D. Independent Contractor Status

Companies often violate the law by not understanding the distinction between employee and independent contractor status. This distinction has become crucial due to increased IRS investigations. The IRS generally opposes independent status because companies who employ independents don't have to withhold income or employment taxes. Additionally, since the independent contractor can manipulate his/her earnings (they are entitled to claim all of their business-related expenses on Schedule C where expenses offset gross business income), many dollars of compensation go unreported.

Other problems can be involved as well. For instance, to obtain greater damages outside of Workers' Compensation benefits, a worker injured on-the-job may resist the Workers' Compensation Law prohi- bition of a direct cause of action against the employer for personal injury by claiming that he was not an employee but an independent contractor at the time of the incident.

No precise legal definition of an independent contractor exists. In fact, each state has its own laws that determine whether an individual is an employee or an independent contractor. When the courts attempt to determine the difference, they analyze the facts of each particular case. The most significant factors that courts look at when making this distinction are:

1. The company's right of control over the worker;
2. Whether the company carries indemnity or liability insurance for the worker;
3. Whether the individual works exclusively for the company or is permitted to work for others at the same time; and
4. Whether the parties have a written agreement which defines the status of the worker.

The distinction between an employee and an independent contractor is that the former undertakes to achieve an agreed result and to accept the employer's directions as to the manner in which the result shall be accomplished, while the independent contractor agrees to achieve a certain result but is not subject to the orders of the employer as to the means which were used. In each case, the court looks at the specific facts in making its determination. For instructive purposes, the company's right of control is best explained by the use of examples. Courts have found workers to be employees if the companies:

• Had the right to supervise the details of the operations;
• Required salespeople to collect accounts on behalf of the company;
• Provided the worker with a company car and/or reimbursement for some or all expenses;
• Restricted the worker's ability to work for other companies, or jobs (i.e., required full-time efforts);
• Required the worker to call on particular customers;
• Provided the worker with insurance and Workers' Compensation benefits;
• Deducted income and FICA taxes.

This list is not meant to be all-inclusive, but rather, to help you determine whether your personnel fall into either the employee or independent category. Since the law is so unsettled and frequently varies from case to case and state to state, and since the IRS has increased its scrutiny and activity in this area, federal legislation was presented in the Senate several years ago to introduce some standards. Although the bill was not passed, it is instructive and outlines a set of rules that can be used as guidelines. By following these rules, your company may minimize problems and/or better document your position in the event of an audit.

According to the parameters set forth in the proposed bill, an independent contractor:

1. Controls his or her own work schedule and the number of working hours;
2. Operates from his or her own place of business or pays rent if an office is provided and supplies his/her own stationery, business cards, etc., not at the company's expense;
3. Risks income fluctuation since his or her earnings are a result of output (i.e., sales, rather than the number of hours worked); and
4. Has a written contract with an employer before work begins that states he or she is not considered an employee for purposes of the Federal Contributions Act, the Federal Unemployment Tax Act, and income is not withheld at the source. The contract clearly states that the individual must pay self-employment and federal income tax.

Following these rules can go a long way toward applying the correct status determination. When attempting to prove employee status in worker injury cases, the company's right of control may be the most important factor.

Counsel Comment #35: If an initial determination is made by the IRS finding employee status, costly damages, penalties and interest can ensue. Often the IRS has the right to impose additional taxes on your other employees similarly situated when a determination is found against your company with respect to the first employee, so act quickly. Speak to a compe- tent attorney or accountant immediately upon receiving an initial IRS request for facts into such a matter. Competent advice and guidance may help "nip a problem" before it gets out of hand in this area.