Hiring · Contractors

Avoiding the contractor vs. employee legal debate?


July 18th, 2015

On-demand workers for companies like Uber and Lyft are constantly debated. As the founder of a startup that also relied on contracted workers (not in the transportation market), what can I (and others like me) do to avoid the contractor vs. employee legal debate? Our product isn’t live yet so we want to take and and all precautions so as to preempt any potential ambiguity about the status of our contracted workers.

Roger Royse Royse Law Firm

July 18th, 2015

You need to plan into this carefully. The consequences of getting it wrong care be life-ending for a startup, especially in California. This IRS has some good resources on this but the question is fact specific and requires analysis of your situation. see http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

see our posts on this also at http://www.royseuniversity.com/misclassification-of-company-workers1/

I will tell you that at a high level, you want to be merely the platform, not the business, if you want to stay out of this issue. By the way, this determination is not the end of it, you then have reporting requirements to deal with, and that area can be quite confusing. I have an extensive white paper on this that you can read if you don't mind the brain damage. http://www.rogerroyse.com/PDF/Section6050Article.pdf

Judi Wunderlich ★ Co-Founder/VP at WunderLand ★ (judi@wunderlandgroup.com)

July 20th, 2015

The misclassification of workers is a huge problem in the U.S.  It's costing the federal government millions in tax revenue, and workers get the short end of the stick if they are misclassified.

What everyone needs to know is that neither the hiring company NOR the worker gets to decide which classification to use - the IRS sets the rules. Someone might be classified as an independent contractor when they do work for Company A, but are classified as an employee when doing work for Company B. And that's perfectly ok. It's situational.

The IRS has a lot of information on their website about this issue, for example as shown below (with my comments in parenthesis). This is how the IRS determines whether someone should be paid an employee or as an independent contractor:

For federal employment tax purposes, the usual common law rules are applicable to determine if a worker is an independent contractor or an employee. Under the common law, you must examine the relationship between the worker and the business. You should consider all evidence of the degree of control and independence in this relationship. The facts that provide this evidence fall into three categories - Behavioral Control, Financial Control and the Relationship of the Parties.

Behavioral Control covers facts that show if the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training or other means.
(Let's say you're a web designer and a company wants to hire you. If the company tells you to use Adobe Illustrator to layout a page instead of letting you decide what's best to create the design, then you're an employee. If they ask you to work in their offices from 9 to 5, you're an employee. It's always THIS relationship that matters, not whether you worked in the past as an independent contractor.)

Financial Control covers facts that show if the business has a right to direct or control the financial and business aspects of the worker's job. This includes:

  • The extent to which the worker has unreimbursed business expenses
    (If the company tells you they will reimburse you for expenses incurred because you have to travel to one of their customers, you're an employee)
  • The extent of the worker's investment in the facilities or tools used in performing services
    (If you have your own office space and tools and use them to provide services to a company, you're probably an independent contractor. But if you work onsite at the company, using their tools, you're probably an employee.)
  • The extent to which the worker makes his or her services available to the relevant market
    (The IRS knows that a truly self-employed person will market themselves in any way possible as they need to keep getting business. But  you're an employee if all you do is post a resume on various websites and then wait for someone to call with a job offer)
  • How the business pays the worker, and
    (An independent contractor submits an invoice for their services, setting the terms for payment (i.e., in 10 days or 30 days). But a worker who waits for the company to issue them a check, based on the hours they worked during that period, is an employee.)
  • The extent to which the worker can realize a profit or incur a loss
    (A 'real' independent contractor might have profit or a loss in any year. Perhaps they rented an office, bought a cell phone just for business use, purchased computer equipment and software, and thus those expenses in one year might mean you show a loss for that year. But when someone is paying you to work 40 hours every week for them, and there is no contracted end date, then you couldn't possibly have a business loss, therefore you're most likely an employee in this situation.)

Relationship of the Parties covers facts that show the type of relationship the parties had. This includes:

  • Written contracts describing the relationship the parties intended to create
    (Independent contractors often create contracts to define the scope of their work for this company; employees rarely have employment contracts)
  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
    (Independent contractors get no benefits; if a company pays you some, then you may be considered an employee)
  • The permanency of the relationship, and
    (This is a gray area, but the IRS looks at how long you worked for one company. If you worked there M-F, 9 to 5 but without a job 'end date', they'll likely consider you an employee.)
  • The extent to which services performed by the worker are a key aspect of the regular business of the company
    (This is one of the criteria that got Uber into trouble. If you were to start a web design business, hiring a team of designers, those workers are integral to your business, and should be classified as employees.)

Amir Yasin Developer, Architect

July 18th, 2015

Homejoy and to a lesser extent Uber and Lyft are in hot water not because they blurred the line between employee and contractor, they just flat out ignore the difference and call employees contractors.

For a good example of a "marketplace" look at Angie's list.  Angie's List will connect you to a plumber, but they don't set the plumber's rate, they don't make the arrangements for when the plumber will come to your house, they don't collect money from you to give to the plumber (paying the plumber on some fixed schedule...say every 2 weeks), and when the plumber shows up at your house, he's not wearing an Angie's List uniform.  The plumber is a legitimate independent business and Angie's List is a legitimate facilitator.  Compare this with Homejoy and I dare anyone to claim with a straight face that Homejoy cleaners aren't Homejoy employees in everything but name.

Antone Johnson Social/Digital Media/Mobile Startup Lawyer, Advisor, Board member, Commentator

July 18th, 2015

Roger gave some great advice above. I would also emphasize, as a California lawyer, these issues (and all employment law issues, for that matter) can be highly state-specific. Not just the law itself, but enforcement by state authorities varies widely. In that sense, California is notoriously one of the most aggressively pro-employee states in the US. (It's testimony to the strength of the startup ecosystem here that we're able to thrive anyway.)

Pragmatically, most early stage startups don't run into this problem simply because they have such a small headcount they don't make the radar screens (yet) of state agencies or plaintiffs' class action lawyers. I would say the same about other common risks such as failure to obtain workers' comp insurance, misclassifying employees as overtime-exempt, or hiring unpaid interns. That doesn't mean it's OK to ignore these laws; companies that do are often in for a rude awakening when they become large or prominent enough, or if a disgruntled employee files a complaint that sparks an investigation by state regulators.

California has a good 10-question FAQ on employee vs. contractor status here:http://www.dir.ca.gov/dlse/faq_independentcontractor.htm.

Juan Zarco Managing Director, Silicon Valley Ventures Growth Partners llp

July 19th, 2015

I re-affirm the IRS standards, but remember, these standards only apply in the U.S. But,as in the case of Uber, some sharable models are operating outside of the U.S., and European and Latin American countries' labor laws favor the employee. For some strange reason, many tech companies believe that U.S. labor rules are universal.  

Let's see why sharable models are attractive: fatter margins.  Besides handling legal matters, I collaborate in building business models and projections. For every dollar paid to an employee, one adds 23%-25% additional costs to cover unemployment insurance, medicals, etc.  Their direct expenses must be reimbursed.  Also, for every 50 or so employees, one hires a HR manager to handle medical, reimbursements, etc. And in the case of taxi/trucking services, one has to have umbrella coverage for master-servant liability. By claiming "contractor" relationship, there are savings exceeding 30%-40% for having employees. Hence, I always include these expenses as part of projections.

On the other hand, the contractor absorbs expenses related to the business.  Not having the leverage to negotiate better premiums, the contractors most likely would be paying higher premiums. And the driving insurance policy has to cover the commercial aspects.  The capital investment for the company would be costs of developing a "phone app".  Great margins.

Yet, as I said earlier, regulators have seen this before the so-called sharable economy.  I myself have seen trucking operations designed that way, until they are challenged by lawsuits. These contractor-employee standards have been around for a while.

Melissa Rich Passionate, Mission Driven, Strategy, Growth & Impact Leader - Founder, CEO, President, Executive Management

July 23rd, 2015

Reposting from another FD conversation about the demise of Homejoy. 

Below is a post I wrote on my personal FB page immediately after reading about the demise of Homejoy (I service I admittedly never used). To put this in perspective - my post was visible to my FB friends, family, colleagues, advisors and yes - former staff members.

This hits very close to home as InterSchola's model was challenged by similar regulatory issues after we had created the first full service solution to help school districts and local agencies create a much needed revenue stream through the sale of their surplus assets and obsolete equipment through eBay style online auctions. Our model generated over $20 million in revenues for our clients (largely school districts and other local agencies), repurposed idle assets into the community and kept over 30 million pounds of surplus from going directly to landfill. Equally important, we created flexible work opportunities for many individuals in areas where similar jobs were not readily available. Our team enjoyed the work and found it rewarding.Although not challenged by a single staff member (unlike Uber or Homejoy- both facing litigation from staff members), in 2011 the state of CAchallenged us to convert our project based, flexible IC staff to employees. Wedid.That shift contributed significantly to our company's demise. We absolutely support workers rights and wished to provide a safety net, but the loss of InterSchola infrastructure following our business closure left our staff scrambling to try to continue to support clients with no net at all. I sincerely believe the country needs to consider an alternative to the employee/independent contractor distinction - a middle ground that supports flexibility for those that want it or need it while also providing company sponsored support for workers. This is a new economy. Think what you will of the Uber's of the world - but small companies are trying to innovate. Meanwhile large companies have been using highly paid ICs for decades with NO recourse because they have the legal resources to structure these relationships to sidestep their transgressions. A middle ground is needed. Interesting to watch both parties presidential candidates struggling to address this topic in their campaign efforts.

There is some good advice in the thread above. Certainly this topic is one that is and will increasingly be under scrutiny. To be sure, if thinking of using the sharing economy as a backdrop for your model (our business predated this term - and likely looked more like Homejoy than Uber), please be aware of themulti pronged tests(differ by state) to understand the classification distinctions. If the government wants to fight this - they can and they will as the tests are nothing close to black and white.

just added:  Most important factor seems to be degree and manor of control.   Be mindful that even if you have reasonable belief and guidance that justify the IC classification and even if you do everything correctly in treating workers as ICs (ie have IC agreements and file w9s), the agencies could still find that you don't meet the IC tests but rather must reclassify.  If I could give advice it would be: if you are concerned, you might have good reason.  Until there is more clarity this is going t be a hot topic.  Perhaps avoid the challenge if you can - go for the employee classification...

Happy to share my experience...

Juan Zarco Managing Director, Silicon Valley Ventures Growth Partners llp

July 19th, 2015

Let me add that I have worked in many startups whose founders attempt to avoid costs for fees/taxes, to register or get a license. Recently a Y combinator company in international money transfer wanted to avoid registrations. I said you have to comply or the penalties are too great. Seasoned investors know this as well. And these risks are found during due diligence. This process is part of the costs of doing business -- hiring counsels, filing or registering the company. Otherwise you are risking investors capital.

Paul Bostwick

July 20th, 2015

The most important way to "avoid a legal debate is to not avoid it but to do the right thing. The sad fact is youll need to hire an attorney to help you understand the law since it is full of precedent and weirdness. Get them to outline the gray areas and steer clear of them. Y I should say, your framing of the question suggests you have a preference for them to be contracted workers. That is fine to have as a hope or preference, but that has no impact on what is happening legally The legit way to go is to honestly state, for your attorney how youd like to work, hear about the legal implications, and then act lawfully. -Paul

Juan Zarco Managing Director, Silicon Valley Ventures Growth Partners llp

July 20th, 2015

I treat all business and legal decisions as business school's expectation value analysis -- what is the risk?  the potential loss? the probability of loss?  expected cash flow?  I recited earlier some risk related to company's money transfer business with Mexico -- a country known for money laundering, etc.  So, if you don't comply with the Dept of Treasury rules, the penalties are too severe.  It makes economic and startup sense to comply.  

As the initial contractor/employee issue raised, if I hire a lot of people as "contractors", yet I de facto have them managed as employees so that I can have fatter profit margins, then I evaluate what financial benefit would there be against the risk of loss -- from litigation, regulatory penalties, punitive damages. One such contracting homestyled company learned that harsh lesson well last week when it attempted to aoid compliance. But I feel that this is an issue of  reasonable corporate management practice.(Note that Sabarnes-Oxley law was instituted for this reason -- raising the penalty bars for lousy management decisions.)  As counsel for startups, I am always guided by the right path where stockholder value increases, while reducing such regulatory risks. Not following those guidelines is why some companies fail.  

Juan Zarco Managing Director, Silicon Valley Ventures Growth Partners llp

July 20th, 2015

Yes- the IRS code does dictate the nature of the employer/contractor relationship.  But these rules did not arise from thin air.  I have taken tax courses from a law school with a notable tax program, and there are two ways that tax code rules originate: by legal precedence (tax court) or by legislation.  In one example, my tax law professor showed each legal precedence for every single word in Section 301 of the IRS Code - and that is only one line of code. So, within the context of this debate, one can find the many background court cases determinative in establishing the rules dealing with independent contractor vs. employee by researching the tax code. By reading them, one understands how the courts reached their decisions and the reasons behind the rules.