions of employment, the greater the chance that the controlling entity will be held to be an employer. (Two entities, each exercising sufficient control, may also be held to be a "joint employer," as discussed more fully below.)
The "right of control" test depends upon consideration of the following ten factors, (no one of which is dispositive), which may indicate independent contractor status:
1. the degree of "employer" control over the details of the work;
2. whether the individual's business is a distinct occupation or business;
3. whether the individual's occupation usually is done without supervision;
4. whether a high level of skill is required by the occupation;
5. whether the worker provides the supplies, tools and the place of work;
6. the length of time the services are provided;
7. method of payment, by the job rather than the hour or day;
8. whether or not the work is part of the regular business of the employer;
9. whether the parties believe they are creating an independent contractor relationship; and
10. whether the hiring entity is not in business.
Restatement 2d, Agency, §220 (1958).
Where the "common law" test is invoked, as by the IRS, several other factors have been added to modify the test for application under particular statutes.
B. The IRS Test
The Internal Revenue Service is concerned with determining whether a worker is an independent contractor because employers are required to arrange for three types of employment taxes for employees. These taxes are required under the Federal Insurance Contributions Act ("FICA") (29 USC § 3121(d)(2)), which governs employer and employee contributions to the Social Security system; the Federal Unemployment Tax Act ("FUTA") (26 USC § 3306(i)), which governs employer contributions to the unemployment fund; and the IRS rules governing employee personal income tax withholding (26 USC § 3401(c). If the employer categorizes independent contractors incorrectly, and the IRS determines that a worker is actually an employee, the employer may be liable for penalties as well as any unpaid taxes. Vizcaino v. Microsoft, 97 F.3d 1187, 1190-91 (9th Cir. 1996) (IRS investigation resulted in reclassification of Microsoft's freelance employees as common law employees subject to withholding taxes, FICA tax and overtime pay).
The Tax Reform Act of 1986, section 1706, limited the exemption previously provided to employers for workers "other than an employee." The exemption has been narrowed substantially in the case of "technical service" employees. Section 1706 provides that "technical service employees include engineers, designers, drafters, computer programmers, system analysts and other similarly skilled personnel who are engaged in similar lines of work who render services to clients of the technical service firms." If an employer uses the services of one of these individuals, an employer must comply with most or all of the factors set out in the IRS independent contractor test. Rev.Rul. 87-41.
The IRS test is essentially the common law test to which several "right of control" factors have been added. 5 The resulting more detailed twenty (20) factors "are designed only as guides to determine whether an individual is an employee; special scrutiny is required to apply the 20 factors to assure that formalistic aspects of an arrangement designed to achieve a particular status do not obscure the substance of the arrangement." See Rev.Rul. 87-41.
The IRS factors include:
1. whether the individual is required to follow instructions;
2. the amount of training of the individual related to that particular job;
3. the amount of integration of the individual into the employer's business;
4. whether services are rendered personally by the individual;
5. whether the employer hires, fires and pays assistants;
6. the existence of a continuing relationship;
7. the establishment of a set amount of work hours;
8. whether the individual must devote substantially full time to the job;
9. whether the individual works on the employer's premises;
10. whether the individual works according to a sequence set by the employer;
11. whether the individual must submit regular or written reports to the employer;
12. whether the individual is paid by time rather than by project;
13. whether the individual is reimbursed for expenses;
14. whether the individual furnishes the necessary tools and materials;
15. whether the individual has invested in the facilities for performing the services;
16. whether the individual can realize a profit or a loss;
17. whether the individual works for more than one firm at a time;
18. whether the individual makes his/her services available to the general public;
19. whether the employer has the right to discharge the individual; and
20. whether the individual has the right to terminate the relationship
C. The Fair Labor Standards Act (FLSA) Test
The FLSA governs the federal minimum wage and overtime pay obligations of many employers. 29 USC §201. Employers cannot reduce these obligations merely by classifying workers as independent contractors. If the US Department of Labor determines that the workers are employees, the employer may be subject to substantial penalties, from the payment of unpaid overtime premiums to liquidated damages, fines of $10,000 and six months' imprisonment for willful violations. Unpaid overtime premiums alone may represent substantial monetary liability depending upon the size of the work force and the length of time that the company has failed to pay appropriate overtime.
The FLSA "economic realities" test focuses on whether an individual is economically dependent on the business to which services are provided, thus establishing employee status, or whether the worker effectively is in business for himself or herself. Unlike the IRS test, the "right of control" under the FLSA is usually determined by reference to one of six roughly equal factors: 6
a. the extent to which the services in question are part of the company's business;
b. the amount of the individual's investment in the company's facilities and equipment;
c. the nature and degree of control retained by management;
d. individual opportunity for profit or loss;
e. the amount of initiative, skill or judgment required; and
f. the permanency and duration of the relationship.
D. California's Borello Test
California's approach to regulating employment differs considerably from that of the federal government, both in the breadth of California's coverage and the extent to which enforcement is achieved through assessment of penalties. California's wage-hour laws, set forth in the California Labor Code and the Industrial Welfare Orders, regulate time, place and manner of payment. While federal wage-hour requirements impose an economic realities test, California employers--until recently--generally had to meet common law "right of control" tests to avoid costly confrontations with state wage and hour administrators. Whether the California Supreme Court's decision in Borello will change this historical "right of control" standard is now an open question as we discuss below.
On March 23, 1989, the Supreme Court of California rejected long-standing application of the common law right of control to determine independent contractor status under at least California's workers' compensation statute. At the same time, the Court declined to adopt any "detailed new standards for examination of the [independent contractor] issue." Borello, supra, 48 Cal.3d 341 at 353. Rather, the Court seemed to credit heavily three different legal tests.
The decision noted that Restatement guidelines regarding the common law "right of control" test "remain a useful reference" and that the standards set forth in Labor Code section 2750.5 are also a "helpful means of identifying the employer/contractor distinction." In addition, the Court suggested that six factors adopted by other courts to consider the remedial purpose of the legislation were also helpful to draw lines between the status of employees and independent contractors.
In the final analysis, the Borello Court appears to bring California more closely in line with the IRS's 20 factor analysis (see Attachment C which compares the 20 factor IRS test to the factors set forth in the common law, California Labor Code §2750.5 [which provides the requirements for licensed construction contractors to be independent contractors) and the factors considered by other courts).
In Borello, the Supreme Court of California held specifically that cucumber pickers were "employees" entitled to workers' compensation coverage based on the following facts: (1) the "sharefarmer" workers at issue had no control over the operation as a whole, e.g., crop cultivation, selection of the buyer and price; (2) sharefarmers had no particular skill or expertise; (3) the work was seasonal, but permanent; (4) sharefarmers had no distinct trade or calling; (5) sharefarmers did not hold themselves out in business; (6) workers invested only their personal service and hand tools; (7) there was no opportunity for profit or loss; the possibility that the crop would fail "is the chance faced by any at-will wage earner that his services will not be needed after all" (Borello, supra, 48 Cal.3d 341 at 358, n. 11); (8) sharefarmers relied solely on field work for their livelihood; (9) there was no practical opportunity for the sharefarmers and their families to self-insure for workers' compensation coverage; and (10) there was no real opportunity to bargain over the preprinted contract that was offered to heads of families who would harvest the crop.
In a workers' compensation setting, independent contractor status now is found in California "when the provider of service has the primary power over work safety, is best situated to distribute the risk and cost of injury as an expense of his own business, and has independently chosen the burdens and benefits of self-employment." Borello, supra, 48 Cal.3d 341 at 354.
Of perhaps even greater import from the Borello decision are "implications for the employer-employee relationship upon which other state social legislation depends." Borello, supra, 48 Cal.3d 341 at 345 (emphasis added). The court noted in dicta that the implications of its decision included application of California laws governing minimum wages, maximum hours and employment of minors (Labor Code § 1171, et seq.; Labor Code § 1285, et seq.), the antidiscrimination provisions of the Fair Employment and Housing Act (Gov't Code § 12940, et seq.) and the Agricultural Labor Relations Act (Labor Code § 1141, et seq.). The decision did not apply specifically to the California unemployment insurance coverage statute since that statute itself requires that the status of a covered "employee" be determined by the "usual common law rules." Unemp.Ins.Code § 621(b); Borello, supra, 48 Cal.3d at 359, n. 16.
Using a similar "control" analysis, the court of appeals for the First Appellate District held that a taxi driver was an employee of the Yellow Cab Company for the purposes of the California workers' compensation statute, even though the employer did not completely control the way in which the taxi drivers performed their work. The court noted that Yellow Cab acted as a clearing house for customers and that it promoted a "distinct identity" to attract members of the traveling public, that the driver's relationship with Yellow Cab could be terminated for misconduct, and that the driver was prohibited from driving for other companies. Yellow Cab Cooperative, Inc. v. Workers' Compensation Appeals Board and Richard Edwinson, 226 Cal. App. 3d 1288 (1991).
