and Independent Contractor Classifications: Potential Employee Benefit Plan Liabilities Under the ACA, ERISA and Other Laws Thursday, February 23, 2017 CLE Luncheon Program Abstract: Many companies hire workers as independent contractors when they may instead be common law employees. This can create many potential liabilities for employers under employment and tax laws, including significant penalties under the Affordable Care Act, ERISA, and other laws affecting employee benefit plans. This session will discuss steps that employers can take to identify and mitigate these risks for their benefit plans. Key learning objectives from today s session: 1. Why companies seek flexibility with their employee classifications 2. The basics of the regulatory guidance issued by the IRS, DOL, and other government agencies to date relating to independent contractors and other non-employee classifications 3. Common situations where employee misclassification issues arise 4. Summary of potential liabilities for companies 5 Specific examples of employee benefit liabilities that may arise under companies health and retirement plans 6. Recommendations and next steps for companies to determine potential risks relating to their employee classifications Internal Revenue Service Factors Independent Contractor Considerations IRS regulations provide that an employer-employee relationship generally exists if the person contracting for services has the right to control not only the result of the services, but also the means by which that result is accomplished. In other words, an employer-employee relationship generally exists if the person providing the services is subject to the will and control of the employer not only as to what shall be done but how it shall be done. See Treas. Reg. 31.3401(c)-(1)(b). Additionally, actual control is not the critical issue; rather, it is the right to control that the IRS focuses on. Making this determination is a case-by-case analysis; however, the IRS has put together a 20-factor test that it uses to evaluate whether a true independent contractor relationship exists. The weight given to
each factor will depend on the facts and circumstances at issue, and other factors may be considered, but it ultimately boils down to control. The IRS 20 factors are set forth below: 1. Instructions. Workers who are required to comply with others instructions about when, where, and how they are to work are ordinarily viewed as employees. 2. Training. Training workers indicates that the company exercises control over the means by which results are accomplished. 3. Integration. When the success or continuation of a business depends on the performance of certain services, the workers performing those services are subject to a certain amount of control by the owners of the business. 4. Services Rendered Personally. If services must be rendered personally, the company is more likely to be viewed as controlling both the means and the results of the work. 5. Other Staff. If the contractor hires, supervises and pays its own staff, the contractor is more likely to be seen as an independent contractor. 6. Continuing Relationships. Continuing relationships between workers and a company indicate the existence of an employer-employee relationship. 7. Set Hours of Work. The establishment of set hours of work by a company indicates control. 8. Full-Time Required. If workers must devote full time to the company s business, the company is more likely to be seen as controlling the workers time. Independent contractors are free to work when and for whom they choose. 9. On Premises. Control is indicated if the work must be performed on the company s premises. 10. Set Sequence of Performance. Control is indicated if workers are not free to choose their own patterns of work but must perform services in a sequence set by the company. 11. Reporting Obligations. Control is indicated if workers must submit regular oral or written reports to employers. 12. Regular Pay Periods. Established regular pay periods are indicative of an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed on as the cost of the job. Conversely, payment the job or straight commission is more indicative of an independent contractor relationship. 13. Expense Reimbursement. The reimbursement of business and travel expenses is viewed as indicia of an employment relationship. 14. Furnishing Tools and Materials. If the company furnishes significant tools, materials, and other equipment, this is viewed as evidence of an employer-employee relationship. 15. Facilities Investment. Independent contractors often invest in facilities that are not typically maintained by employees (such as office space). Employees typically depend on employers for such facilities. 16. Profit and Loss. Workers who can realize profits or losses (in addition to profits or losses ordinarily realized by employees) are typically viewed as independent contractors.
17. Multiple Clients. If workers perform services for a number of unrelated persons at the same time, they are usually viewed as independent contractors. 18. Services Generally Available. Workers are usually independent contractors if they make their services available to the general public on a regular and consistent basis. 19. Right to Discharge. If the company retains at will termination rights, this is an indication of employee status. 20. Right to Terminate. If the worker can terminate the relationship at any time without incurring any form of liability, that is an indication of employee status. Department of Labor Factors The DOL s analysis is similar, but not identical, to the IRS analysis. It applies a set of Economic Realities Factors to evaluate whether the worker is economically dependent on the company or in business for him or herself. 1. Is the Work an Integral Part of the Employer s Business? If the work performed by a worker is integral to the employer s business, it is more likely that the worker is economically dependent on the employer. The example used by the DOL is that of a construction company carpenters are integral, whereas developing software to track bids is not. 2. Does the Worker s Managerial Skill Set Affect the Worker s Opportunity for Profit or Loss? A worker in business for him or herself faces the possibility to not only make a profit, but also to experience a loss. Managerial skills impact the opportunity for profit or loss beyond the current job, such as by leading to additional business from other parties or by reducing the opportunity for future work. Conversely, a worker s ability to work more hours to make more money does not reflect a true managerial skill set. 3. How Does the Worker s Relative Investment Compare to the Employer s Investment? An independent contractor typically makes investments that support the business beyond any particular job. Even if a worker has made an investment, the DOL will not consider this in isolation; rather it will look to the relative investments that matter between the company and the contractor. 4. Does the Work Performed Require Special Skill and Initiative? Here, the DOL focuses on a worker s business skills, judgment, and initiative, not his or her technical skills, to evaluate whether the worker is economically independent. The DOL uses an example of a carpenter who, beyond performing a skilled trade, markets his services, determines when to order materials and the quantity of materials to order, and determines which orders to fill. 5. Is the Relationship between the Worker and the Employer Permanent or Indefinite? Permanency or indefiniteness in the worker s relationship with the employer suggests that the worker is an employee. 6. What is the Nature and Degree of the Employer s Control? To be an independent contractor, the worker must actually control meaningful aspects of the work performed, and not just have the ability to do so in theory.
From the DOL s perspective, most workers are employees under the FLSA, and it will evaluate the Economic Reality Factors in favor of broad coverage. IC Agreement Best Practices Ultimately, titles and the agreement of the parties is not determinative, but the claim of an independent contractor relationship can be strengthened if the parties put their understanding in writing. The following tips for the content of independent contractor agreements should help minimize legal uncertainty regarding a worker s status. Of course, each situation is different, and should be evaluated carefully with the assistance of counsel. 1. Statement Addressing Relationship. The most obvious way in which to avoid uncertainty is to include a statement in a contract to the effect that the parties understand and intend to establish and maintain an independent contractor relationship. 2. Address the Right of Control. Similarly, a statement may be incorporated into a contract whereby the right of control over a project is specifically designated in favor of an independent contractor. (It is important to note, however, that statements alone may not be enough, as courts may look into the facts to determine who in fact exercised control in a particular situation.) 3. Address Who Owns the Tool Belt: Because courts have placed weight on whose tools and/or workplace is used, a provision specifying that the contractor will provide these is beneficial. 4. Payment Terms: Although not dispositive, payment by the project, rather than by smaller units such as the hour or day, suggests an independent contractor relationship. 5. Workers Comp: To avoid confusion in the event of an injury to the employee of an independent contractor, companies should include provisions that the independent contractor is responsible for providing workers compensation to its employees. However, to avoid having an employee of an independent contractor coming after the company for a workers compensation claim, see if the company can be named as an additional insured and address the issue through indemnification obligations. 6. No Benefits: Companies should include an express provision to the effect that the independent contractor is ineligible for any employee benefits the company provides employees. 7. Specific Termination Date: Companies should include a specific termination date based either upon a specific date or upon the completion of a specific project. Such a provision indicates that the parties were not anticipating an ongoing relationship. 8. Expenses and Taxes: By including such a provision, the company is showing that it does not have control over significant aspects of the independent contractor s operation. These expenses and taxes may include incidental and overhead expenses as well as payroll taxes.
Independent Contractor Classifications: Potential Employee Benefit Plan Liabilities Under the ACA, ERISA and Other Laws Scott Gilbert Andrew Douglass Polsinelli PC. In California, Polsinelli LLP
The Risks of Misclassification are Growing Some employers have sought to reduce costs by replacing employees with independent contractors. This has always posed risks to the employer, but under the ACA, those risks are exponentially increased.
Benefits to IC Classification Employer generally has less responsibility for and less responsibility to independent contractors. Liability for torts and contracts. Coverage of labor laws and civil rights protection, including ERISA. Employer is generally the focus for both tax compliance and the source of benefits for employees but not for independent contractors. No tax contributions (FICA, FUTA v. SECA). Not entitled to fringe benefits like retirement plans. Limited reimbursement of expenses. Independent contractors are not entitled to insurance under the ACA.
The Government is Watching In recent years, the IRS and DOL have both announced specific audit initiatives centered on potential employee misclassifications IRS typically audits companies for possible underpayment of employment taxes, incorrect tax reporting, and potential penalties under employee benefit plans DOL audits for compliance with protections extended to employees under federal employment laws (i.e., FLSA) DOL and IRS often cross-refer enforcement matters to each other (i.e., DOL misclassification audit can lead to an IRS audit) Employee misclassifications can also result in state agency audits of employers for compliance with worker s compensation, unemployment, and other state laws
Typical Situations in Which Potential Independent Contractor Risks May Arise Former employee returns to work as an employee of a third party contractor (e.g., under an arrangement with a staffing/outsourcing company) Performs the same work he/she did as employee Individual works as an independent contractor under an individual written agreement with the company Performs the same or similar work if he/she previously worked for the company Other individuals who previously received IRS Form W- 2s from the company and who now receive Form 1099s
Typical Situations in Which Potential Independent Contractor Risks Arise (cont d) Employee comes back for specific limited period of time to perform certain tasks with a third party contractor or as an individual independent contractor New workers classified as individual independent contractors or as employees of subcontractors who perform the same or similar work as regular employees Subcontractors or individual independent contractors who perform work on a seasonal or temporary basis
How Will Your Classification Be Tested?
Economic Realities Test Used by the DOL, IRS, and Other Enforcement Agencies Is the work an integral part of the employer s business? Does the worker s management skill affect the worker s opportunity for profit or loss? How does worker s relative investment compare to employer s investment? Does the work require special skills and initiative? Is the relationship between the worker and the employer indefinite (as opposed to short duration)?
It Boils Down to Control Most important factor: Right to control the manner and means of performance, details of performance, not just the object to be attained. Control need not be exercised. In jobs having a high degree of discretion or independence, only a lesser degree of control is required IRS focuses on 3 types of control. Behavioral Control. When & where to work, assistants, supplies, order & sequence of work, uniforms & logos, degree of evaluation. Financial Control. Investment in equipment or facilities, reimbursement of expenses, available to public, how paid, opportunity for profit or loss. Relationship of the Parties. Intent of parties, whether incorporated, employee benefits, state law, right to discharge/quit, indefiniteness of relationship, part/full time, location of services.
Factors Favoring Employee Classification Individual contracts directly with company rather than as an employee of a subcontractor Individual performs the same work he or she performed while employed at company Individual is working for company on an indefinite basis Individual is performing work only for company and not for any other company Individual s work is an integral part of company s business
Employers Face Possible Employment Penalties and Liabilities Employment taxes (e.g., FICA/FUTA withholdings) and income tax withholding Penalties and interest assessed against employers for missed withholdings Penalties for issuance of incorrect tax reporting (i.e., Form 1099 vs. W-2) Worker s compensation payments Unemployment violations FLSA (overtime) lends itself to class actions Entitlement of individuals to FMLA/COBRA protections and other rights under state/federal employment laws afforded to employees
Case Study International Genetic Technologies ( InGen ) has 15,000 employees InGen has approx. 5,000 individuals working under independent contractor agreements Numerous staffing and temporary labor contracts Unknown number of individual IC agreements with varying terms
Examples of Potential Employee Benefit Penalties and Liabilities InGen s Health Plans Affordable Care Act (ACA) requires offer of qualifying health insurance to at least 95% of its full-time employees If enough independent contractors should be classified as full-time employees (or the current number grows in the future), significant ACA risks and penalties may apply if it causes InGen to fall below the 95% coverage threshold Potential ACA penalty each year is generally $2,000 (as indexed for inflation) times all full-time employees (minus first 30) Example: If InGen has 15,000 full-time employees, potential ACA penalty each year is almost $30 million (i.e., $2,000 times 15,000 full-time employees) It only takes one misclassified individual who gets coverage through an ACA health exchange (and who qualifies for an ACA tax credit) to trigger the entire penalty!
Examples of Potential Employee Benefit Penalties and Liabilities InGen s Pension and 401(k) Plans Misclassified individuals may bring claims for retroactive benefits they would have received had they been considered employees instead Individuals may bring claims for retroactive vesting and benefit accruals May require company to make restorative company contributions (plus missed investment earnings) In addition to the costs for the additional pension/401(k) benefits, this may lead to large penalties if the misclassifications are found upon audit by the IRS Starting point for negotiating sanction amount with the IRS is a percentage of aggregate dollar amount for total adverse tax consequences to participants and company if the plan were to lose its tax-qualified status For large companies, the starting IRS sanction amount could be enormous!
Recommendations and Next Steps Categorize typical independent contractor scenarios and estimate number of individuals in each category Review small samplings of IC agreements from each category and determine potential risks to the company Determine whether adjustments to employment practices and/or revisions to IC agreements can be made to mitigate potential penalties to the company for higher-risk scenarios Review employee benefit plans and determine corrective options (and/or whether clarifying language limiting impact of employee misclassifications should be inserted) Preservation of attorney-client privilege is critical if outside vendor is used to review IC agreements Consider having outside counsel retain vendor to maintain full privilege
Questions? Scott M. Gilbert Shareholder, Labor and Employment sgilbert@polsinelli.com 312.463.6375 W. Andrew Douglass Chair, Employee Benefits and Executive Compensation adouglass@polsinelli.com 312.873.2933
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