Employee or Contractor? How to Get Worker Classification Right

Katrina Faessel:
Distinguishing between employees and independent contractors is crucial for legal compliance and fair treatment, but how can you navigate the regulations around worker classifications? We now welcome TriNet colleagues Boyd Rogers, Divisional Vice President and Lead Council Employment, and Kelly Pacatte, Lead HR Compliance Consultant, to help with practical insights and explanations of the recent Department of Labor (DOL) regulation.

Kelly Pacatte:
Thank you for joining today. We are excited to discuss a topic that impacts many small to medium-size businesses: how to get worker classification right. I'm Kelly Pacatte and I'm joined by Boyd Rogers today.

Boyd Rogers:
Good afternoon, Kelly. Thank you for…

Kelly:
Oh, I was gonna say, Boyd, what is worker classification and why does getting it right matter?

Boyd:
Well, thank you, Kelly. That's a great question. Let's start at the beginning. Businesses require all types of labor and services in order to function. Now, some of these services can be provided by employees in a traditional employment relationship, while other types of labor may only be needed by a business sporadically or for very specific purposes, such as for projects that are outside of the company's core product or service offerings.

When assessing the need for talent, companies need to pay close attention to what type of work needs to be done and identify the right type of skill, background, education, experience required to perform that work. Now, this work might be what I'll call core work, which is the work necessary to produce the company's products or provide services to the company's customers.

Every business also has some work that needs to be done that is ancillary to or separate from what we call core work. For example, custodial services or in the wintertime, someone to ensure that the snow is plowed from the parking lot. Depending on the type of work that is needed and whether the functions are core to production or providing a service, employers can determine the right type of worker the business needs to procure and how to classify the worker.

At a very high level, workers can be classified either as employees, which is a classification tending to indicate performance of a core company function, and in situations where a long-term need or relationship are considered, or as a contract worker, which could indicate performance of a non-core company function or where a shorter-term relationship is desired.

Now this is an important task because the classification selected often then determines the relationship between the company and the worker, and the responsibilities of the business to the worker and vice versa. For example, in a traditional employee employer relationship, a business is required to set rates of pay, set and maintain an appropriate pay frequency schedule, withhold and pay employment taxes, secure workers' compensation insurance, decide what types of medical or health benefits they might offer, determine paid time off and vacation policies, and other types of leave such as sick leave, which under applicable law could be required or either paid or unpaid, but a contractor or contingent labor relationship is very unique. It is a contractual relationship where typically a fee is paid in exchange for completion of a project or provision of a service. The relationship is defined by negotiated contract terms, and the work can be done on a project basis or completion of work basis, often on the contractor's own timetable as long as certain deliverables are provided.

In a typical contract relationship, the business does not need to determine or manage the items I just mentioned that pertain to the employment relationship, such as payroll, PTO and benefits, but instead deals in the world of drafting a contract, setting fees, utilizing purchase orders and submitting invoices by the contractor, and then paying the contractor via an accounts payable process, just as with any other vendor, and not a payroll process.

Now key to this discussion is that in the United States, the public policy at both state and federal levels strongly favors an employment relationship, which provides greater protection and benefits for workers. Generally speaking, government agencies and investigators often will simply assume from the outset that a worker is an employee.

That is their default and then it is up to the business to prove that workers are indeed contractors and not employees. So Kelly, as you might be imagining, businesses face certain challenges and risks when they make these initial worker classification decisions.

Kelly:
That's right, Boyd. Let's be clear. The consequences of misclassifying workers can be severe for businesses because misclassification involves several different areas of the employment relationship, which may not be uniform in terms of their impact, analysis or consequences.

Regulatory or legal action may result in fines, penalties, interest and potential back payments for regular wages, overtime wages, benefits and taxes. In addition to financial repercussions, misclassification can damage a company's reputation and lead to increased scrutiny and investigations. And why will regulatory agencies investigate?

Primarily, because misclassified workers do not receive the protections and benefits they would otherwise be entitled to under employment laws and if they had been classified correctly. These protections include things like minimum wage, overtime, workers' compensation, protection from anti-discrimination laws.

The takeaway is that it's vital to get it right from the beginning. Don't be pennywise and pound foolish and if a business has done it incorrectly, it's important to fix it immediately and not to kick the can down the road, hoping that it will never become an issue. Boyd, I think now might be a good time to check in with our poll results before we go on.

Boyd:
Sure, absolutely. It looks like of the questions we asked, that a vast majority of our attendees today are using employees as a majority with some contractors or contingent workers. Nobody is using contractor contingent workers solely depending on the time of year or seasonality. Some, a very small percentage, are using employees only and then a very small percentage again are using majority contractors and contingent workers.

We're glad that you're here today, we're glad that we can share some of this insight with you and hope they will be of some value. Where this takes us is to the why. I mean, where does this all start? Why do businesses misclassify? What might be the root cause of the decision making behind a worker classification decision?

Again, as Kelly kind of mentioned there, why are regulatory agencies so busy investigating businesses' employment practices? Well, first of all, as with many things, the question presumes that there was actually any consideration given at all to the difference at the beginning of that relationship.

It could be that some businesses simply make assumptions or replicate what they may have seen or experienced with other companies or in prior careers, or mistakenly believe that they can quote unquote "do whatever they want because it's their business." In other words, they just bring people on board, and they don't realize that there are a lot of HR compliance requirements out there that should be taken into account.

Now, unfortunately, this is sort of the dark side of all of this. There are some businesses that, in the words of the U.S. Department of Labor, and I am quoting here, "wrongly classify their workers as independent contractors in order to lower their costs unlawfully and create for themselves, a competitive advantage that hurts law abiding businesses."

That phrase has a little bit of a sting to it. Serious words from the DOL and they're not kidding around. While businesses can attempt to quote unquote "paper it all up as best they can," or utilize contracts drafted by the best lawyers on the planet, these government agencies are not necessarily bound to defer to the classification decisions that are included in a written contract between the worker and the business.

So what this means is that investigating agency, whether it's from the Department of Labor or state revenue department or whatever else it might be, it might not care that the parties have agreed in writing that the relationship is a contractor relationship.

They may not care that the parties both want to have a contractor relationship. They may not care that the business has been paying and reporting paying invoices and reporting earnings on a 1099 instead of a W2. They probably are not going to care that contract labor supposedly is customary or routine in a particular industry.

The agency, and this is one of the kickers, but something we'll talk about a little bit later in our best practices section, they may not necessarily care if the contract worker operates as a sole proprietor legally, an LLC, or an incorporated business entity. All these things are important to be aware of. Kelly, tell us a little bit about some of these evolving rules around we're seeing in the HR compliance world.

Kelly:
Yes. Well, and like you said, it's not just one component. Effective back in March of this year, the DOL issued a final rule that provides an unofficial return to what we call the six economic reality factors that both the DOL and the federal courts have historically applied. It's evaluated based on the totality of circumstances. I say official because in recent years, there's been a lot of legal activities surrounding independent contractors and the test has changed somewhat over the years. Let's kind of talk through what the six factors are.

Number one, the opportunity for profit or loss, depending on managerial skills. A good example of this would be your company has an in-office childcare option available to employees. The childcare worker doesn't have the option to work at another daycare or to provide childcare for other non-employee dependents while performing their services, and the childcare worker does not have the managerial decision making to impact their own profit and would most likely be an employee of the company versus an independent contractor.

The second factor of the six is the nature and degree of control and this fact, we use the term control a lot, so the factor looks at the level of control the potential employer has over the performance of the work and the economic aspects of the working relationship. Examples of control could be disciplining the contractor, how you terminate the contractor, if you're scheduling the contractor, or even having prohibitions for the contractor to work for other similar organizations through a non-compete or similar agreements.

The third factor of the six is investments by the worker and the potential employer. That really looks at whether the contractor supplies their own tools and equipment. Are they doing the work at the business's premises or are they doing it at the contractor's business place?

The fourth factor looks at the degree of permanence of the work relationship and this really is examining the length of the contractor relationship.

The fifth factor is the extent to which the work is performed by the contractor and is it an integral part of the business the contractor is performing services for.

Finally, skill and initiative, and this is primarily looking at if their contractor uses the skill and knowledge they bring to perform the job, or does the contracting role require that the employer provide some type of training for them to be able to do their job. Boyd, it seems important that the DOL's final rule did not adopt what we know as the ABC test, which is a more difficult test that is used in California and some other states to determine whether a worker is misclassified or not.

But given these broad factors at the federal level and the different tests used by some states, it seems especially important that businesses who utilize contract workers should work with their own legal counsel to help ensure proper classification. Will you walk us through the ABC test, Boyd, and how it differs from the federal DOL test?

Boyd:
Yeah, I sure will, Kelly. Thank you for pointing out the complexity of these things. I know for many of us, when we hear six factor tests or some other number, we start to wonder, are we ever going to be able to keep track of all these things? It becomes very difficult and I'm afraid right now, I'm going to make it just a tad more difficult for you.

I apologize in advance. What Kelly has talked about is the federal Department of the Labor out of Washington, D.C. However, as you know, in the United States, we have different levels of jurisdictions. We have the state level and also the local level.

At the state level, there is often a different type of rule or a different type of factor set that is applied to these very difficult decisions. This is where we begin to see more complexity on this misclassification question. State agencies and different agencies even in a state have different rules and different tests. One of the more popularly known tests is known as the ABC test and you can see that on your screen that there are just a few words in those colored boxes, but behind each of those words lies more complexity.

That's right. That's what's behind door number one, two and three. Let me start here. There are about two dozen states that will apply the more stringent ABC test, and California is included among those, as Kelly mentioned, but there are other very populous states such as Illinois, New Jersey and Massachusetts that also apply this test.

Under the ABC rule, it's very clear, stated from the beginning, that the default classification of a worker is as an employee, and to be considered otherwise, with regard to any particular worker, the business has to meet all three parts of the ABC test.

These tests are where these parts are A) control. Kelly mentioned control and we do talk a lot about that. The worker must be free from the control and direction of the business in connection with the performance of the work in two places, both in the terms of the written contract and in the actual performance of the work. Kelly mentioned some of those types of items about scheduling a contract worker to come in at a certain time and telling them how to do the job and what things they need to do. Those things can run afoul of this control test.

B) The worker performs work that is outside the usual course of the hiring entity's business. Now, both of us have mentioned these two types of items. When I talked about the snowplow driver who would come and clear the lot, that's outside the normal course of most businesses. Kelly talked about the daycare workers, even if it's on premises. Is that in the course of work or not? Could a business legitimately hire an independent contractor possibly or a vendor to do that? Yes, but again, these factors have to be considered.

And C) the worker has an independent business that routinely performs the same type of work for other clients or businesses.

This goes to what Kelly mentioned about use of like non-compete agreements or exclusivity or things like that. The business, the worker that's supposedly a contractor has to be free to provide its services to other businesses outside of the contracting entity. If it's not exactly precise, it might be helpful if I can share this with you and you can consider it this way.

States using the ABC test are investigating and verifying that the relationship between a worker and the business truly is a vendor to vendor or B2B arm’s length relationship where the worker is not economically dependent upon the business or the company to which the worker is providing services.

No control and no economic dependence. Now, although we've highlighted these two tests, they're not uniform across the entire United States or in every jurisdiction. This is a very complex environment, Kelly, for businesses, especially small and medium-size businesses. What are some best practices that can be implemented to address and mitigate this complexity?

Kelly:
Yes, thanks Boyd. I mean, and this is complex. So even preparing for this presentation today it was interesting, overwhelming reading through the material and understanding it. Just as we, and I would recommend to our clients to review job descriptions and the performance of your normal employees.

It's also important to have a practice of regularly reviewing and auditing the components of an independent contractor relationship. When examining the relationship, it is best practice to look at things like their invoicing method. Do they have business insurance like workers' compensation or liability insurance? Do they even have an employer identification number or EIN? Do they have a physical business location? Do they do independently viable advertising, marketing, like posters or ads or have an online media presence? Really, it's also important just not only to look at these aspects of their business, but how is the contract actually performing?

What is the work they're doing? It's a good practice to see, you know, the results of the contract. It's also, just to echo what we've said on the other slides, it's important that they supply things like their own tools and equipment for performing their services and that the contracting business does not do that.

To echo things that we said before, it's really important to get this right to work with a legal professional when discussing independent contractor relationships. Classification issues are so complicated, as Boyd discussed in the beginning and misclassification can result in huge costs.

Boyd, when reviewing contracts for independent contractors, what are you looking for?

Boyd:
Yeah, Kelly, I'm looking for some sort of evidence even outside the written contract that establishes that this business or worker with whom my client or my business would want to contract with actually is its own independent business, that it's not economically dependent, and I would also look at sort of the payment terms and how we are paying the person.

For example, are we paying this contractor on an hourly basis, because that's generally how we would pay employees. We want to avoid that if we can and look for a more opportunity to perhaps pay on a project or work completed basis. Those are the kind of things that businesses should look out for and make sure are not only in the contract, but then are being complied with in reality when the rubber hits the road.

Kelly:
Thanks Boyd. One of the things I know you and I discussed when we were talking about this conversation today, was how prevalent using systems like Venmo, which is tied to an individual person and not a business is so common in our personal lives and sometimes in our work lives as well.

However, paying your contractors, it's really best practice to have payments tied to an invoice. And again, it's best practice if they're going to an LLC and not a specific individual. So documenting these payment transactions is another recommendation that we would have to support the independent contractor relationship.

If you're using a contracting company for a specific project, make sure that you document the terms of the project, measure the performance based on timelines and deliverables, and like Boyd said earlier, do not track hours. We're not paying them by the hour.

We're paying, we need to trust that the independent contractor is going to perform their job within the parameters of the project without any managerial control. Finally, one item that sometimes gets forgotten during these conversations about independent contractor is to focus on the overall contractor experience.

It's important to have a good working relationship with your contractors. Just as you would expect that your invoices are paid timely, you should do the same for your contracts. Your treatment impacts your brands and potentially your bottom line. Contractors have opportunities to voice their opinion on social media platforms impacting your business.

Paying your contractors timely is so important to your day-to-day operations. We'll talk more about paying your contractors in a little bit, but now let's transition and we're going to talk about some tools that TriNet PEO clients have available to them to help with managing and understanding contract relationships.

Boyd and I've talked about several tests that are used to determine the independent contractor classification, and this can be hard to manage. I get it. Particularly, if you're a multi-state company. You may be asking yourself, "Well, how do I do this? How do I know the regulatory requirements for California and Texas?"

The answer to this can be complex, if you don't have the right tools. I know that some of the attendees on today's session are TriNet PEO customers, and I want to remind you of the great tool that you have in our compliance center on the platform. I'm sure that many of you use it regularly to generate offer letters and job applications and to research my favorite topic, paid sick leave, among other things.

However, I wanted to call out our navigator independent contractor tool within the compliance HR platform. This tool generates a classification risk assessment based on factors you enter regarding the relationship. The tool is designed to make it easier to actually understand the specific risks for your circumstances and in turn, hopefully make it a little less overwhelming.

I just want to highlight that it includes federal and state regulations of over 1,700 court cases. That's the tool, once you've finished doing it, we’ll present a summary of applicable laws impacting the relationship as well as the questionnaire transcripts that you can use with legal counsel to discuss next steps.

I tease this a little bit, but the final tool that I wanted to talk a little bit about is our new TriNet contractors' payment feature. Boyd and I have discussed how important it is to pay contractors timely and in a manner that supports independent contractor relationships. TriNet contracts payment is another application that TriNet customers can use to help manage your independent contractors.

This is a relatively new product for TriNet PEO customers. We launched it earlier this year. The application allows you to onboard and pay your independent contractors through the TriNet platform and admins can easily access the application from TriNet and your independent contractors can access from desktop and mobile for quick access for their pay documents, pay information and tax forms. There is more information about this feature in the resources section, if you're a TriNet PEO customer and want more information, just talk to your customer relationship manager to get started.

Boyd, I think we have time. I saw a couple questions come through. I think we have a couple minutes for questions.

Boyd:
Sure, sure, absolutely. We've got a couple that I think are very healthy and geared towards this presentation. This is one that I've had routinely over the many years. What if my company thinks that a certain worker or group of workers should be employees and not contractors, but when we have a conversation with these potential workers, they say, you know what, I don't want to be an employee. Maybe they've had a bad experience in the past. Maybe they've said, no, I'm just working independently now and I don't want to be an employee. I don't want an employee relationship. I just want to be a contractor.

How should we handle that? I think the right best practice here from an HR compliance perspective, and Kelly, tell me if you think I'm wrong, would be just to continue to engage in some conversation about this, because some of these relationships can be that way and again, focus on the control.

Is this something where this contractor, this potential worker is so valuable to you, and you trust them to go and do this service on their own without you having to really micromanage or even manage day-to-day? Can they do this offsite? Are they using their own tools? You're probably going to be okay if you're doing that, assuming that they're already set up to keep track of whatever the projects are, report back the deliverables, submit the invoices and get payments. You may have to make that sort of risk assessment as to how valuable this worker is going to be versus what's the risk that you're taking. Of course, you can always consult your own legal counsel to get a sense of where you are and what the rules are in your jurisdiction. Kelly, what do you think about that?

Kelly:
Yeah, I think it sounds great, particularly if there's an agreement in place, but we all, you know, everybody has the best intentions at the beginning of an agreement.

Boyd:
Yes.

Kelly:
Then I seem to get calls from clients when the agreement sours. And so it's really important, like Boyd said, to work with legal counsel, even if you think you have a good agreement in place just to better understand your risks.

Boyd:
Yeah, I think that's absolutely right. Unfortunately, I don't think we have time to get to our second question today but I would like to thank you, Kelly, for the opportunity to have this discussion about misclassification.

It's very important and a lot of folks don't give it a lot of thought and I hate to sort of throw out all the complexity around this, but again, TriNet PEO customers have the opportunity to have this great tool through compliance HR that will help navigate them to getting it right.

Kelly:
Thanks, Boyd.

Boyd:
And thank everyone for attending. We really appreciate it.