By Adam Atlas
Attorney at Law
ISOs grow by engaging agents to sell for them. Some agents are employees; some are not. The purpose of this article is to dig into this legal issue, its relevance and approaches to help manage the related risk.
An employee-employer relationship is fundamentally different from that of an independent contractor doing work for a business. State and federal laws impose obligations on employers, such as providing tools and equipment and payroll deductions for taxes, 401(k) contributions, wage garnishments or child support payments. State law also reads certain rights into the employer-employee relationship, notably around termination, minimum wage and other key topics. ISO insurance policies may also provide for different treatment of employees and independent contractors.
Both ISO and agent should be clear as to the precise nature of their relationship. Failure to do so could result in disappointment for both parties. For example, an ISO that thought all its agents were independent contractors when, as matter of law, they were employees, could end up having to pay penalties to the state.
Whether someone is an independent contractor or an employee is a legal question. The answer to that question might not be obvious from one source only, such as the contract. This is what makes the contractor versus employee issue vexing to some people, because the nature of the relationship can sometimes be interpreted differently, depending on who is asking and why.
ISOs will naturally prefer that their agents be independent contractors, not employees, because that may cost less and also simplify tax and compensation matters. An agent may also prefer independent contractor status because they may wish to deduct business expenses from their revenue that would not be deductible if they were an employee. The key takeaway is that the relationship might not be what you think it is. Despite your best efforts to create one type of relationship, you may have actually created the other.
To determine with certainty whether an agent is an employee or independent contractor, you must consult a local lawyer in the relevant state. However, some well-established criteria will point in one direction or another. The IRS maintains a handy web page on this, https://bit.ly/2V5oWwH, which lists the three most important indicators of an employment relationship:
As the criteria above indicate, control is a key factor. If the ISO sets appointments and provides a desk, coffee and a computer, the agent appears to be much like an employee. On the other hand, if the agent sets their own appointments, buys their own computer, and comes to the office for training and to hand in applications, this could be evidence of an independent contractor relationship.
Some ISOs endeavor to develop a form of independent-contractor agreement and believe (incorrectly) that this will fully protect them against their agents being deemed employees. But the status of an agent as an employee or independent contractor depends on both the contract and the facts and circumstances of the actual relationship. And this issue is an unusual legal subject where behavior trumps express language in a contract.
To be clear, a contract could describe a perfect independent-contractor situation, including language to the effect that the agent is independent and responsible for their own expenses etc. But if the behavior does not match the wording of the contract, then the IRS will rely on the behavior to determine the status of the agent.
Curiously, this is a one-way street—inclined toward employment relationships. It is very unlikely that a signed employment contract will, by behavior alone, be interpreted by courts to be an independent contractor relationship. This bias is, naturally, built to favor the protection of employees and their rights under the law.
As an ISO owner, once you have selected the type of relationship you prefer to have with agents, it’s best to align your legal agreements, accounting treatment and personnel practices. To do this, get your lawyer, accountant and operations people to meet and create a common plan of implementation and action. This will incur costs to the ISO, but will save the expense of responding to an audit from the Department of Labor or IRS.
Agents should also take stock of their designated relationship as a W-2 employee or 1099 independent contractor and consider whether the behavior of the parties matches the intended relationship. If either party finds a mismatch, they should meet to reach an understanding and make the necessary adjustments. The most successful ISOs I've worked with have built their businesses using mostly employees.
Employees are entitled to not be subjected to discrimination on the basis of gender, race, religion etc. The law does not provide as many protections in this regard to independent contractors. For example, independent contractors who become pregnant have been denied access to benefits that they would have been able to access had they been employees.
With ever more people working as independent contractors and remotely, I expect the bar to be raised with respect to independent contractor rights, such that they will get closer to those of employees. Common sense and reasonableness are winning ingredients in any agent relationship whether it’s designated as W-2 or 1099.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law via email at firstname.lastname@example.org or by phone at 514-842-0886.
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