Episode #17 – Employees vs Contractors

In the Performing Arts Lesson business we often question what is the best way to design our lesson program…with Contractors or Employees?

In this episode we interview special guest Holly Stam who is an attorney that specializes in HR.

Holly Hublou Stamm is the founding partner of Apto Law – which bills itself as the “employers’ partner”. Ms. Stamm is a national HR legal expert, who for over 10 years litigated and defended employment cases for large Fortune 500 clients.  She started Apto 15 years ago which is a HR Compliance firm that specializes in helping employers navigate the complex employment laws throughout the United States.

Listen to “Independent Contractors VS Employees – Special Guest Holly Stam” on Spreaker.

We hired Holly to give us insight to properly help multi-teacher studios operate with either model.  It seems that after tons of research, the easiest hands down is to go with employees. If you already have your Teachers as W2 Employees, you’ll still get a ton of benefit as we highlight the most important elements to promote continued growth in our Lesson Studios.

Today we will break this up into two parts… ”Business and Legal” / “Vision and Purpose”

 

Business and Legal

• Legal –  The trend in the U.S. is for courts and taxing authorities to presume an employment relationship exists and the burden falls on the employer to show the reasons the relationship is one of independent contractor.  The reason main reason being, state and federal regulators want the payroll and related taxes, and individuals want to ensure they are paid minimum wage (plus sometimes overtime) and government mandated employee benefits.  The main issue for the IRS and state regulators and courts is the level of CONTROL the hiring entity has over the worker: that the worker is free from the control and direction of the hiring entity in connection with performance of the work.  More and more states are finding that “gig economy” companies (such as Lyft/UBER/Post mates) are employers vs. hiring contractors, such as UBER in the state of NY (vs. Pennsylvania), and even delivery drivers in California have been deemed to be employees in a recent Cal Supreme Court case (Dynamex).

IRS opinions on the matter are a bit dated and grey, but a number of them indicate that the following factors would make instructional teachers, such as music teachers, employees vs. independent contractors: 1.  the work of the instructor is continuous and regular (set hours per week); 2. The school provides instructions to the instructor on scheduling, communicating, billing, and/or curriculum; 3. The school controls the timing and place of the instructions; 4. The instructor is paid hourly vs. lump sum per project; 5.  The invoicing/money flow is controlled by the school vs. instructor; 6. The instructor isn’t regularly/customarily engaged in an independent trade/occupation or business of the same nature as work performed (teaches elsewhere); 7. The worker doesn’t perform work that is outside the work of the usual course of the hiring entity’s biz; and 8.  The hiring entity can fire the worker.

Per the IRS:

An employee is more likely an Employee than an Independent Contractor if the worker:

1. 1. Is required to comply with the employer’s instructions about the work.
2. Receives training from the employer.
3. 3. Provides services that are integrated into the business.
4. Provides services that must be rendered personally.
5. Hires, supervises and pays assistants for the employer.
6. 6. Has a continuing relationship with the employer.
7. Follows set hours of work.
8. Works full-time for the employer.
9. Works on the employer’s premises.
10. Does the work in a sequence set by the employer.
11. Submits regular reports to the employer.
12. Receives payments of regular amounts at set intervals.
13. Receives payments for business or traveling expenses.
14. Relies on the employer to furnish tools and materials.
15. Lacks a major investment in facilities used to perform the service.
16. Cannot make a profit or suffer a loss from the services.
17. Works for one employer at a time.
18. Does not offer services to the general public.
19. 19. Can be fired.
20. Can quit at any time without liability.

 

• Taxes —  Here’s an article on this
• Hiring – Hiring an instructor isn’t as complicated as it seems, in additional to basic payrolling that most music stores have, all you need is a hiring packet with the following best practice tools and agreement:  Offer letter, Employee Handbook, Arbitration Agreement, Confidentiality Agreement, and bsic HR policies.
• Financial –  To properly manage profits it is important that we have control in our pricing and payroll.  Employees offer the greatest control when it comes to managing a profitable lesson studio.

 

Vision and Purpose

• Security
• Culture (who they are…know your people)
• Team (people that are apart of something feel safe…it’s biology)
• Retention (students and teachers)
• Purpose and your Why

Here’s a deeper dive into case studies:

1. IRS INFO – FROM IRS WEBSITE

RE Independent Contractors

People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.

If you are an independent contractor, you are self-employed. To find out what your tax obligations are, visit the Self-Employed Tax Center.

You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.

If an employer-employee relationship exists (regardless of what the relationship is called), you are not an independent contractor and your earnings are generally not subject to Self-Employment Tax.

However, your earnings as an employee may be subject to FICA (Social Security tax and Medicare) and income tax withholding.

RE Employees

Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

Overall Test

Common Law Rules

Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Basic Facts That Are Indicative of An Employee Relationship Per IRS

An employee is more likely an Employee than an Independent Contractor if the worker:

1. 1. Is required to comply with the employer’s instructions about the work.
2. Receives training from the employer.
   3. Provides services that are integrated into the business.
   4. Provides services that must be rendered personally.
   5. Hires, supervises and pays assistants for the employer.
   6. Has a continuing relationship with the employer.
   7. Follows set hours of work.
   8. Works full-time for the employer.
   9. Works on the employer’s premises.
   10. Does the work in a sequence set by the employer.
   11. Submits regular reports to the employer.
   12. Receives payments of regular amounts at set intervals.
   13. Receives payments for business or traveling expenses.
   14. Relies on the employer to furnish tools and materials.
   15. Lacks a major investment in facilities used to perform the service.
   16. Cannot make a profit or suffer a loss from the services.
   17. Works for one employer at a time.
   18. Does not offer services to the general public.
   19. Can be fired.
   20. Can quit at any time without liability.

 

Form SS-8

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF).

 

1. IRS RULINGS ON INSTRUCTORS

Revenue Ruling 70-308 A school retained part time instructors to teach courses for certain occupations in the airline industry. Each of the instructors had work experience in the area of instruction; the courses were scheduled during hours that would not conflict with their regular jobs. The instructors followed the school curriculum and were subject to “periodic observation as to…teaching techniques”. The school could terminate the relationship “if the instructor [did] not follow the curriculum”. There were indications of an independent contractor (an independent business or occupation and termination only if the instructor [did] not follow the curriculum), yet the school retained a significant degree of control. It was the school’s curriculum. The instructor was required to follow the school’s instructions. The instructor was subject to periodic observation. The service determined the instructors to be employees.

Revenue Ruling 70-338 Teachers performed two types of services for a music conservatory: first as instructors of regular classes offered by the conservatory and second as instructors of their own pupils in private lessons. As to the first type of service, it is no surprise that the service determined those teachers to be employees. As to the second, the service discussed the many factors which comprise the relationship between the conservatory and teacher (few of which are typically encountered by the university), concluding that “the conservatory does not exercise, or have the right to exercise, over the teachers in the second group the degree of direction and control necessary to establish an employer-employee relationship under the usual common law rules”. Again, note the emphasis on control.

Revenue Ruling 70-363 A private college hired lawyers from the community to teach law classes as part of the regular curriculum for the school year. The following quote, illustrates a number of the factors previously mentioned: “An important consideration in the determination of the existence of an employer-employee relationship, as distinguished from the status of an independent contractor, is whether the contract for services is made with one engaged in a business distinct and independent of the person contracting for the services. Although the instructors of the law college are outstanding members of the legal profession, the contracts for their services as instructors are with reference to the regular business of the college, and the instructors, in so far as their relationship to the college is concerned, are not engaged in an independent calling. On the contrary, the facts show that the college retains the right to control and direct the instructors and the substitute instructors to an extent sufficient to establish the legal relationship of employer and employee.” Although engaged in a distinct and independent business, the instructors, “in so far as their relationship to the college is concerned, also are engaged in the ‘regular business of the college’”. The Service concludes that the college “retains the right to control and direct instructors”.

PLR 8728022 A college retained an instructor to teach an art class which met each Friday for a three hour period. He was paid a lump sum for his services. He performed similar services “for others with only 25 percent of his professional time spent in service to the college”. He “reported personally to the college or its representative once per week for consultation”. Despite some indications of an independent contractor relationship, the service concluded that the instructor was an employee. “Although the class was part-time employment for the worker, the relationship with the college was continuous in nature…the worker’s services were necessary and incident to the business conducted by the college, and the worker was not engaged in an independent enterprise in which the worker assumed the usual business risks. The worker’s investment in art supplies was not of a substantial nature”. The IRS dismissed the fact that the instructor was engaged in an “independent business” (with only 25 percent of his professional time spent in service to the college), in light of several factors: · His services were integral to the business conducted by the college; · He was thought not to have incurred the “usual business risks” of a bona fide business; · He had little investment in his “business”; and · His service with the college was continuous. The IRS goes on to articulate how little control is necessary to constitute that “degree of direction and control necessary to establish an employer-employee relationship under the common law rules”. It does not take much. “While the college may not have exercised rigid control over how each class was taught, the college of necessity exercised control over the curriculum, the facility, and the scheduling of classes, and the college consulted with the worker weekly regarding the performance of the teaching services”.

PLR 8801019 A dance studio retained instructors to conduct dance classes on a mutually agreed upon schedule for approximately four hours per week. The instructors provided similar services for other dance studios, however this particular dance studio “has priority on the time” agreed upon by the instructor and the studio. The instructors may be terminated “at any time without incurring a liability”. In finding that the instructors are “subject to certain restraints and conditions that are indicative of the firm’s/studio’s control over them,” the IRS points to the following factors: “The instructors render their services personally. They have a continuous relationship with the firm as opposed to a single transaction. Their services are an integral part of the firm’s business. The instructor’s wages are based on an hourly rate. They perform their services at the firm’s studio and are furnished with stereo equipment and records. They do not incur any expenses while teaching their classes for the firm. Either the firm or the instructors may terminate the agreement for services at any time without incurring a liability. These factors indicate the existence of an employer-employee relationship.”

PLR 8925001 Although this ruling addresses various classes of adjunct faculty at a tax-exempt university, the most significant relationship was that of adjunct faculty engaged at the law school. The adjunct faculty were retained under contracts to teach specific courses; the adjuncts practiced or had practiced law as a primary career; payments for services were based on the faculty members’ experience and complexity of the course; payments for services were made in a lump sum at the end of the contract term; no payments were made if the course was canceled due to low enrollment; the contracts required the adjuncts to perform the services personally or obtain a substitute approved by the university; the university could terminate an adjunct faculty member effectively with no further liability to that person; and the adjunct faculty members were subject to evaluation and further approval before their contracts were renewed.  The university’s relationship with adjunct faculty differed significantly from its relationship with regular faculty in ways that arguably pointed toward independent contractor status. Adjunct faculty were hired only for a particular course and term, were compensated by the course in a lump sum, received no fringe benefits, received separate compensation for working with a student on independent study, were not paid for a course canceled for low enrollment, were not provided with offices or other space for course preparation, were subject to only informal student evaluations and did not participate in the academic business of the university. The IRS ruled that the adjunct faculty were employees and maintained that they were subject to certain restraints and conditions indicative of the university’s control over them, regardless of their continuous or temporary relationship with the university.

PLR 8951039 In connection with the state department of motor vehicles and the division of alcohol abuse, an institution of higher learning offered a driving course for persons convicted of driving while under the influence. The institution contracted with instructors and stipulated that they were to be treated as independent contractors. Any instructor could hire substitutes or helpers. The contract stated that institution did not provide staff support, office space or supplies; but in fact the institution did so. The IRS considered the instructors employees of the institution.

PLR 9105007 The IRS applied the common law factors in concluding that part-time instructors at a public community college were employees, not independent contractors. Most of the instructors held other full-time jobs and taught only one course during the semester. The college did not have a main campus; classes were held at various community buildings. The college did not prescribe course content. The instructors were paid a flat amount per course in two lump sum installments. The college could terminate the instructor if he/she breached the conditions of the professional services agreement. However, if the college terminated the instructor without cause, it had to pay him/her for the full semester. Notwithstanding these facts, the IRS relied on other factors in finding the instructors to be employees. The instructors had to meet with a college representative for course planning and had to comply with college rules and regulations. Their services were an integral part of the college’s business and were expected to be provided personally. Courses were taught at regular intervals during the contract period. The college set class schedules, required the instructors to submit attendance reports and furnished copy machines, computers and other equipment needed. The instructors had no investment in facilities and were not compensated based on profit or loss.

Principal Investigators: Revenue Ruling 55-583 The question of employment status also has arisen where professors perform research under grants and hire others to assist them. One case involved a professor employed to teach at a state college and designated by the college to carry out a research project under a foundation grant. The professor continued to draw his salary as a professor and received additional compensation from the grant funds for time spent on research in excess of his regular teaching time. The professor hired and supervised a stenographer who was paid by the college out of the grant funds. The IRS held both to be employees of the college.

Student Aides: PLR 9216021 A private university has internship program where the university’s students perform services as substitute teachers or teacher’s aides. The university receives payment for the student’s services and the students receive paid tuition and fees for books and supplies. The IRS held that the students were the private university’s employees.

Musicians: PLR 9123010 A musician was hired on a concert-by-concert basis by a nonprofit organization. The organization does not train the musician, but instructs and supervises through its orchestra director. The organization requires the musician to be present at rehearsals and concerts on time, and has first call on his services. The musician provides his own instrument and concert attire, Rev. 12/2011 University of Nevada, Reno 7 Controller’s Office and is free to compete and advertise for similar engagements. The IRS ruled that the organization exercises the degree of control indicative of an employer-employee relationship.

Medical: PLR 8937039 Doctors who provided services to patients of a clinic, as assigned by the clinic, in the offices of the clinic on specified days, are employees of the clinic, even though they may maintain private practices and hold themselves out to the public as performing for their own account, the same services provided for the clinic.

PLR 9236004 A professional medical corporation provides emergency room services, engaging workers pursuant to an oral agreement. Workers are engaged to provide services for a specific shift and may be fined if that shift is missed, but they are free to select the shift they prefer. Workers’ services must be performed personally, although they may find a replacement from other workers who perform services for the hospital. The workers are paid weekly for the time worked. All tools, equipment, materials, and supplies are provided by the hospital except for personal hand tools. The IRS rules that the emergency room staffers are employees of the professional medical corporation.

PLR 9041007 A manufacturer of telephone equipment engages nurses to provide care for its employees, to conduct audio and orthorator testing, to maintain medical records, and to perform certain other medical procedures. The nurses work pursuant to contracts which identify them as consultants and independent contractors. The agreements prohibit the hiring of substitutes by the nurses, permit either party to terminate the relationship after two weeks notice without incurring a liability, and require nurses to buy malpractice insurance in stated amounts. The nurses are compensated with an hourly wage with no guarantee of a minimum amount of pay and no fringe benefits. They are permitted to perform similar services for others, but do not advertise or otherwise attempt to do so. They have no financial investment in a business relating to the work they do for the manufacturer. The IRS ruled that the nurses are employees.

 

• California Supreme Court Case – 2018

Dynamex Operations West, Inc. v. Superior Court of Los Angeles County, 2018 Cal. LEXIS 3152 (Cal. Apr. 30, 2018).

Under the new standard, to establish that an individual is in fact an independent contractor, an employer must prove that:

• It does not control how the individual performs the work;
• The individual provides a service that is not part of the employer’s usual business; and
• The individual customarily engages in an established business, trade, or profession that is independent of the employer’s business.

Control-of-Work Test

In expanding the definition of employee, the Supreme Court examined at length, but ultimately deemed as non-exclusive, the nearly 30-year-old analysis established in S. G. Borello & Sons, Inc. v. Department of Industrial Relations, 796 P.2d 399 (Cal. 1989), which it acknowledged was “the seminal California decision on the subject.”

In Borello, the Supreme Court had adopted, in the context of a workers’ compensation claim, the common law “control-of-work” test. The test asks “whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.”  The Court in Borello further identified several non-exclusive factors that inform the analysis, including:

• The right of the employer to discharge the individual without cause;
• Whether the individual is engaged in a distinct occupation or business;
• Whether, in the location at issue, the work is usually done without supervision by the employer;
• The skill required in the particular occupation;
• Whether the employer or the individual supplies the necessary equipment, tools, and place of work;
• The length of time for which the services are to be performed;
• Whether payment is made by the job or by the time spent;
• Whether the work is a part of the employer’s regular business; and
• The apparent intent of the parties as to whether an employer-employee or independent contractor relationship exists.

ABC Test

Noting that the pertinent state wage order (covering matters such as minimum wages, maximum hours, and meal and rest breaks) defines the term “employ” as “to engage, suffer, or permit to work,” the Supreme Court concluded in Dynamex that, in light of the history and remedial purpose of the wage order, the more appropriate analysis for determining whether an employer-employee relationship exists is the “ABC Test” adopted by some other state courts.

 

Under the ABC test, a worker is presumed to be an employee unless the worker:

(A) Is free from the employer’s control and direction;

(B) Performs a service that is either outside the usual course of the business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and

(C) Customarily engages in an independently established trade, occupation, profession, or business.

 

While recognizing the importance of the factors set forth in Borello, the Court concluded that Borello’s highly nuanced, multi-factor test “makes it difficult for both hiring businesses and workers to determine in advance how a particular category of workers will be classified, frequently leaving the ultimate employee or independent contractor determination to a subsequent and often considerably delayed judicial decision.” The result of such circumstances “often leaves both businesses and workers in the dark with respect to basic questions relating to wages and working conditions that arise regularly, on a day-to-day basis.” Moreover, the Court explained, application of a more complex, multi-factor test “affords a hiring business greater opportunity to evade its fundamental responsibilities under a wage and hour law by dividing its work force into disparate categories and varying the working conditions of individual workers within such categories.”  In adopting the simpler ABC test, the Court noted that, by being presumptively classified as employees, workers would have the benefits and protections of the wage order available to them, while companies would be protected against competitors who attempt to save costs by circumventing the wage orders’ obligations.

 

1. Interesting Blogs

http://www.fkco.com/tax_resources/images/seminar%20handouts/NAMM-20-Factor-Test.pdf

http://www.rrubinsoncpa.com/independent-contractor-in-ca/