Legalese Column: Cautionary Tale on Independent Contractors

This article ran in the October 2014 issue of AVN magazine. Last month's Legalese column talked about the legal principles dealing with employees, touching briefly upon the contrast between independent contractors and employees. A pair of federal appellate decisions since that article was put to bed punctuate the problem that arises from trying to manufacture independent-contractor status, as employers continue to attempt to misclassify as independent contractors workers who plainly should be classified as employees. In two recent cases (see citations below), FedEx largely took a shellacking on this issue. The topic of those two cases: FedEx Ground drivers—you know, the people who zip around town in vans with the "FedEx Ground" logo on the side, delivering packages all day long. What happened was that FedEx tried to engineer a way to label these drivers as independent contractors, rather than employees. Why would FedEx want to do that? Money, of course. If you are an employer, you probably know all too well. Using the FedEx drivers as an example, the difference is dramatic. First, there are deductions for any employee. The employer deducts from the employees’ gross pay amounts for Social Security and Medicare, an amount that the employer must match. Additionally, there are other employment “taxes” of sorts, such as state disability insurance and unemployment insurance premiums. Along with that, employers are required to carry workers compensation insurance on their employees. Together, those things are sometimes called “burden”—and you can figure it’s over 20 percent of the employees’ gross salaries. Atop that, there is the Affordable Care Act on the horizon! In the FedEx example, there is more. In most states, you can no longer require employees to purchase their own uniforms if they are unique. That is, you can tell employees that they must wear white golf shirts and khaki pants because those kinds of clothes are good for ordinary life. But uniforms are different. Employees in some states, including California, cannot be required to furnish their own uniforms if they aren’t good for general use. The same is true with other tools of the trade. Two bad problems can happen if you misclassify employees as independent contractors. Bad Problem Number One is that the taxing authorities—the IRS or, for those many states that have them, the state income-taxing authorities—can drop by and conduct misclassification audits. The reason, of course, is that independent contractors are required to pay their own taxes, which they don’t always accomplish too well. The IRS, you understand, has created this ingenious system whereby employees actually look forward to filing their tax returns. Employers are required to over-withhold, leaving the IRS owing a refund to taxpayers. So, the employees go rushing to H & R Block the minute that they get their W-2 forms. It’s like Christmas in February. Independent contractors, on the other hand, are required to be disciplined about paying taxes. If they receive over $600/year from a given employer, the independent contractor and the IRS receive a 1099 form on which the independent contractor is supposed to pay taxes. The taxing authorities have problems: first, that collecting taxes from these folks can sometimes be like pulling teeth; and second, independent contractors tend to invent doubtful business expenses that the taxing authorities do not like to spend time unraveling. How misclassification audits happen, incidentally, often arises when someone who had been classified as an independent contractor is dismissed. He or she goes to the unemployment office and fills out the forms, claiming to be the victim of a layoff. The unemployment folks check with the company, which responds, “That was not an employee; it was an independent contractor.” When the work that the claimant describes having done for the company appears otherwise, the taxing authority sets up a misclassification audit—which can be very lucrative for the taxing authority for reasons including that, if the company loses, it must fork over all of the taxes that it should have withheld except where the company can prove that the alleged independent contractor paid all taxes owed—and good luck proving that! Bad Problem Number Two that can result from misclassification comes when greedy class-action lawyers find a few former employees who would like to pick up a few extra bucks—who wouldn’t?—and don’t really like the company, anyway. (After all, who is loyal to a former “employer”?) But wait! The independent contractor was paid more than minimum wages; so, what’s the problem? The problem is that the newly found-to-be-employer failed to pay, for example, its half of Social Security and Medicare. Now, that may seem small. But take FedEx: That’s nearly 8 percent of salary! Multiply that times the number of employees times annual salaries times three years. For FedEx, that’s a mountain of money. Oh, and by the way, usually attorneys’ fees can be recovered, which, in smaller cases, can be “the tail that wags the dog.” In California, for example, there is a multi-part test to determine whether someone can properly be classified as an independent contractor. So, here’s what FedEx did: It manufactured a system carefully designed to defeat as many of the factors as it could. For example, one of the independent-contractor factors is who supplies the “instrumentalities, tools and place of work for the person doing the work.” How FedEx addressed that is incredible: You assumed that FedEx owns all of those trucks, hand-held computers, dollies, etc., right? Wrong! The drivers own all of that stuff. And they purchase their own uniforms. Another factor is whether the person is paid by the hour or by the job. FedEx drivers were paid allegedly by the job, because they were paid to deliver a load of packages that could be done in a 9.5- to 11-hour day. Another factor is whether the parties intended to create an employer-employee relationship. You won’t be surprised to learn that there was an extensive written contract in place, called an “Operating Agreement,” that included every imaginable provision that would create an independent-contractor arrangement. Guess who wrote that! The problem, the court said in each case, was control. The court found that FedEx exerted and was entitled to exert an enormous amount of control over the drivers. They couldn’t use any old truck. Have you noticed that FedEx trucks all look the same? Control. Uniforms are all alike? Control. Deadline to deliver the packages? Control. Drivers not allowed to use the trucks for any other purpose? Control. Delivery trucks all look the same with the approved FedEx trademark? Control. You can figure out how it goes on and on. If it looks like a duck, walks like a duck and quacks like a duck, it’s a duck. The same holds true for an employee. The sophisticated and convoluted system created by FedEx in an effort to characterize its drivers as independent contractors is generally failing. And don’t you know that FedEx had an army of lawyers concocting that system? So don’t try this at home. A good rule of thumb is this: If you have someone working on your premises, ask yourself this: Are you hiring a company or a person? Take the example of a retail store that has outside cleaning and security, with a security guard in the evening and a cleaning person or people that comes in every night to scrub the place clean. If you are paying the personnel directly, the presumption is that they are employees; and they probably are. On the other hand, if you are paying a company, that is a true independent contractor; but be sure that the company that you are paying is treating the workers as employees of theirs. If that is the case, the workers are receiving the benefits that are required to be given to employees and have no grounds to complain. Finally, if you learn anything from this, learn that you shouldn’t try to manufacture a circumstance to create a ruse to give independent contractor status to workers who should be employees. That is essentially what FedEx did. As we see from the FedEx cases, courts look to form over substance.Citations: Alexander v. FedEx Ground Package Systems, Inc., ___ F.3d. ___, 2014 WL 4211107 (9th Cir., August 27, 2014) and Slayman v. FedEx Ground Package Systems, Inc., ___ F.3d. ___, 2014 WL 4211422 (9th Cir., August 27, 2014)