Does Every Business Owner Need to Be an Attorney? Who or What is an “Employee?”

technical update logo

Historically, most business owners understood that someone working for them was an “employee.” Further, “independent contractors” were infrequently used by the average business. However, times have changed.

Administrative, benefit and regulatory costs related to employees have increased, leading business owners to search for ways to moderate these costs. Using workers who are not called “employees” has become increasingly popular with these same owners as a way to cut costs. Owners may refer to these workers as “independent contractors” or even “1099 employees.”

Well… to quote Shakespeare, “What’s in a name? That which we call a rose by any other name would smell as sweet.” But, if a bird walks like a duck, quacks like a duck, and flies like a duck, it’s a duck regardless of what you prefer to call it.

This discernible change in the historical employer/employee relationship has resulted in a controversy called “employee misclassification.” Traditionally, the insurance industry’s interest in this matter centered on workers’ compensation; however, there are many other facets that should concern insurance professionals, including tax withholdings, unemployment insurance and employee benefits.

State legislators are now taking up this issue. The problem with state legislatures is there are many conflicting interests that can complicate legislative action.
Just this year, the Federal Government has entered the controversy. The Department of Labor (DOL) – Wage and Hour Division, has issued an opinion on “employee misclassification.” On July 15, 2015, Administrator David Weil published Administrator’s Interpretation No. 2015-1 entitled The Application of the Fair Labor Standards Act’s “Suffer or Permit” Standard in the Identification of Employees Who are Misclassified as Independent Contractors.

The Fair Labor Standards Act (FLSA) regulates certain aspects of employment for enterprises engaged in interstate commerce and who have revenues of $500,000 or more. However, the NC Wage and Hour Act is modeled on the Federal FLSA which also defines the term “employ” to mean “suffer or permit to work.”

The DOL’s interpretation may be the first consideration of this issue at the federal level, but a foundation for this interpretation is already laid in North Carolina General Statutes.

State courts have traditionally applied a common law “control test” to determine employee status. This test focused almost solely on the degree of control the business had over the means, manners and methods a worker used to accomplish the work. When Congress enacted the FLSA, the control test was rejected in favor of the “suffer or permit to work” standard. Weil states that the ‘”suffer or permit” standard was specifically designed to ensure as broad a scope of statutory coverage as possible. He quotes the U. S. Supreme Court with reference to FLSA:

‘[I]n determining who are “employees” under the Act, common law employee categories or employer-employee classifications under other statutes are not of controlling significance. This Act contains its own definitions, comprehensive enough to require its application to many persons and working relationships, which prior to this Act, were not deemed to fall within an employer-employee category.’

Federal courts have further stated that an entity “suffers or permits” an individual to work if, as a matter of economic reality, the individual is “dependent on the entity.” Consequently, the federal courts use a “multi-factorial ‘economic realities’ test.” This test relies on a determination of the worker’s economic dependency on the business/employer to differentiate an “employee” from an “independent contractor.” Typically, the factors in the test include:

“the extent to which the work performed is an integral part of the employer’s business;”
“the worker’s opportunity for profit or loss depending on his or her managerial skill;”
“the extent of the relative investments of the employer and the worker;”
“whether the work performed requires special skills and initiative;”
“the permanency of the relationship;” and
“the degree of control exercised or retained by the employer.”

The Administrator’s interpretation discusses and gives examples for each of the bullet points of the “economic realities” test. Some of the examples are clear and helpful. However, the example for work being an “integral part of the employer’s business,” may raise more questions than it answers.

This example uses carpentry in the residential construction business. “[C]arpenters are integral to the employer’s business because the company is in the business to frame homes, and carpentry is an integral part of providing that service.” The suggestion is that carpenters being integral to the construction of a home would be economically dependent on the builder and, therefore, more likely to be an employee rather than an independent contractor. The Administrator uses an example of an independent contractor and a software developer engaged by the home builder to create software to help the builder in “tracking bids, scheduling projects and crews, and tracking material orders.” The development of software is not considered to be integral to the builder’s business “which is indicative of an independent contractor.”

While the distinction between a carpenter and a software developer is sufficiently obvious, what about construction trades other than carpentry, i.e. plumbing, electrical or roofing? These other trades are as integral to the construction of a home as carpentry. Does this create a rebuttable presumption of employment rather than independent status?

Application of the “economic realities” test should be qualitative rather than quantitative. In other words, it is not a mathematical formula and no one factor should be given more weight than any other. The goal is to determine if an “economic reality of dependence” actually exists – regardless of the labels or names used to describe the relationship between the business and the worker. (A Florida federal district court opinion states, “A worker’s receipt of Form 1099-MISC from employer does not weigh in favor of independent contractor status.”)

There appears to be an emerging understanding of employment based on the provisions of both federal and state labor laws which is broader that the “control test” traditionally used by some state courts. Thus, it is likely that scope of employer-employee relationships will be larger, meaning that a more stringent standard will be applied to an “independent contractor” relationship.

A true “independent contractor,” therefore, must clearly and unquestionably be a separate and independent business with all that such an independent status entails. Prudence and caution requires that a worker whose status is questionable be considered an employee until their independence can be clearly and unquestionably established. Any question concerning the status of a worker beyond the legal skills of the business owner requires consultation with an attorney, preferable one with a good grasp of both state and federal labor laws.

N.B. There is legislation pending before the NC Legislature to address the “employee misclassification” issue which establishes an agency to enforce and sets fines and penalties for the violation of the fair classification of employees. If passed, it will establish in statute an eight part test to determine independent contractor status that has existed in NC case law since 1944.

Here are some additional resources to check out:

IRS: Independent Contracttor (Self-Employed) or Employee?

SBA: Hire a Contractor or an Employee?

stuartStuart Powell, CPCU, CIC, CLU, ARM, ChFC, AAI, ARe, CRIS, has over 40 years experience in the industry, both as an independent agent and as IIANC’s resident insurance guru for the last 20 years. A valuable resource for IIANC members providing technical information, Stuart is well-known across the country for his vast insurance knowledge. He regularly teaches for numerous insurance organizations and is on the national faculty for the Society of Certified Insurance Counselors.

Questions? Contact Stuart at spowell@iianc.com or 888-275-8914.