Tips for Avoiding Independent Contractor Misclassification Scrutiny

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Last month’s column alerted Oregon employers to a renewed government interest in cracking down on those employers (mistaken, well-intentioned or otherwise) who misclassify workers/employees as “independent contractors.”  

So what can an Oregon employer do to avoid government scrutiny in the first place, and the painful financial consequences that can flow from such scrutiny (or a lawsuit involving misclassified workers)?  Perform an audit, or have an outside party perform one for your company. There is no time like the present to assess whether current independent contractor arrangements meet applicable legal standards, and to take reasonable steps to correct any mistakes that are found.

Step 1: Identify your company’s independent contractors. This can be accomplished by reviewing existing written independent contractor agreements, or by locating those individuals for whom your company filed IRS 1099 forms. During this identification phase, the auditor should: (1) Identify those workers with whom the company has a written independent contractor arrangement; and (2) Flag those workers who “seem” to have an independent contractor arrangement with the company, but for whom no independent contractor agreement appears to have been entered into.

For those workers who fall into the latter category, the employer should meet with the worker to discuss the worker’s duties (to determine whether the worker is, in fact, performing like an independent contractor) and enter into a written independent contractor agreement with those workers who meet the general criteria for independent contractors. Although written independent contractor agreements are never wholly determinative as to a worker’s status, they can be helpful proof of an employer’s intent regarding a worker’s status. Further, such agreements put the worker on notice of the employer’s expectations regarding an independent contractor’s duties and responsibilities.

Step 2: Review the terms of the written independent contractor agreements. The auditor should ask a couple of questions when reviewing the company’s independent contractor agreements. These are questions that assess whether the company, by using specific terms in the independent contractor agreements, treats the worker in question as a true independent contractor under the various legal tests that define the status of an independent contractor:

Does the agreement’s terms track the reality of the working relationship? An otherwise well-crafted independent contractor agreement will not serve as a good defense to a claim of misclassification if it does not accurately reflect what the worker does or how the worker gets assignments. Similarly, contractor agreements that include provisions typically be found in an employer-employee contract will weigh against employers whose classification decisions are challenged. Finally, if the independent contractor is performing the same duties as some of the company’s employees, the worker is less likely to be considered a true independent contractor.

Does the agreement state that the contractor gets to decide how, when, and where the work will be accomplished? One of the essential criteria of an independent contractor is whether the worker in question gets to control how and when tasks are performed. True contractors should be accountable for outcomes, not the means by which they are achieved If, for example, the employee can work whenever she wants, but must do the work in an office designated by the company (or using company-provided equipment), the worker is not likely a true independent contractor. The more autonomy the contractor has over work schedule, methods and place of performance, the more likely a company can withstand a misclassification claim.

Does the agreement prevent the contractor from providing services to other companies?  A company should never prevent an independent contractor from pursuing outside business opportunities. True contractors act like independent businesses, and ideally are earning income from multiple sources. Companies can require its independent contractors to complete a project by a specific date, but companies cannot require true contractors to refrain from working from others before the project’s due date.

Does the worker receive any benefits that employees receive, such as insurance or paid time off?  Employee benefit plans should clearly define “employee” and exclude all contingent workers, including contractors. Further, signed acknowledgements from the contractors regarding this exclusion are essential. Finally, under no circumstances should an independent contractor receive a copy of the company’s employee handbook, because true contractors are not covered under federal or state discrimination laws (and there should be no suggestion by the company that they are).

Step 3: Assess where the company keeps its records relating to independent contractors, and what records are kept. At this stage, the auditor should review and determine if the company: (a) Maintains signed independent contractor agreements for six or more years;  (b) Ensures that ledgers and other accounting records are consistent with employment/contractor relationships; and (c) Maintains IRS Form 1099s. Finally, have a qualified tax lawyer, accountant or tax preparer review the condition of the company’s three most recent years’ of employment tax returns, as well as all supporting documents and records – have all contractor payments been reported?

Unfortunately, Oregon and Federal law uses several tests to assess whether a worker is an independent contractor, so whether your company’s audit utilizes some or all of the audit tools above, or others, must be determined on a company-by-company basis. But taking time now to assess how your company’s independent contractors compare to these various tests is money and time well-spent, and may avoid scrutiny later.

Tamara E. Russell, an attorney at Barran Liebman LLP, has successfully represented employers and companies in government agency audits regarding independent contractor classification issues. Her practice focuses exclusively on the rights of management and employers in the world of private- and public-sector employment law. Questions about this article or Ms. Russell’s practice should be addressed to: trussell@barran.com or 503-276-2182.

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