If you haven’t heard the ever increasing buzz about worker misclassification yet, you will. The issue of whether a worker should be classified as an independent contractor or an employee is a hot topic and getting hotter all the time. Subscribers to HRSentry, can easily and quickly access our newly created online training and accompanying slides on the topic, along with a host of relevant resources. For others, the following provides key information to help you assess what you need to know and the steps you should take.
There are many parties interested in proper worker classification ranging from the IRS to the U.S. Department of Labor (DOL) to state governments to workers themselves. It’s much cheaper for employers to use independent contractors over employees because they avoid paying the following: employer portion of payroll taxes, workers’ compensation and unemployment insurance premiums, overtime payments and the expensive benefits that often go along with hiring employees.
On the flip side, there’s a growing risk if you misclassify employees as independent contractors, especially if you do so willfully. In addition to the possibility of owing back pay (if minimum wage requirements haven’t been met) and overtime, you could also face paying: back taxes, including the employee portion; penalties and interest; fines; retroactive employee benefits; costs of staff time and effort; and possible legal fees if faced with going to court. Additional costs, less quantifiable but important nonetheless, include negative publicity for your organization and possible employee morale issues.
Even inadvertent misclassification can be expensive but imposed fines and penalties grow increasingly severe the more willful the nature of the violation. Both state and federal governments are paying greater attention to this issue than in years past. The IRS and DOL have even teamed up with eleven states (thus far) to share information and resources in a joint effort to uncover violations. So there’s strong incentive these days for employers to do their best to get it right.
The IRS makes is clear that there is no magic formula or simple test as to whether or not a worker is an independent contractor. They emphasize that each case is fact specific. In general, however, the best place to start is to consider whether you, the employer, have the right to control, not just the outcome but also how the worker performs the work. Whether or not you actually exercise this right is irrelevant to the worker’s status. There are many times, for instance with highly experienced employees, when organizations provide little guidance or oversight. The real question is whether or not you have the right to do so.
How does the IRS decide upon the degree of control an employer has over how the work is performed? It comes down to looking at a number of factors that comprise three main categories: Behavioral Control, Financial Control, Type of Relationship. Remember, no one factor is decisive as circumstances differ; the totality of the situation must be evaluated. IRS guidance is abundant on their web site.
You should also take a look at the DOL’s Economic Reality Test. This test relates to whether the Fair Labor Standards Act (FLSA) applies. The seven factors it contains overlap those that the IRS looks at and likewise consider whether or not the worker has a bona fide business that does not provide services integral to yours. Be sure to familiarize yourself with all seven factors of this test in addition to IRS guidance.
So how do you prove that someone is indeed an independent contractor and not your employee? The best documentation shows that the person has a bona fide business quite separate from yours; that control over how the person does the work resides with the worker; that the work being contracted is not an integral part of what your business provides and the worker is free to make a profit or loss and be hired by others. Keep a vendor file for each independent contractor just as you would for any other vendor or supplier, such as the folks who deliver your coffee supplies or service your copier machines. Here are some important items that should be kept in that file:
A written contract—Always a good idea, the contract should outline the nature of the relationship, although saying the person is an independent contractor doesn’t make it so. Indicate the project’s expected results, the fee and date(s) of completion. Note that you don’t control how the results are achieved; the worker uses his/her own equipment/tools; is free to hire others without your approval and that the person provides liability insurance to his/her workers, and is not eligible for benefits with your company. Note that the person has their own business and tax I.D. number. Make sure it is signed by both parties and create a new contract if the worker takes on a new project for you. Each project should have a separate contract.
Proof of a real and separate business—Keep any letters on business stationery, business cards, brochures, or newspaper advertisements. With so much done electronically these days, print off a copy of an appropriate page of the worker’s web site, online advertisement of services or copies of emails detailing services offered.
Invoices—Every payment to an independent contractor should be based on an invoice. The worker should never submit expense reports to you as that would point toward the person being an employee. The worker’s mileage or purchase of equipment or supplies should be part of their own business expenses, not yours. Keep every invoice and make sure it ties in with the Form 1099 you issue to the person for that calendar year.
Form W-9—Obtain this form when hiring an independent contractor and make sure it is filled out properly. If the person does not check the box exempting him- or herself from tax withholding, you are legally obligated to withhold taxes at 28%. An independent contractor should check the box file their own self-employment taxes on their own.
Due to lots of bad practices that organizations got away with in the past, businesses may think they are classifying workers correctly when they are not. Increasing scrutiny demands that the facts of each situation be reviewed. Here are some common red flags to watch for:
After an employee terminates, you hire the person back to do work that resembles their old job, even on a temporary, project basis;
If an intern is doing actual work, not just shadowing or learning; be sure to check DOL Fact Sheet #71 for the six criteria related to interns. In order to not pay interns minimum wage and overtime, all six criteria must be met.
When you provide the equipment, supplies or office space the worker uses;
If the worker replaces one of your employees or supervises any of your employees;
If the worker receives any benefits or perks your employees receive, gets paid on a regular basis, or submits expense reports;
If the relationship is ongoing and long-term;
If a supervisor hires a worker and pays the person through Accounts Payable unbeknownst to human resources or payroll.
The last item happens more often than you might think, especially in larger organizations, but all organizations are vulnerable without proper communications and procedures in place. If the person administering payroll also issues 1099s and is thus aware of all workers, misclassification can be avoided. But if your organization is too large for that, make sure there are good channels of communication among payroll, accounts payable and human resources and train managers to get approvals from human resources when engaging any worker.
A final caveat is that state laws may differ from federal laws in important ways. It’s possible for a worker to be classified as an independent contractor for IRS purposes, yet, by state definition, require workers’ compensation or unemployment insurance premiums paid on his or her behalf. So be sure to check your state laws as well! Subscribers to HRSentry may simply search on the term independent contractor to pull up helpful federal resources and relevant state resources as well.
Fox Searchlight Pictures, the maker of last year’s award winning film, Black Swan, is named as the defendant in a lawsuit filed by two former interns claiming multiple violations of the Fair Labor Standards Act (FLSA) and New York state labor law regarding recordkeeping, minimum wage and overtime violations. The suit seeks class action status that would potentially encompass up to 100 individuals who worked as assistants and interns and, it is alleged, were unpaid unlawfully. Of course the lawsuit has to unfold before wrongdoing or lawfulness can be pronounced; however, it noteworthy that this previously somewhat neglected category of FLSA violation is now being scrutinized with a high profile company. This Hollywood spotlight has strong potential to light the way for similar suits.
The difficult economy, lack of job openings and preponderance of students and others willing to accept unpaid internships can create a tempting situation for employers. But this lawsuit sends the message that it’s probably no longer safe for employers to reason, “everyone does it.” The Department of Labor has long had a six factor test for unpaid internships so if you’ve not already done so, and you have interns, you should become familiar with it immediately.
Here are a few additional tips:
Implement procedures that ensure the HR department is always in the loop and managers can never bring anyone on board without HR’s prior knowledge and approval;
If the internship is not tied to an academic program, your chances that it qualifies as unpaid go down;
If the intern is brought on board in lieu of a regular employee doing the work, the intern is actually an employee and the FLSA and state laws apply;
If HR determines the internship position does pass the DOL six factor test, supporting documentation should be kept on file;
Understand and document what interns are doing, how their work is overseen and by whom;
Check state laws as well to ensure both federal and state compliance;
The FLSA makes an exception for bona fide volunteers in the non-profit sector or for state or local government agencies.
The punishment for violating the FLSA can be severe and may include steep fines in addition to back regular pay and back overtime pay, back taxes, and attorneys’ fees for the opposing side. Even when companies prevail, lawsuits are generally costly. It will be interesting see how this version of the Black Swan story turns out.
On the heels of several natural disasters across the nation and with winter weather just around the corner, at least for folks in northern climes, now’s a good time to prepare for the inevitable questions related to time off that inclement weather inevitably brings. Of course it’s vital to avoid running afoul of the Fair Labor Standards Act (FLSA) so bear in mind the disparate legal requirements related to exempt vs. non-exempt employees.
Staff should always be considered non-exempt unless they meet a series of salary and duties tests for one of the exemptions laid out under the FLSA. More information is available on the US Department of Labor (DOL) Wage and Hour Division’s compliance page. Nonexempt employee protections under the FLSA include being paid at least at the prevailing federal or state minimum wage rate, whichever is higher, as well as being paid at an overtime rate of one and one half times the regular rate of pay for any work hours that exceed 40 in one workweek.
But keep in mind that the FLSA does not require employers to provide paid sick, vacation, holiday or personal leave. Of course if you do have policies providing such leave, you need to follow them. There’s nothing worse for an employer than having policies and not following them. That said, for nonexempt staff, the FLSA says that an employer is not precluded from lowering an employee’s hourly rate, provided the rate paid is at least the minimum wage, or from reducing the number of hours the employee is scheduled to work. And the FLSA does not require employers to pay non-exempt staff for hours they have not worked.
So, when inclement weather hits and you close your workplace, you are permitted under the law (assuming you don’t have a policy in place to the contrary) to deduct pay from non-exempt employees’ paychecks commensurate with the reduced work time. Likewise, if you keep your workplace open but a non-exempt staff person does not make it in due to the weather, you are allowed by law to deduct those hours not worked from their pay, again personnel policy to the contrary notwithstanding. Note that if you do make such deductions from pay, be sure to apply them to non-exempt staff across the board to avoid discrimination claims. And there’s one more caveat: in today’s plugged in world, employees often perform work remotely from personal computers and electronic devices such as smartphones. Even if they are just checking email, you must count such work done remotely as time worked.
The paragraph above outlines what is permitted under the FLSA, but there may be lots of reasons for employers to choose to be more generous and pay non-exempt employees for time off related to a disaster or inclement weather, especially if the loss of work hours is based on the employer’s decision or on severe and unusual circumstances beyond employees’ control. Important issues to consider include employee morale, retention, loyalty and engagement as well as the culture, core values and mission of your organization.
What about exempt staff? You are not permitted to reduce an exempt employee’s predetermined weekly pay without jeopardizing their exempt status except under limited circumstances. However, you are permitted to reduce their accrued sick, vacation or other leave bank, even if the reduction is less than a full day and even if the absence is directed by the employer due to lack of work; however, the exempt employee must still be paid their predetermined weekly salary in any week in which any work is performed. Note that the full salary must be paid: even if the leave bank is exhausted; if it becomes or goes further into the negative; even if the employer does not have a bona fide benefits plan at all; and even when the leave is required by the employer due to inclement weather according the the DOL Wage and Hour Division Opinion Letter FLSA2005-41.
So take some time now to establish the leave policies your organization needs or to review those you already have in place, including inclement weather and disaster policies. Make sure they are in compliance with the FLSA and that they support your culture, goals and mission.
The US Department of Labor (DOL) is stepping up efforts to crack down on the misclassification of workers as independent contractors rather than as employees. According to its press release, the DOL, in partnership with the IRS, has signed memorandums of understanding (MOU) with agencies or officials in 11 states (Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah, and Washington, Hawaii, Illinois, and Montana, and New York.) The intent is to provide better information sharing as well as enforcement efforts aimed at employers that misclassify workers.
There is a strong financial motivation for employers to hire independent contractors rather than employees in the avoidance of a number of expenses: social security and Medicare taxes, unemployment and workers’ compensation premiums, overtime pay and employee benefits. Yet, classifying workers as independent contractors should always be done carefully, particularly in light of heightened scrutiny. There are somewhat different standards related to the Fair Labor Standards Act (FLSA) and used by the IRS. Under the FLSA, courts have looked at the following factors:
1. The extent to which the services rendered are an integral part of the principal’s business.
2. The permanency of the relationship
3. The amount of the alleged contractor’s investment in facilities and equipment.
4. The nature and degree of control by the principal.
5. The alleged contractor’s opportunities for profit and loss.
6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
7. The degree of independent business organization and operation.
The IRS looks at the degree of control and independence the worker has related to the following three categories:
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools and supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.?) Will the relationship continue and is the work performed a key aspect of the business?
Employers would be well-advised to review both sets of standards in relation to its hiring of independent contractors. Further guidance is available at IRS.gov and DOL.gov.
As far-reaching and ubiquitous as the Fair Labor Standards Act (FLSA) is, it’s easy for employers miss some key points. Last week, we brought you a few highlights from HRSentry’s July webinar in case you were unable to attend. This week, we’ve got a few more basic tips on avoiding common errors:
1. Never determine exempt/non-exempt status of a position based on its title. Titles can mean anything! The FLSA has duties tests and a minimum salary requirement for each of the permitted exemptions so become well acquainted with them and make an individual determination for each position.
2. Don’t mistake the term “hourly” for non-exempt or “salaried” for exempt; a position can be salaried and still be non-exempt; conversely, it’s possible for computer professionals who are paid hourly to be exempt. So use the terms exempt and non-exempt if that’s what you mean.
3. It’s common sense that we pay overtime to non-exempt staff for any hours worked that exceed 40 in a work week. But what’s a work week? You establish the work week for your organization based on seven consecutive 24-hour periods. For instance, you might choose Sunday through Saturday or you might choose Friday through Thursday. But once you define your organization’s workweek, you pretty much have to stick with it. That doesn’t mean you can never change it, but such a change would be rare and you must never change a workweek simply to avoid paying overtime premiums.
4. There are also some common misconceptions among employees and employers about what the FLSA mandates. You should know, for instance, that the FLSA does not require: paying a premium for weekend or holiday work; paying a premium for work that exceeds 8 hours per day; a certain number of sick, vacation or holidays or other fringe benefits. But make sure you are aware of the laws in your state that may cover these or other employment-related benefits. For instance, Connecticut recently enacted a law mandating sick leave for certain employees under certain circumstances. So always check your union contracts, if you have any, and state laws that may mandate benefits or protections that exceed those of the FLSA.
