Contractor Status? Make Sure It’s Right For You

October 20, 2015 by Julie A. Uebler, Esq.

Since the California Labor Commission’s decision in June that a driver for Uber was an employee entitled to reimbursement of certain business expenses, and not an independent contractor, we have seen a lot of commentary about the prevalence of worker misclassification in the United States. Hiring employees, as opposed to engaging independent contractors, is more expensive for businesses due to the cost of complying with extensive legislation designed to protect employees. As a result, we see companies label their workers as contractors, even when they meet the definition of employee. In July, the Department of Labor issued administrative guidance designed to educate businesses about how to classify employees under the terms of the Fair Labor Standards Act (FLSA), signaling additional enforcement efforts in this area.

Many thought leaders are also suggesting that thecurrent legal framework of categorizing workers as either an employee or an independent contractoris no longer workable in the “on demand,” “gig,” or “shared” economy.In considering the claims of drivers who worked for Uber’s rival Lyft, one judge referred to the jury’s task of determining employee status as “being handed a square peg and asked to choose between two round holes.”

No doubt, there can be improvement in the way the law classifies workers. Many of the laws protecting employees were adopted at a time when employees worked for one employer who had significant control over pay and working conditions. To make the analysis more complicated, the definitions of “employee” are not identical among the various legal schemes. Today, surveys suggest that close to 40 percent of millennials work as “freelancers,” who seek more flexibility in how and when they work. As the way we work changes, we can expect both business and worker advocates to seek legislative fixes to the current structure. Until that happens, this edition of Your Work Matters will outline why your status matters, provide guidance on how to determine the classification applicable to your work situation, and identify steps you can take to protect yourself if you decide to work as an independent contractor.

Employee or Contractor? Why Does It Matter?

If you are an employee, you will be eligible for a variety of benefits and protections that do not apply to contractors.

Wage Laws, including the Minimum Wage and Overtime Rules.The federal and state laws in place to protect employee earnings, such as the minimum wage and overtime rules do not apply to contractors.

Unemployment Compensation. As an employee, you will be eligible for unemployment compensation benefits if your employer terminates your employment for reasons other than willful misconduct. As a contractor, you have no similar protection against a lack of work.

Workers’ Compensation. As an employee, you are eligible for benefits in the event of a work-related injury or illness, including lost wages and payment of medical expenses. As a contractor, you will not receive any benefits if you are hurt at work.

Anti-Discrimination Laws.The statutes in place to prohibit discrimination in employment based on protected characteristics such as race, gender, age, religion and disability, among others, only apply to employees. Note that the Pennsylvania Human Relations Act does prohibit companies from refusing to contract with certain independent contractors because of discriminatory bias if the contractor is in a profession licensed by the state, including accountants, nurses, cosmetologists. If you are an independent contractor who does not work in a licensed profession, you will not have legal protection against a company’s discriminatory decisions about hiring and firing you.

Collective Bargaining. The protections of the National Labor Relations Act, including the right to union organization and collective bargaining, apply only to employees.

Employee Benefits. Although we are seeing changes to the model of employer-paid employee benefits as the norm, employees often are eligible for a variety of employee benefits (whether through employer contributions or access to group employee rates) that are harder to afford as an individual, such as health care, disability, and life insurance.

If you are an independent contractor, you may also have additional costs and tax reporting obligations.

Business Expenses. Generally speaking, the independent contractor is expected to pay his or her business expenses, whereas an employee’s business expenses are reimbursed by the employer.

Employment Taxes. As an employee, you will pay only part of the contributions towards Social Security and Medicare, and your employer will pay its portion. As a contractor, you would pay a higher self-employment tax.  As a contractor, taxes will not be withheld from your pay, so you will have to track your earnings and expenses, and be prepared to make estimated quarterly payments of income and employment taxes.

Other factors to consider may be the worker’s interest in intellectual property and/or to be free from restrictive covenants. Typically, an employer will require an employee to assign the rights to all intellectual property created during the employment to the company. Similarly, post-termination restrictive covenants, such as non-competes and non-solicitation provisions, are more often part of an employment relationship.

Employee or Contractor? How to Decide?

The Internal Revenue Service, the Department of Labor, and the agencies enforcing unemployment and workers’ compensation laws all have different standards to evaluate whether a worker is an employee or a contractor. In general, however, the analysis is based on three primary factors: behavioral control; economic realities and financial control; and the type of relationship.

Behavioral Control. Does the Company control or have the right to control what the worker does and how the worker does his or her job?

  • – The type and degree of instruction are factors that reflect employer control over the worker’s behavior, such as what and where to do the work; what tools and equipment to use; whether the worker has discretion to hire other workers or assistants; and what order or sequence to do the work.
 
  • – The evaluation system used will reflect behavioral control. If the way in which the work is performed is evaluated, then this factor suggests employment status. If only the end result is considered, then this factor may weigh towards contractor status.
 
  • – The amount and nature of training provided to a worker will also be considered in evaluating behavioral control. A contractor will typically be expected to use his or her own methods to perform the work. If the company requires the worker to be trained on how to do the work, then the worker is more likely an employee.

Economic Realities and Financial Control. Which party bears the financial risk, and receives the financial reward, of the services to be performed? The following factors are considering when evaluating this issue.

  • – Is the worker economically dependent on the company or in business for him or herself?
 
  • – Has the worker made a significant investment in the equipment or tools needed to perform the work? How does that investment relate to the company’s investment?
 
  • – Is the worker responsible for paying his or her own business expenses?
 
  • – Does the worker have the opportunity for profit or loss?
 
  • – Is the worker offering his or her services to more than one company?
 
  • – Is the worker being paid a regular wage for time worked, or is he or she being paid a flat fee for the work completed?

Type of Relationship. Government agencies will also look at the type and nature of the relationship to evaluate the proper classification.

  • – Is there a written agreement governing the work relationship and what does it say about the worker’s classification? Note that even if both parties agree to an independent contractor relationship, such an agreement is not determinative.
 
  • – Is the worker providing services that are integral to the company’s business? Is the worker performing tasks that are also performed by the company’s employees?
 
  • – Is the relationship indefinite, or is the work being performed for a specific time period?

As you can see from these factors, it is not always clear whether you should be an employee or a contractor, particularly as jobs change to allow more flexibility to workers. Legal disputes over worker classification often come up in industries where the work does not fit the traditional mold and/or where the worker population is most vulnerable to misclassification, such as construction, janitorial, landscaping, drivers, and publishing, among others.

If you think you have been misclassified, consult with an attorney who can help you evaluate your situation before deciding what to do. There may be certainprotections for employees who talk to their employers about potential misclassification, but making “whistleblower” complaints about your employer’s compliance with the law always carries some risk of retaliation. Also, keep in mind that you may face penalties in the event of an audit if you agree to be a contractor, but it is later determined by a government agency that you were really an employee.

As a Contractor, How Can I Protect Myself?

Written agreement. If you are working as a contractor, insist that the terms of the relationship be confirmed in a written agreement. If you are not paid at the end of a project, you want adequate proof of the deal to enforce your right to payment. To the extent possible, make sure the terms are clear and unambiguous, and not subject to differing interpretations.

Identify Scope of Work and Payment for Services. You want the written agreement to clearly define the specific services you are to perform, as well as the terms of payment. Payment terms should include the timing, and not just the amount, of compensation for your work. Use invoices to further document when payments for services are due.

Payment upon Termination. Make sure the agreement addresses what happens to your compensation when the contract is terminated. Often, when compensation is paid as the work is performed, this isn’t an issue. However, if you have agreed to complete a project that will take weeks (or months) of work without compensation until the final product is delivered, what will happen if the company decides to terminate the agreement before your work product is delivered? Consider negotiating for a pro-rated payment, payment of an hourly rate for the investment you already made, payment of commissions for a “tail” period following the termination of services, and/or reimbursement of expenses to cover any out of pocket costs.

Indemnification and Insurance. When you work as a contractor, a company will typically seek an agreement by the contractor to indemnify the company for any loss or damage caused by your actions. Depending on the nature of your work, you may want to investigate insurance options to minimize your risk of liability. Another option is to attempt to limit the indemnification obligation to actions by you that are grossly or willfully negligent, with each party bearing the risk of loss or damage caused by simple negligence in the performance of the work.

Additional Enforcement Terms. The agreement for services should identify the law that applies to the contract (typically the state in which the work takes place), and require that any changes to the contract be made in a writing signed by both parties. In some cases, you may want to consider identifying how a breach of the agreement will be enforced, such as in arbitration as opposed to a lawsuit. If you do have to take legal action to enforce the agreement, it will be helpful to have a “prevailing party” attorneys’ fee provision, which provides that the party who wins the dispute will be entitled to reimbursement of the attorneys’ fees and costs incurred in seeking to enforce the agreement. If the company has the obligation to pay fees and costs, it will reduce the chances of getting a “sue me if you want” response when you claim you were underpaid.

Regardless of whether you have opted for contractor status out of choice or necessity, protecting yourself against the risks associated with worker classification or misclassification starts with understanding the current legal landscape. In the future, keep an eye out for new legislation designed to balance worker protections with the changes in the way we work.

Julie A. Uebler, Partner | Employment Law

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