Employee or Contractor?  Many Factors Determine the Answer

Does your firm use outside workers for some jobs? This can result in significant savings if the workers are properly classified as independent contractors rather than employees.

Key point: If a worker is an employee, your company must withhold federal income tax and employment taxes from his or her wages. In addition, your business is responsible for paying the employer's share of federal payroll taxes. Conversely, if a worker is characterized as an independent contractor, your company isn't liable for these payroll tax obligations.

Court: Drivers Are "Wholly Integrated" Into Company's Operation     The California Appeals Court ruling earlier this year stated: "FedEx's control over every exquisite detail of the drivers' performance, including the color of their socks and the style of their hair, supports the trial court's conclusion that the drivers are employees... "     According to court documents, here are some of the requirements of the drivers under the terms of their written contracts with the company. Drivers were required to provide their own trucks meeting FedEx's specifications, mark them with the company logo, pay all costs of operating and maintaining the vehicles (including repairs, cleaning, fuel, tires, taxes, licenses and insurance). The drivers had to wear uniforms and use specific scanners and forms, all obtained from FedEx and marked with the company's logo. (The trial court also noted that FedEx provided business cards for the drivers with its logo.) To pay for the trucks and other required items, drivers could obtain loans through FedEx's business support programs (with repayment through pay deductions). FedEx offered drivers a deferred compensation or retirement plan and other "employee benefits" (including direct deposit, a seniority-based "time-off program" for unpaid leave, and a scholarship program for their children). The drivers worked full time, with regular schedules and routes and were required to work exclusively for FedEx.     In practice, the court concluded: "The work performed by the drivers is wholly integrated into FedEx's operation. The drivers look like FedEx employees, act like FedEx employees, are paid like FedEx employees, and receive many employee benefits." (Estrada vs. FedEx Ground, Calif. Ct. of Appeal, B189031)

In addition, employers aren't required to offer independent contractors the same fringe benefits that regular employees receive, which can result in extra savings. And they generally provide their own equipment and supplies.

However, it's not always easy to distinguish independent contractors from employees. There are several factors the IRS and courts examine but it often boils down to a "control" issue. If your business controls how, where and when the worker does the job, he or she is usually classified as an employee.

FedEx Corporation is the latest company caught in a series of well-publicized court cases involving independent contractors. In October, a federal judge allowed thousands of drivers to proceed with a class action against the shipping firm on claims that they are employees who are due full-time benefits under federal law.

And in November, the California Supreme Court denied FedEx's appeal to overturn a state court that ruled that the shipping company's drivers are employees, rather than independent contractors (see right-hand box for details of the case).

FedEx must now pay the West Coast drivers more than $11 million in expenses and interest. In similar cases, workers have sued companies for benefits including health insurance and retirement plan contributions.

To make matters worse, the IRS continues cracking down on companies that hire independent contractors. If the tax agency "reclassifies" a worker as an employee, a company could be hit with large bills for back taxes, interest and penalties. Audits by state agencies are also common and frequently occur when independent contractors apply for unemployment or Workers' Compensation.

Unfortunately, no single factor determines a worker's status. The IRS looks at a number of issues, such as:

 Tools. An employer usually gives tools, equipment and workspace to employees. In contrast, subcontractors often provide and invest their own money in equipment, tools and facilities.

 Other customers. Independent contractors generally make services available to the public and are able to work for two or more businesses.

 Hours. Employees often have set work schedules, while contractors are allowed some flexibility. (However, the IRS recognizes that some work, by its very nature, must be done at specific times.)

 Assistants.  Employees don't hire and pay others to help them do their jobs. But contractors often hire, supervise, and pay their own assistants.

 Training. Employees are more likely to receive training from an organization than independent contractors.

 Pay.  Employees are generally paid hourly or weekly, while contractors are paid by the job. It's a good idea to require contractors to submit invoices since they provide proof of non-employee status.

Employers that misclassify workers as independent contractors can end up with substantial tax bills as well as penalties for failing to pay employment taxes and file required forms. They may also face employee benefit liability. Workers sometimes contact the IRS to say they have been misclassified. (There is a form they can fill out to ask for a determination of their status.)
 
Here are a few quick tips to help protect your business:

• Have written contracts with independent contractors that spell out the details of the relationship.

• Once contracts are in place, resist the urge to supervise independent contractors in the same way you manage employees.

• Maintain good records. You obviously need to keep information required by the IRS, such as workers' taxpayer information numbers. But also keep items that can help prove a person is self employed, such as business cards, newspaper and yellow page advertisements, invoices and letterheads.

• If you have a question call Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856) 665-2121..