Independent Contractors: Overcoming the
Legal Perils and Challenges
October 17, 2013
Presenters

Moderator

Thomas F. Hurk...
Agenda
 Tests Used to Determine Employee vs.
Independent Contractor
 Laws and Obligations that May be Implicated
and Ris...
PART I:
Tests Used to Determine
Employee vs. Independent
Contractor

3
Classification Criteria:
Employee or Independent Contractor
 Different tests used, and must know each one to
consider how...
The “Right to Control” Test
 Many statutes and regulations based on ―right to
control‖ test
 Question whether employer e...
The “Right to Control” Test
(continued)

 Although the factors may vary slightly depending on
jurisdiction, the following...
The “Right to Control” Test
(continued)

 Whether the worker provides the supplies, tools,
and place of work
 Length of ...
IRS Three-Factor Test
 For audit purposes, IRS auditors use a modified
version of the 20-Factor Test that focuses on thre...
Economic Reality Test
 Used by DOL and courts for Title VII, ADEA, ADA,
FLSA, and FMLA
 Primarily examines:
 the extent...
Economic Reality Test
(continued)

 Primarily examines:
 the nature and degree of control by the ―employer‖
 the worker...
ABC Test
 Used in a growing number of states
 Creates a presumption of employee status for
purposes of wage and hour law...
ABC Test
(continued)

 This stringent state law test creates a presumption of
employee status for purposes of wage and ho...
What Standard Is Applied
Under the NLRA?
 Common law of agency: NLRB v. United
Insurance Co. of America, 390 U.S. 254 (19...
Current NLRB Standard
 Restatement (Second) of Agency 220(2)
 Examination of all factors, not just ―right of control.‖
R...
What Standard Is Actually Being
Applied by the Obama Board?
 Focus on ―economic dependence‖ or ―economic
realities‖
 For...
Joint Employer Standard Under NLRA
 Whether two (or more) entities ―share or codetermine
those matters governing essentia...
PART II: Laws and Obligations
that May be Implicated and
Risks in Misclassifying
Individuals

17
Downside Risks
 Misclassification carries significant risks and potential
exposure:
 Multimillion-dollar wage and hour a...
Downside Risks
(continued)

 Misclassification carries significant risks and potential
exposure to:
 Immigration issues,...
Joint Employer Status Risk
 Independent contractors are found to be employees
or co-employees
 Potential liability under...
Wage and Hour–Related Risks
 Failure to pay applicable minimum wage or overtime
 High-stakes civil litigation – class ac...
Employee Benefit Plan–Related
Liability/ERISA
 Vizcaino v. Microsoft (9th Cir. 1997) charted course
for exclusion of misc...
Select Benefits Issues
 Watch the 1,000-hour rule - generally individuals with
the status of common law employees need to...
Independent Contractor Status
and Tax Consideration
 Statutory liability in ―worst case‖ scenario equal to at
least 40% o...
Independent Contractor Status
and Tax Considerations
 IRS is inherently skeptical of independent contractor
relationships...
Immigration Risks
 Increased enforcement by U.S. Immigration and
Customs Enforcement (ICE) of laws governing the
hiring o...
Additional Risks
 Discrimination: Liability for discriminatory acts of
outside agency as a joint employer
 Traditional L...
PART III: Litigation Trends

28
Litigation Trends
 Class actions are common because misclassification
seldom limited to one or two people
 Exposure for ...
Litigation Trends
(continued)







30

Company practices are often difficult to defend
Low bar for certification
Wr...
PART IV: Government
Initiatives/Enforcement

31
Government Initiatives: Proposed
Federal Legislation






32

S. 2004 (110th): Independent Contractor Proper
Classific...
Government Initiatives: Proposed
Federal Legislation
(continued)









33

H.R. 3178 (112th): Employee Misclassific...
Government Initiatives: State
Legislation
 State activity is increasing
 CA and NY stepping up enforcement efforts
 20+...
Government Initiatives: California
Willful Misclassification Act, SB 459
 Prohibits persons and employers from engaging i...
Government Initiatives: DOL
 DOL and IRS sharing information on audits
 ―Plan/Prevent/Protect‖ Program
 Wage and Hour D...
Government Initiatives: DOL
(continued)

 WHD has requested 14 million dollars to investigate
and combat misclassificatio...
Government Initiatives: IRS
 IRS Employment Tax National Research Program
(NRP)
 Targeting misclassification with goals ...
Information-Sharing Programs:
IRS/DOL Memorandum of
Understanding
 IRS/DOL joint initiative to improve classification
com...
Information-Sharing Programs:
IRS/State Programs
 State Information-Sharing Program
 The IRS/state information-sharing p...
PART IV: Recommendations
for Reducing Risk

41
Best Practices for Structuring the
Independent Contractor Relationship
 Allow independent contractors to determine how,
w...
Best Practices for Structuring the
Independent Contractor Relationship
(continued)

 Avoid retaining former employees as ...
Best Practices for Structuring the
Independent Contractor Relationship
(continued)

 Do not discipline and/or terminate w...
Best Practices for Structuring the
Independent Contractor Relationship
(continued)



Do not treat identical or substanti...
Best Practices for Structuring the
Independent Contractor Relationship
(continued)

 Review definition of ―covered employ...
Self-Assessment to Avoid Risks of
Employee Misclassification
 Perform regular internal audits to ensure proper
classifica...
Voluntary Classification Settlement
Program
 The Voluntary Classification Settlement Program
(VCSP) seeks to encourage pr...
Suggested Points for Independent
Contractor Agreements
 Suggested points to address in independent
contractor agreements ...
Suggested Points for Independent
Contractor Agreements
(continued)

 More suggested points to address in independent
cont...
Suggested Points for Independent
Contractor Agreements
(continued)

 More suggested points to address in independent
cont...
Related Resources
 Independent Contractor Classification
 Using Independent Contractors and Outside Firms:
Avoiding Empl...
QUESTIONS?

53
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Worldwide Employee Benefits presentation on October 17, 2013 - Presenters: Thomas F. Hurka of Morgan, Lewis & Bockius LLP; Craig A. Bitman of Morgan, Lewis & Bockius LLP; Moderator: Heidi Winzeler of Practical Law Company

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Independent Contractors: Overcoming the Legal Perils and Challenges

  1. 1. Independent Contractors: Overcoming the Legal Perils and Challenges October 17, 2013 Presenters Moderator Thomas F. Hurka Morgan, Lewis & Bockius LLP Heidi Winzeler Practical Law Company Craig A. Bitman Morgan, Lewis & Bockius LLP 1
  2. 2. Agenda  Tests Used to Determine Employee vs. Independent Contractor  Laws and Obligations that May be Implicated and Risks in Misclassifying Individuals  Litigation Trends  Government Initiatives/Enforcement  Recommendations for Reducing Risk 2
  3. 3. PART I: Tests Used to Determine Employee vs. Independent Contractor 3
  4. 4. Classification Criteria: Employee or Independent Contractor  Different tests used, and must know each one to consider how to manage contractors and staffing agencies:     4 Common Law Test: ―Control/Right of Control‖ IRS Three-Factor Test Economic Reality Test ―ABC‖ Test
  5. 5. The “Right to Control” Test  Many statutes and regulations based on ―right to control‖ test  Question whether employer exercises ―control‖ or has the ―right to control‖ the individual’s performance of the job and how the individual accomplishes the job 5
  6. 6. The “Right to Control” Test (continued)  Although the factors may vary slightly depending on jurisdiction, the following are the typical factors considered by courts under this test (none of which is dispositive):  Degree of ―employer‖ control  Whether the individual’s business is a distinct occupation or business  Whether the individual’s occupation is usually done without supervision  Whether a high level of skill is required 6
  7. 7. The “Right to Control” Test (continued)  Whether the worker provides the supplies, tools, and place of work  Length of time the services are provided  Method of payment, e.g., by the job rather than the hour or day  Whether the work is part of the regular business of the ―employer‖  Whether the parties intend to create an independent contractor relationship  Whether the ―employer‖ is engaged in a business enterprise 7
  8. 8. IRS Three-Factor Test  For audit purposes, IRS auditors use a modified version of the 20-Factor Test that focuses on three factors:  Behavioral control factors  Financial control factors  Relationship of the parties factors  The IRS Three-Factor Test considers the work that is being performed and the business context in which it is being performed 8
  9. 9. Economic Reality Test  Used by DOL and courts for Title VII, ADEA, ADA, FLSA, and FMLA  Primarily examines:  the extent to which the services rendered are an integral part of the ―employer’s‖ business  the permanency of the relationship  the amount of the worker’s investment in facilities and equipment 9
  10. 10. Economic Reality Test (continued)  Primarily examines:  the nature and degree of control by the ―employer‖  the worker’s opportunities for profit and loss  the amount of initiative, judgment, or foresight in openmarket competition with others required for the success of the claimed IC  the degree of independent business organization and operation. 10
  11. 11. ABC Test  Used in a growing number of states  Creates a presumption of employee status for purposes of wage and hour laws  Employers have the burden of overcoming the presumption  Test is difficult to meet if workers are providing services that are within the company’s usual course of business 11
  12. 12. ABC Test (continued)  This stringent state law test creates a presumption of employee status for purposes of wage and hour laws, unless all of the following are true:  (A) the worker is free from the company’s control and direction in performing the service, both under a contract and in fact  (B) the service provided by the worker is outside the employer’s usual course of business  (C) the worker is customarily engaged in an independent trade, occupation, profession, or business of the same type 12
  13. 13. What Standard Is Applied Under the NLRA?  Common law of agency: NLRB v. United Insurance Co. of America, 390 U.S. 254 (1968)  ―All of the incidents of the relationship must be assessed and weighed with no one factor being decisive‖  Analysis involves ―no special administrative expertise‖  Court deference to Board’s choice between ―two fairly conflicting views‖ 13
  14. 14. Current NLRB Standard  Restatement (Second) of Agency 220(2)  Examination of all factors, not just ―right of control.‖ Roadway Package System, 326 NLRB 842 (1998); Dial-A-Mattress, 326 NLRB 884 (1998)  Recent focus on ―entrepreneurial opportunity for gain or loss.‖ FedEx Home Delivery v. NLRB, 563 F.3d 492 (D.C. Cir. 2009) (D.C. Circuit vacated NLRB Order and found drivers to be independent contractors) 14
  15. 15. What Standard Is Actually Being Applied by the Obama Board?  Focus on ―economic dependence‖ or ―economic realities‖  Former Chairperson Liebman’s dissent in St. Joseph News-Press, 345 NLRB 474 (2005):  ―[I]t is entirely appropriate to examine the economic relationship … to determine whether the carriers are economically independent business people, or substantially dependent on the Respondent for their livelihood‖  Argues that increasing use of ―contract labor‖ and other ―nontraditional‖ relationships ―makes the question of labor law coverage worthy of a fresh evaluation‖ 15
  16. 16. Joint Employer Standard Under NLRA  Whether two (or more) entities ―share or codetermine those matters governing essential terms and conditions of employment‖. Did the ―non-employer‖ exercise actual or ―de facto‖ control over:      Hiring Firing Discipline Supervision/Direction Wages, benefits, working hours, overtime  High Risk in WARN situations 16
  17. 17. PART II: Laws and Obligations that May be Implicated and Risks in Misclassifying Individuals 17
  18. 18. Downside Risks  Misclassification carries significant risks and potential exposure:  Multimillion-dollar wage and hour and other employment claims  Liability for payroll taxes subject to withholding from ―wages‖  State unemployment insurance payments  Workers’ compensation insurance premiums (and potential liability for workplace injuries) 18
  19. 19. Downside Risks (continued)  Misclassification carries significant risks and potential exposure to:  Immigration issues, attorney general suits  Eligibility for benefits under existing employee benefit plans 19
  20. 20. Joint Employer Status Risk  Independent contractors are found to be employees or co-employees  Potential liability under employment-related laws, including for discrimination, harassment, and wage and hour issues  Potential liability for wrongful acts of outside vendors or independent contractors against a company employee (e.g., discrimination)  Potential liability for unpaid overtime, vacation, medical leave, and other wages 20
  21. 21. Wage and Hour–Related Risks  Failure to pay applicable minimum wage or overtime  High-stakes civil litigation – class actions, double damages, long statute of limitations periods, attorneys’ fees  Violation of laws concerning meal and rest breaks, deductions from wages, reimbursement for business expenses  Corporate officers may be individually liable 21
  22. 22. Employee Benefit Plan–Related Liability/ERISA  Vizcaino v. Microsoft (9th Cir. 1997) charted course for exclusion of misclassified workers from ERISAgoverned plans  Plan sponsors tightened language to exclude contractors  Prototype pension plans usually contain the right language  Welfare plans (life insurance, long-term disability, etc.) often prepared with less care to plan sponsor liability 22
  23. 23. Select Benefits Issues  Watch the 1,000-hour rule - generally individuals with the status of common law employees need to either be eligible for retirement plans after they work 1,000 hours or have limited tenure  Non-discrimination testing  PPACA Requirements  Transitioning employees to IC status  Separation from service issues • Pension • 401(k) • Deferred and equity compensation 23
  24. 24. Independent Contractor Status and Tax Consideration  Statutory liability in ―worst case‖ scenario equal to at least 40% of payment—         24 25% Federal Income Tax Withholding exposure 7.65% Employer FICA 7.65% Employee FICA FUTA tax exposure Information reporting penalties Negligence —potential 20% penalty Failure to deposit Interest
  25. 25. Independent Contractor Status and Tax Considerations  IRS is inherently skeptical of independent contractor relationships  Understand the relief provisions and programs (e.g., Code Section 530, IRS Classification Settlement Program)  Retroactive tax liability for failure to withhold income and FICA taxes 25
  26. 26. Immigration Risks  Increased enforcement by U.S. Immigration and Customs Enforcement (ICE) of laws governing the hiring of undocumented workers  Unlawful to hire a foreign national not authorized to be employed in the United States – I.N.A. § 274A(a)(1)  Forms I-9 must be used for all new employees  Criminal or civil penalties can be imposed 26
  27. 27. Additional Risks  Discrimination: Liability for discriminatory acts of outside agency as a joint employer  Traditional Labor: Employees can engage in ―concerted activity‖ and can organize to have unions  Trade Secrets/Confidential Information 27
  28. 28. PART III: Litigation Trends 28
  29. 29. Litigation Trends  Class actions are common because misclassification seldom limited to one or two people  Exposure for back wages, overtime, Social Security, deductions, and penalties for breaks and failing to keep ―employee‖ records, etc.  Benefits, workers’ compensation, unemployment  Depending on the particular state, can be liable for up to six years 29
  30. 30. Litigation Trends (continued)      30 Company practices are often difficult to defend Low bar for certification Written agreement is not controlling Employees have minimal burden of proving damages Courts and governmental agencies tend to be suspicious of classification
  31. 31. PART IV: Government Initiatives/Enforcement 31
  32. 32. Government Initiatives: Proposed Federal Legislation    32 S. 2004 (110th): Independent Contractor Proper Classification Act of 2007 (Failed)–requires employers to treat workers misclassified as independent contractors as employees for employment tax purposes upon determination of misclassification H.R. 3408 (111th): Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (Failed)–allows independent contractors to petition IRS for a determination of classification, and increases penalties for misclassification S. 3254 (111th): Employee Misclassification Prevention Act of 2010 (Failed)–requires recordkeeping for independent contractors and imposes penalties for misclassification
  33. 33. Government Initiatives: Proposed Federal Legislation (continued)     33 H.R. 3178 (112th): Employee Misclassification Prevention Act (Referred to Committee)–requires recordkeeping for independent contractors and imposes penalties for misclassification S. 770 (112th): Payroll Fraud Prevention Act (Referred to Committee)–requires notice to independent contractors of basis for classification and creates penalties for misclassification H.R. 4123 (112th): Fair Playing Field Act of 2012 (Referred to Committee)–eliminates Section 530 of the Revenue Act of 1978 (the ―safe harbor‖), which businesses rely upon to justify contractor status H.R. 6643 (112th): Independent Contractor Tax Fairness and Simplification Act of 2012 (Referred to Committee) –would codify Section 530 in a new code section and create a broader safe harbor that applies to federal and income taxes and applies to the business receiving the services, the individual and the service provider
  34. 34. Government Initiatives: State Legislation  State activity is increasing  CA and NY stepping up enforcement efforts  20+ states have enacted or are considering laws and/or have task forces  Increased penalty legislation in several states (e.g., CT, NE, NY)  Financial pressure will force more state action 34
  35. 35. Government Initiatives: California Willful Misclassification Act, SB 459  Prohibits persons and employers from engaging in willful misclassification and charging certain expenses to contractors (or making deductions) if forbidden for employees  $5,000-$25,000 penalty misclassification  Must post content of Act in the workplace 35
  36. 36. Government Initiatives: DOL  DOL and IRS sharing information on audits  ―Plan/Prevent/Protect‖ Program  Wage and Hour Division (WHD) proposed ―Right to Know‖ regulation increasing transparency and disclosure to workers  WHD has not yet announced any regulations  The DOL plans to conduct a 30 months survey of employees on their understanding of worker misclassification laws. This may suggest the agency is moving forward on the right-to-know regulations it announced in 2010  WHD continues to take aggressive positions regarding contractor status 36
  37. 37. Government Initiatives: DOL (continued)  WHD has requested 14 million dollars to investigate and combat misclassification of workers as independent contractors  $3.8 million to investigate misclassification  $10 million for Employment Training & Administration (ETA) grants to states to identify misclassification and recover any unpaid taxes within the unemployed insurance 37
  38. 38. Government Initiatives: IRS  IRS Employment Tax National Research Program (NRP)  Targeting misclassification with goals to  (i) close the tax gap  (ii) study trends in compliance/noncompliance  (iii) increase future compliance  IRS conducting payroll tax audits to determine employee misclassification 38
  39. 39. Information-Sharing Programs: IRS/DOL Memorandum of Understanding  IRS/DOL joint initiative to improve classification compliance  DOL to refer to IRS any wage and hour investigation information ―and other data‖ that DOL believes raise employment tax misclassification compliance issues  IRS to share DOL employment tax referrals with state and municipal taxing agencies under existing sharing agreements  Currently, 14 states have signed memoranda of understanding with IRS and DOL regarding employee misclassification 39
  40. 40. Information-Sharing Programs: IRS/State Programs  State Information-Sharing Program  The IRS/state information-sharing program facilitates and expands joint tax administration relationships between IRS and state authorities  The shared information includes  Audit results  Individual and business tax return information  Employment tax information 40
  41. 41. PART IV: Recommendations for Reducing Risk 41
  42. 42. Best Practices for Structuring the Independent Contractor Relationship  Allow independent contractors to determine how, when, and where work will be performed  Manage only results, not methods  Avoid treating employees and independent contractors the same  Avoid training  Arrange for independent contractors to use their own tools, equipment and resources  Off-site work preferable  Limit duration of independent contractor relationship 42
  43. 43. Best Practices for Structuring the Independent Contractor Relationship (continued)  Avoid retaining former employees as independent contractors/contingent workers  Do not allow independent contractors to perform core business functions  Limit building access to where work performed  Only provide policies that relate to their status as independent contractors (harassment, workplace violence, security, confidential information, insider trading)  If feasible, workers should be physically separated from the company employees  Issue 1099s to independent contractors 43
  44. 44. Best Practices for Structuring the Independent Contractor Relationship (continued)  Do not discipline and/or terminate workers except under the terms of the contract  The company should not grant awards, bonuses, or ―annual raises‖ to nonemployee workers  No formal or informal performance reviews  Allow subcontracting or independent contractor’s own employees  Workers should not hold themselves out as company employees (e.g., cards and email addresses) 44
  45. 45. Best Practices for Structuring the Independent Contractor Relationship (continued)  Do not treat identical or substantially similar workers differently (i.e., some as employees and others as ICs)  Obtain services from ICs who have incorporated or who are provided by third parties  Avoid audit red flags - do not issue Forms W-2 and Forms 1099MISC to the same worker in the same year  Ensure ICs remain current on their payroll taxes (consider obtaining Forms 4669 or similar statements from ICs)  Adopt and implement standardized IC contract language  45 Neutralize employee benefit risks associated with disgruntled ICs • Use proper IC contractor language • Add ―Microsoft language‖ to all plans—qualified plans, nonqualified plans, fringe programs, etc.
  46. 46. Best Practices for Structuring the Independent Contractor Relationship (continued)  Review definition of ―covered employee‖ in benefit plan documents  Benefit plans should exclude workers who are not receiving Forms W-2 from the plan sponsor  Amend plans to add ―Microsoft language‖ • Paid from accounts payable • Workers ineligible for benefits even if the worker is subsequently reclassified as an employee • Reclassification will not be done on a retroactive basis  Review employee communications (including handbooks and benefits websites) to ensure documentation accurately describes the categories of eligible individuals 46
  47. 47. Self-Assessment to Avoid Risks of Employee Misclassification  Perform regular internal audits to ensure proper classification  Review what is actually occurring in the relationship  Update, review, and limit the tenure of independent contractors  Consider cost/benefit of alternative arrangements (short-term employment)  Review agreements and relationships with vendors/staffing agencies providing contingent workers to ensure compliance with relevant laws 47
  48. 48. Voluntary Classification Settlement Program  The Voluntary Classification Settlement Program (VCSP) seeks to encourage prospective worker reclassification  VCSP is an alternative to the Classification Settlement Program, which only applies to taxpayers actually under audit  Under the VCSP, there is no IRS audit in exchange for:  A taxpayer’s agreement to treat a class of workers as employees for future tax periods for payroll tax purposes, and  A payment of 10% of the Section 3509 rates 48
  49. 49. Suggested Points for Independent Contractor Agreements  Suggested points to address in independent contractor agreements to reduce risk of employee misclassification:  Contractors and subcontractors have specialized skills  Vendor does not supply workers exclusively for the company and workers are free (or contractor is free) to work for other firms  The company does not hire or supervise or have control over independent contractors or subcontractors’ employees 49
  50. 50. Suggested Points for Independent Contractor Agreements (continued)  More suggested points to address in independent contractor agreements to reduce risk of employee misclassification:  The company does not provide employee benefits; or, specify that independent contractors waive employer’s coverage  The company does not maintain or have access to independent contractors’ or subcontractors’ payroll, time, or other records  Require the independent contractor or subcontractor to comply with all wage and hour and wage payment laws as well as federal, state, and local taxes 50
  51. 51. Suggested Points for Independent Contractor Agreements (continued)  More suggested points to address in independent contractor agreements to reduce risk of employee misclassification:  Broaden and strengthen indemnification provisions in agreements  Require that independent contractors and subcontractors require workers to sign confidentiality agreements specific to temporary work  Independent contractors and subcontractors should pay for and control background checks for their own employees 51
  52. 52. Related Resources  Independent Contractor Classification  Using Independent Contractors and Outside Firms: Avoiding Employee Misclassification Checklist  Independent Contractor/Consultant Agreement (Proclient)  Independent Contractors: State Q&A Tool 52
  53. 53. QUESTIONS? 53
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