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February 18, 2020

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Miserable Hangover: Worker Misclassification

Independent contractors back in the news

This week, independent contractors have made the industry news again, bringing with them the subsequent issues of employment classification. America’s 17.7 million independent workers earned about $1.2 trillion before the close of the 2013 fiscal year, according to a study published last October. Employers see the rising freelance economy as good for workers, who get to set their own hours and work from the comfort of their homes. Regulators say that misclassifying employees as contractors robs governments of crucial tax revenues and exploits workers, depriving them of health care and other benefits.

The U.S. Government Accountability Office (GAO) reports that the IRS claims to lose millions of dollars each year in uncollected taxes from the misclassification of independent contractors. Because of the project-based nature of the work, specific industries run higher risks when utilizing freelance labor. Companies in the utilities and construction sectors, for example, often rely on contract labor. GAO estimates, based on current misclassification cases, indicate that 21 percent of contract labor performing ongoing work for an energy or utility company may be misclassified.  

Most employers are aware by now that state and federal governments are cracking down on worker misclassification. Audits, enforcement actions and lawsuits focused on the misclassification of workers as independent contractors have become commonplace, and the potential costs of misclassification—back wages, tax liabilities, and retroactive exposure for employee benefits, unpaid unemployment insurance contributions, fines and penalties—can be steep.

So what happened recently? One of the landmark classification cases, FedEx, finally came to a close. Theultimate ruling prompted John Hyman -- a partner in the Labor & Employment practice of Meyers, Roman, Friedberg & Lewis -- to observe that “while this case does not necessarily spell the end of the independent contractor, it very well could be the beginning of trend of cases leading down this path.”

We don’t believe that this is the “end of independent contractors as we know it,” or that the use of independent contractors should be limited or abolished altogether because of perceived risks or heightened scrutiny by regulators. In fact, this is an excellent opportunity for MSPs to bring further value to the hiring managers they serve. Learn more about the support MSPs offer their hiring managers

The FedEx case

In 2007, the transportation industry was put on worker misclassification high alert as FedEx Ground/Home Delivery was audited by the IRS. FedEx received a $319 million assessment for potentially misclassifying drivers as independent contractors.  While the IRS withdrew the assessment late in 2008, workers pursued claims that they were treated as employees by FedEx.  The withdrawal did not conclude that workers were properly classified as independent contractors, and resulted in future assessments.

In Estrada v FedEx, FedEx Ground/Home Delivery agreed to pay $27 million to 203 drivers pursuing claims that FedEx misclassified drivers as independent contractors. Over $14 million was to be paid to drivers in California as reimbursement for expenses, taxes and workers compensation, along with $12 million in legal fees.

The case exposed an opportunity for the IRS and other state and local agencies to investigate corporate misclassification abuse to seek recovery of unpaid taxes, insurance and other penalties.

In October 2009, three other states (New York, New Jersey and Montana) announced plans to file suit against FedEx for violating labor laws by illicitly classifying employees as independent contractors, causing a “serious injustice” to more than 1,000 drivers in order to save money.

On August 27, California’s 9th Circuit Court of Appeals definitively concluded that FedEx’s delivery drivers were employees of the company, not independent contractors: “FedEx contends its drivers are independent contractors under California law. Plaintiffs, a class of FedEx drivers in California, contend they are employees. We agree with plaintiffs.”

Control issues

Many of the leading MSPs and staffing firms today have incorporated some level of independent contractor compliance and administration into their programs. Their evaluations seek to assess ICs based on independent business history and structure, main control factors (Financial, Behavioral and Relationship of Parties), and the IC’s ability to carry the required business insurance. The assessment process covers a wide berth of factors.

  • ABC Tests: The most common state-driven evaluations for measuring worker classification by criteria that establish control over the worker, where the work is performed and proof of the contractor’s independent business operations.

  • IRS Common Law Tests: The IRS uses this test to measure whether an independent contractor controls the manner and means by which the contracted services, products or results are achieved.  The factors cover behavioral control of the worker, financial control and the relationship of each party in the engagement.

  • Fair Labor Standards Act (FLSA) Economic Realities Test: As with the preceding assessments, this test seeks to understand the extent to which the services in question are part of the company’s business; the amount of the individual’s investment in the company’s facilities and equipment; the nature and degree of control retained by management; the individual’s opportunity for profit or loss; the amount of initiative, skill or judgment required; and the permanency and duration of relationship.

Despite the complex and often subjective nature of the qualification criteria, the use of VMS modules to automate classification processes, the laborious amount of documentation collected and reviewed, and the sprawling defense files built, the simple reality is that all inherent risk boils down to the issue of control. Which party is controlling the contractor’s work? The client, the MSP, the staffing firm or the independent talent? The other considerations -- financial, work location, supplies furnished, etc. -- are all directly related to the primary factor of control.

The recent ruling in the FedEx case only bolsters this: “As a central part of its business, FedEx contracts with drivers to deliver packages to its customers. The drivers must wear FedEx uniforms, drive FedEx-approved vehicles, and groom themselves according to FedEx’s appearance standards. FedEx tells its drivers what packages to deliver, on what days, and at what times. Although drivers may operate multiple delivery routes and hire third parties to help perform their work, they may do so only with FedEx’s consent.”

The IRS has again simplified and emphasized the core principle of the common-law rule: any worker who performs a service for a client will be considered a statutory employee if that client controls how, what and where the work will be done.

What MSPs Can Do to Help

It often seems that the assessment process is where things begin and end. Whether the MSP’s team is conducting the evaluations or the client has self-identified and (hopefully) vetted ICs, this undertaking alone tends to emphasize conformity and indemnification over compliance. The prevailing concern is control. So after taking every precaution to deflect risks in qualifying ICs, how can an MSP help manage the issues of control? Primarily by treating ICs as the service providers they truly are; by approaching the relationship in the same way they deal with staffing supplier partners.

Independent service providers should receive the same dedicated representation as suppliers through an MSP’s supplier management group. Independent service providers should have access to communications and all necessary materials they have requested in order to perform their services. They should not, however, have access to company uniforms, equipment, vehicles or regular facilities at a client site.

The MSP can design and oversee the engagement, on-boarding and ongoing administration processes of independent service providers in the program, and identify red-flags along the way that could lead to risk exposure.  Performance issues should be discussed only as they relate to agreed upon contractual obligations between the IC and the client -- the same as they would with any outsourced service provider.

  • Designing an environment for independent contracting should focus on standardization, consistency and compliance.

  • The MSP should build a document management portal, which is maintained in a controlled environment.

  • The MSP should limit any perceived managerial roles with the contractor:

    • Administration and on-boarding procedures are performed by the MSP

    • Regular communication occurs between the independent service providers and the MSP, only in relation to contractually bound and scheduled milestones, deliverables and Statement of Work (SOW) commitments -- not employee related issues such as attendance, timekeeping, hourly productivity checks, etc.

  • The MSP can act as a payment processing agent between the IC and the client, yet those terms should be clearly outlined upfront in the Professional Services Agreement (PSA) and SOW. The billing structure should be negotiated to ensure that financial control factors are adhered to.

  • The MSP should restrict the inclusion of ICs in company functions unless absolutely necessary to the performance of the work as contractually stated.

  • All HR related information must be directed to the IC.

  • As a best practice, the MSP can reassess ICs who stay on projects longer than a predetermined amount of time, addressing red flags.   

  • The MSP can ensure that the utilization of ICs occurs for specific, specialized work only, such as projects with established start and end dates that full service employees are not performing.

It’s not a headache, it’s a hangover

Clients caught in the crossfire of an employment classification battle between government regulators and ICs are miserable. Many who wish to use ICs end up passing because they “don’t want the headache.” The reality for companies that run afoul of the law, however, is that it’s really more like a hangover. They had too much fun the night before, felt on top of the world and then paid for it the next day. The point is, the throbbing pain these organizations are now feeling could have been avoided through a bit of restraint, moderation and control.

The use of ICs doesn’t need to be prevented, and there’s no reason to think they’re going the way of the dodo because of the FedEx ruling. The government is merely reiterating the foundation of existing case law.

The first step is to restructure the relationship with ICs in a manner consistent with legislation and corporate objectives. The second step is revising professional services agreements to enforce the independence of the contractor, treating the individual as any other company that provides services -- not as full-time or even temporary talent.  The third step in managing an IC population is not to manage them at all.

We don’t oversee the way in which mechanics repair our vehicles. We don’t control their schedules, provide them tools, dictate their workspaces or request timesheets. We sign a contract at the start of the work. If the contract is breached, we are owed restitution. If the work is unsatisfactory, we discontinue service. The relationship with independent contractors should be viewed as no different.

The value of MSPs would be akin to having a personal assistant, who is utterly familiar with the process of car repair, to intermediate the relationship and payment processes on our behalf -- to provide additional input, offer administrative support to expedite the work, ensure contractual compliance for deliverables and report on the quality of the output from a position of expertise.

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