Independent contractor status: If it walks like a duck …

Many businesses use independent contractors. You might use them. If both the business and the individual agree, and even put their agreement in writing, then the individual is an independent contractor, there’s nothing to worry about, right? Wrong.

Classification

The status of a person as either an independent contractor (“IC”) or an employee, when performing work for/with a business, is referred to as “classification.” Throughout this article, the terms “classification” and “misclassification” will be used to reference the IC/employee status. You may also have heard (or used) the term “1099” to refer to the person or the person’s status, though 1099 is the number of the IRS form that must be issued to an individual or entity who you paid to perform services. (Note: The writer is not a tax expert and this article does not purport to speak to when a 1099 must be issued.) For example, “I just 1099’d him.” That means you classified him as an IC. Was your classification proper?

Whether an individual is or can be properly classified as an IC, rather than an employee, is governed by the relationship and whether certain factors are present. The existence of a contract that states, “we are independent contractors” can be one helpful piece of evidence to support the classification. However, regardless of what the contract says, conduct governs: If it walks like a duck, and talks like a duck, it’s a duck. Even if there is a contract saying it is a goose, it is still a duck.

Multiple agencies

There is not one rule, or set of rules, that governs IC classification. There are several, depending on the government agency who is doing (or reviewing) the classification. Most businesses need to be concerned with the IC classification rules of three agencies: the Internal Revenue Service; the Department of Workforce Development (“DWD”) – Worker’s Compensation Division; and the DWD – Unemployment Insurance Division (“UI”). So, even when someone says “the DWD said …” the question becomes which division of the DWD? In this article, we’ll look at what the UI division of the DWD has to say about IC classification.

The test for IC classification under UI laws has two parts. The first part is often referred to as the “control or direction” factor. The second is the “six of nine conditions” factor. Let’s break down each.

Control and direction

The “control or direction” factor takes a holistic view, where the following questions come into play but the answers to each is not dispositive, nor are these questions exclusive. In other words, the answers to these questions will play a large role in the classification, but so can other factors that may be indicators of control or direction of the worker (individual) by the employing unit (business).

1. Is the individual required to comply with instructions concerning how to perform the services?
2. Does the individual receive training from the employing unit with respect to the services performed?
3. Is the individual required to personally perform the services?
4. Are the services required to be performed at specific times or in a particular order established by the employing unit?
5. Is the individual required to make oral or written reports to the employing unit on a regular basis?

(Continued)

Six of nine conditions

If the person passes the first part of the test (e.g., the answers to the questions above are “no”), you can then move on to the second part: six of nine conditions. This part of the test is exclusive, rather than holistic — it lists nine conditions, six of which must be met in order for the individual to be classified as an IC. If the person only meets five or fewer of the conditions, (s)he is an employee. The conditions are as follows:

1. The individual advertises or otherwise affirmatively holds him or herself out as being in business.
2. The individual maintains his or her own office or performs most of the services in a facility or location chosen by the individual and uses his or her own equipment or materials in performing the services.
3. The individual operates under multiple contracts with one or more employing units to perform specific services.
4. The individual incurs the main expenses related to the services that he or she performs under contract.
5. The individual is obligated to redo unsatisfactory work for no additional compensation or is subject to a monetary penalty for unsatisfactory work.
6. The services performed by the individual do not directly relate to the employing unit retaining the services.
7. The individual may realize a profit or suffer a loss under contracts to perform such services.
8. The individual has recurring business liabilities or obligations.
9. The individual is not economically dependent upon a particular employing unit with respect to the services being performed.

Without going through all nine conditions, let’s point out a few that tend to be problematic. Some relate to how the IC operates as a business. Condition 1 — it is appropriate that it is first. Many businesses that use ICs think that if they make sure the IC has an LLC, that is enough — but it isn’t. The IC must advertise or affirmatively hold herself or himself out as being in business. This can mean a website, online ads, business cards, signage, etc. Condition 3 can be another tough one because it is far beyond the employer’s control. What if the IC only wants to perform work for the one business? Then this condition is not met. Condition 9 is also likely not to be met, if the IC’s sole or main source of revenue is the employer. If, on the other hand, the IC performs services for another business and/or has her/his own clients, this condition can be met.

Other factors that often come under heavy scrutiny relate more to the economics of the situation. Condition 4 requires that the IC incur the main expenses. So if supplies and equipment are paid for entirely (or mostly) by the employer, this condition will most likely not be met. This condition often goes hand in hand with conditions 7 and 8. If the IC is not incurring much expense, the IC cannot likely suffer a loss. On the flip side, if there is a chance that the expenses could outweigh the IC’s revenue, as is a risk with most businesses, then this condition may be met.

The issue of whether an individual performing services for an employer, or “employing unit” can properly be classified as an IC is not cut and dried — the number of factors to be considered illustrates that it involves a fact-intensive analysis. To avoid being in hot water with the UI Division, businesses using ICs should be sure to undertake this analysis and may wish to consult legal counsel in the process.

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