With the current economic difficulties, small and growing businesses have used the “lean and mean” staffing strategy – favoring the use of temporary consultants and independent contractors instead of permanent employees when possible – as a way to control labor costs.
According to Dennis Alessi of the New Jersey law firm Mandelbaum Salsburg this strategy can cause companies to run afoul of the Department of Labor’s rules on how workers are classified: as an employee or independent contractor.
Alessi provides an overview of how the Department of Labor (DOL) makes its determination of who is an employee and who is an independent contractor.
Adds Alessi, “at the initial investigatory level, Department of Labor investigators often take a very simplistic approach in deciding whether an individual should be classified as an employee or an independent contractor. “
Here are three areas to consider when utilizing contract employees and the solutions offered by Alessi.
Working Exclusively For One Firm May Indicate “Employee” Status: The first, and overwhelmingly most important, factor which investigators consider is whether the individual has multiple clients/customers or works exclusively for one company. If the individual is so exclusively engaged, it is very likely that the investigator will consider him/her as an employee. Because of this exclusivity, investigators generally do not consider these individuals as actually being in business for themselves, which is what an independent contractor is.
Consequently, Alessi says, if at all possible, it is most important for a company to arrange an independent contractor’s work schedule so that he/she has some significant time during the regular workday, or workweek, to provide services for another client/customer.
He adds, even if the individual decides not to do so, it is still important for the company to give the individual the opportunity to have other clients/customers. Similarly, it is important not to include any form of non-compete provision in an Independent Contractor Agreement. A non-compete requirement is a significant factor in finding that the individual is, in fact, an employee.
According to Allessi, another, closely related consideration is whether the individual was hired for a limited, definite period of time to perform a discreet service or to complete a particular project or task for the company.
It is important to show these terms are stated in an Independent Contractor Agreement or Letter of Engagement.
Having these terms set forth in such a document is particularly important if the company needs the contractor to work full-time during the term of his/her engagement.
Alessi also points out that whether the individual has incorporated or created a limited liability company -- and that the employer makes payments to this entity rather than the individual -- is not at all a controlling factor in the DOL’s determination.
If the investigator finds that one employer is the only real client/customer of the entity which the individual has created, then, in making its determination, it is highly unlikely that the DOL will give any weight to this entity’s existence or to the company’s payments to it, instead of directly to the individual.
Independent Contractors Should Determine Methods, Hours & Work Location: The second important factor, in determining employee versus independent contractor status, is the degree or extent to which the company establishes step-by-step tasks and goals and how closely it supervises/monitors the individual in completing them, and the entire project, for which the company has engaged him/her.
Alessi suggests the company should only set general time limits within which any interim tasks or goals must be completed, and then an ultimate deadline for the entire project.
Alessi says to be considered an independent contractor, the individual must be left to decide, independently, the methods and means, and the resources (e.g. personnel and otherwise), which he or she will use to complete these interim tasks/goals and ultimately the entire project. And the individual must be left to decide the pace at which the work will be performed; subject only to the general interim and final time limits the company has set.
In this same vein, Alessi adds, the company should not establish a work schedule for the individual, and should not require that he/she be at the company's facilities at certain times during the day for certain days. Rather, to maintain independent contractor status, the company should only schedule periodic meetings with the individual to report on progress; to have the work-to-date critiqued, and then, if necessary, to receive additional general directions for the remaining tasks/ goals to complete the project.
According to Alessi, another element of this second factor is whether the individual has any entrepreneurial risk, given that an independent contractor is in business for themselves.
For example, the individual should be paid by the company only when various interim steps/goals for the project are achieved up to certain, objective standards or quality of performance, as provided in the Independent Contractor Agreement.
Also, a major portion of the individual’s compensation should not be paid until the project is completed; again subject to these same performance standards. With this payment structure the individual is more likely to be considered an independent contractor.
This is because they have the risk of not being paid for substandard work, or having the payment reduced, or having to redo the work to an acceptable standard without additional compensation.
Another point Alessi makes, conversely, if the individual routinely receives a pay check every two weeks from the employer, regardless of how much progress has been made in completing the project, then the individual is more likely to be considered an employee.
Independent Contractors Offer Services Unlike Those Offered by Their Clients: The third, and final key factor is whether the individual is engaged in a trade, occupation profession, or business which is customarily considered as working independently.
Alessi cites as the best example of this factor is the freelance journalist. A closely related element of this factor is whether the individual is providing a service for the company which is not at the core of the company's business; but rather, is outside of its normal course of business. A good example is a company that is engaged solely in the manufacturing of tangible products which hires a computer consultant, as an independent contractor, to assist with upgrading the company's IT systems software.
According to Alessi, “this article has very briefly addressed only three of the key factors, and the various elements of each, which are considered in determining employee versus independent contractor status.”
Alessi adds. “In making this determination for tax purposes the Internal Revenue Service has a 20-factor test, so this determination is often not as simple a matter as it may appear from this brief discussion. Consequently, the advice of an experienced employment lawyer is a must before the individual is hired.”
Dennis Alessi is Co-Chairman of the Employment Law Department at the law firm Mandelbaum Salsburg (www.msgld.com). He can be reached at 973-736-4600, ext. 151, or at email@example.com