Employer Bulletin No. 325
June 5, 2000

The Need to Address Independent Contractor Relationships

What do Microsoft, Pacific Bell, Allstate, Perdue Farms, Pacific Gas & Electric, and Time-Warner have in common?  The answer is expensive employment litigation over back-tax and benefits eligibility claims which concern whether a person is an employee or an independent contractor!  The decision-makers who see the business justification for engaging independent contractors are frequently surprised to learn that the managers who are responsible for the contractor's performance have contaminated the legal relationship.  How the supervisor "relates" to the contingent workforce can be determinative.  While a well-drafted independent contractor agreement is your first line of defense, the contract will be ignored if the "economic realities" indicate the supervisor is exceeding the degree of control permitted.

Constangy, Brooks & Smith, LLC is prepared to help you determine your exposure to employment claims, tax liabilities and benefit eligibility issues related to your use of independent contractors.  With the independent workforce continuing to grow, over 8.5 million people so classified now receive 1099s, and almost all are denied company-sponsored benefits.  When you include those individuals furnished by temporary agencies, it raises the "contingent work force" to around 13 million.  "Downsizing" coupled with the rapid growth of a contingent workforce with limited benefits, has caused many "independent contractors" to question whether they were correctly classified.  For example, the exclusion of Microsoft's "contractors" from stock options and the concurrent rise in Microsoft's stock price was an impetus behind that litigation.

Historically, the question of who is an employee and who is an independent contractor has been affected by the definition of employee and the nature of the statutes involved, such as the National Labor Relations Act, the Internal Revenue Code and the Fair Labor Standards Act.  For example, the Internal Revenue Service has adopted a 20-factor analysis.  Today there are at least three basic tests in determining independent contractor status, ranging from the 20-factor IRS test, the FLSA economic realities test and a so-called hybrid test.
 Court rulings consistently find a bona fide independent contractor relationship to exist if a separate entrepreneurial entity is hired for a defined period and has opportunity for profit and loss on the project.  The contractor typically furnishes special skills to complement or supplement the core business activities of the employer, makes services available to more than one company, is paid by the job rather than by the hour, and controls the manner and means by which it accomplishes the work.  Conversely, an employee's work is generally integrated into the employer's day-to-day business activities, and the employee's economic livelihood and need for benefits depend on the employment relationship which the employer controls.  Independent contractor agreements need to assert the employer's lack of control over the manner and means of achieving the result, and declare an intent to create an independent contractor relationship with a limited duration and purpose.

The Issue Of Control: Why Exposure Is Difficult To Determine

The IRS divides the issue of control into three categories: (1) behavioral control; (2) financial control; and (3) the relationship of the parties.  The behavioral-control category consists of evidence that substantiates a company's right to direct or control the details and means by which a contractor performs the required services.  Training and instructions imposed by a company are particularly relevant.  The financial-control category considers evidence of whether a company has the right to direct or control the economic aspects of a contractor's activities.  Factors within this category include whether a contractor has a significant investment in the contractor's business, whether a contractor incurs un-reimbursed expenses, and whether a contractor makes services available to the relevant market.  Also relevant is the method of payment to a contractor and a contractor's opportunity for profit or loss.  The relationship-of-the-parties category takes into account how a contractor and a business perceive the contractor's status.  Factors in this category include whether the written agreement between the parties expresses the intent to create an independent contractor relationship and whether compensation paid to a contractor is reported on a Form 1099 (signifying independent contractor status) or on a Form W-2 (signifying employee status).

In benefits and tax cases, the courts have adopted a hybrid test looking to the right of control over the manner and means of work and also the economic realities of the situation.  The FLSA "economic realities" test assesses six factors and, based on the "totality of circumstances," decides whether the contractor is economically independent on the business to which he renders service.  The first factor is the degree of control exercised by the company over the contractor's performance.

Constangy, Brooks & Smith Can Help

From our client work we have devised an audit to help you investigate exposure, including how to make appropriate modifications to present conditions to help assure that those you wish not to treat as employees satisfy the legal tests for independent contractor status.

When you are ready to have our attorneys aud it your compliance, contact Al Rolnick in the Atlanta office or your regular Constangy, Brooks & Smith attorney contact in any of our offices.