The use of independent contractors, typically a sole proprietor or small business, has significantly increased in recent years. Independent contractors allow companies to outsource work without the risk of investing the time and resources they would for an employee. Use of independent contractors continues to rise as businesses respond to health insurance mandates, a changing economy, and growing compensation demands. Independent contractors do not require overhead costs, overtime pay, workers’ compensation insurance, vacation pay, unemployment insurance, or payroll taxes.
The prospects for independent contractors for 2016 are expected to increase and double by 2020. Given the expected growth rate for 2016 and beyond for independent contractors, it is important for companies to prepare appropriate Independent Contractor’s Agreements. Furthermore, it is still vital to avoid erroneously classifying employees as independent contractors or to evade payroll taxes and other employment-related expenses.
Misclassification challenges can result in significant liabilities and penalties under state and federal laws. Specific examples include state and federal income tax payments, Social Security, Federal Insurance Contributions (FICA) taxes, Medicare and Federal Unemployment Tax Act (FUTA) taxes. Penalties include failure to withhold and pay taxes, liability for violating the Fair Labor Standards Act (FLSA), failure to pay minimum wages, failure to pay overtime, liability for employee benefits, vacation, sick pay, stock options, pension plan contributions, and vesting.
For example, Uber, the company who digitalized on-demand transportation, is currently facing a class action lawsuit that stemmed from one (1) misclassification challenge. US District Judge Edward Chen sided with an earlier decision that ruled against Uber and opened the case to class-action status. Now, Uber faces a jury trial to resolve this class-action lawsuit in California regarding misclassifying their drivers as independent contractors.
Because of these stringent regulations, companies that utilize independent contractors need to protect themselves from inadvertently misclassifying these entities and facing a class-action lawsuit similar to Uber. Creating and implementing an Independent Contractor’s Agreement is imperative.
Independent Contractor’s Agreement
It is imperative to implement a written contract between the Company and the independent contractor. The contract should clearly state the nature of the independent relationship between the parties and expectations for completion of the project. Also, having a written contract allows for customization for each Independent Contractor the Company retains. Customizable contracts protect the Company by:
• Defining the parameters and expectations for all parties involved.
• Defining the nature of the business relationship—clearly stating that the independent contractor is not an employee.
• Form agreements hold little credence in a misclassification lawsuit.
• Customization provides opportunities for the addition of specific provisions. For example, the inclusion of a provision that requires refraining from unfair competition.
The Contracts Limits
All contracts have limits; an Independent Contractor’s Agreement is no different. In the event of a dispute, the contract can withstand the scrutiny of a court if executed as written. The court scrutinizes the implied relationship per the contract and the reality of the relationship based upon the facts each party provides. However, if the duties of an Independent Contractor resemble that of the Company’s employee, the court may consider the contract to be invalid.
Certain industries imply the presumption that they only hire employees, posing a problematic assumption for the Company to overcome. If the Company has links to one of these industries, consider the options and have a well-written contract drawn up before hiring the Independent Contractor.
Legal Considerations
Write Independent Contractor’s Agreements with the intention that the Internal Revenue Service (IRS) or an associated agency may be reviewing the contract for classification purposes. Writing an Independent Contractor’s Agreement with this view in mind, provides an asset in the event of a dispute or misclassification challenge. In the case of a misclassification challenge, the IRS looks at multiple factors grouped into three (3) distinct categories:
Control
• The level of behavioral control that was exerted over the independent contractor by the Company.
• Whether the Company had the right to control and direct job performance of the independent contractor.
Financial control
• The reimbursement or payment of business expenses by the Company.
• The Company’s role in the Independent Contractor’s decision of seeking out additional employment opportunities.
• The Company’s payment method to the Independent Contractor—lump sum, weekly, bi-weekly, or at project milestones.
Relationship
• Definition of the relationship between the Company and the Independent Contractor within the written contract.
• If a defined end was projected or permanency was implied in the contract.
• Expected work and work performed resulting from the relationship.
• The role the Company played in the methods and schedule of the Independent Contractor completing the project.
• If the work performed by the Independent Contractor is a crucial aspect of the Company’s business.
If the Department of Labor (DOL) brings the misclassification challenge, the “economic realities” test is utilized to determine the status of the independent contractor. The “economic realities” test looks at the definition of employ, which includes “to suffer or permit to work.” The test determines whether the Independent Contractor is economically dependent upon the Company or purposely in business. However, if the Equal Employment Opportunity Commission (EEOC) brings the misclassification challenge, the Independent Contractor is considered an employee and a discrimination challenge asserted. As a result, the Company faces scrutiny in the manner and method of how the Independent Contractor conducted his duties. Did the Company exercise too much control?
In summary, writing an Independent Contractor’s Agreement to meet the standards of a particular test or means of measure is ill advised. An Independent Contractor’s Agreement should reflect a business relationship, where each party is on equal footing. Most importantly, companies need to consider the element of control. The higher the degree of control exerted by the Company over an Independent Contractor results in a decreased chance to defend successfully against a misclassification challenge. The IRS considers the amount of control the Company exerts over Independent Contractor’s to be a critical element in their decision process.
As a rule, never prepare a contractor’s agreement without a lawyer’s review and approval. The FILIPPOV LAW GROUP, PLLC provides sophisticated legal services and business advice to individuals and businesses of all sizes, ranging from start-ups to Fortune 500 companies. Our attorneys are experienced in negotiating, drafting and reviewing independent contractor and vendor agreements with an eye towards the client’s best interest. If you need an independent contractor or vendor agreement or want to consider your legal options, call us at 832-900-2177 or email our managing member [email protected].
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