By Sarah Weston
Jaffe, Raitt, Heuer & Weiss PC
It is difficult to distinguish between an employee and an independent contractor, especially because of the ever-changing and often confusing rules the IRS uses to make that determination. However, if you misclassify employees as independent contractors, the odds that you will face expensive penalties are increasing.
Due to the sagging economy, legislators are seeking additional sources of revenue. State and federal officials are becoming more aggressive in investigating companies that misclassify employees as independent contractors.
Under the proposed 2011 federal budget, an additional $25 million will be provided to the Department of Labor to add 100 enforcement personnel and provide grants to states to enforce penalties for misclassifications.
The IRS intends to audit 6,000 companies to ensure compliance with worker classification rules. Additionally, many states are proposing legislation and creating task forces to investigate worker misclassification.
Employers have an incentive to classify workers as independent contractors, rather than employees, because by doing so they can avoid paying the employer contributions to Social Security and Medicare, unemployment insurance, payroll taxes, mandated minimum wages and overtime, and workers' compensation insurance.
Generally, companies using independent contractors also avoid providing health insurance and other benefits that are typically provided to employees, such as sick time, flextime and vacation.
Thus, the government alleges employers have strong incentives to classify as independent contractors workers who are really employees.
For ISOs and merchant level salespeople (MLSs), this means it is time to take a second look at your agreements to make sure that MLSs, for example, are being properly classified as independent contractors. The following tests can help with this process.
The IRS uses two tests to determine whether a worker should be classified as an employee or an independent contractor. The first is a three-factor test that weighs the amount of behavioral control the employer has over the worker, the financial control the employer has over the worker and the type of relationship the employer and worker have.
While employees are dependent on their employers for everything needed to perform their jobs, independent contractors are in business for themselves; they control their own transactions and cover their own expenses. With this in mind, it is easy to see why the more control an employer has over a worker, the more likely it is that the worker will be classified as an employee.
The second IRS test involves 20 factors. Again, the more control the employer has over the worker, the more likely the worker will be classified as an employee. Below are the seven factors most relevant to the payments industry. No single factor is dispositive, and having a certain number in either category is not conclusive.
If you want to make sure your agents will be deemed independent contractors, your agents should have their own place of business. If they're working in your office, it is an indication that they are actually employees.
But if you take liability through your processing relationship and you want to make sure your agent will be deemed an independent contractor, you may want to pass that liability down to the agent.
If you want to make sure your agents will be deemed independent contractors, limit the amount of training required, and do not tell them how to perform their jobs.
If you want to make sure your agents will be deemed independent contractors, make it clear that they can perform their job duties on their own schedule without mandatory work hours.
If you want to have some certainty that the worker will be available but still want your agents to be nonexclusive, consider using minimums. Minimum levels should be low enough that the independent contractor has a reasonable amount of time to acquire merchants for other processors. In other words, don't set minimums that are so high that agents will effectively be prohibited from marketing for other companies, even if they are technically "nonexclusive."
If you want to make sure your agent will be deemed an independent contractor, make sure your agent agreements run for a specific term, terminable early only for specific causes.
Using agents who are entities, as opposed to individuals, is one way to stack the odds in favor of their being classified as independent contractors. Remember, when entering into an agreement with such an agent, obtain proof of the legal status of the other entity, such as a good standing certificate from the applicable state or the entity's certified articles or certificate of formation.
The factors listed herein may help you determine whether you are classifying your workers appropriately. If several factors indicate you exert behavioral or financial control over your workers' services, consider having your accountant or attorney review your practices.
Further, it is not sufficient to simply change the wording of a contract unless the underlying relationship also changes to mirror what the contract requires. In other words, if your contract reflects an independent contractor relationship but your actions reflect an employment arrangement, any investigating party will focus on the way the relationship actually works, not the way the contract says it should.
Companies caught misclassifying employees as independent contractors - even unintentionally - not only risk penalties, they can also be required to make retroactive payments for minimum wages, overtime, payroll taxes and interest that, but for the misclassification, would have already been paid for workers' past services.
The recommendations herein are general suggestions; they are not a substitute for legal advice. For specific information, consult experienced legal counsel. Sarah Weston is an attorney at Jaffe, Raitt, Heuer & Weiss PC and advises businesses on contract and regulatory issues in the merchant acquiring, stored value, automated clearing house and payment systems industries. You can reach her at 248-351-3000 or at firstname.lastname@example.org.
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