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Employee or Independent Contractor?

By Erik Schimmelbusch

Retail employers often face the question of whether certain workers should be classified as employees or independent contractors for income tax reporting and withholding purposes. This article briefly discusses the considerations that apply to worker classification under federal income tax law.

The status of a worker, either as an employee or independent contractor, must be determined with reference to the degree of control exerted over that worker by the person paying him or her. Generally, an employment relationship exists when a person for whom services are performed has the right to control and direct the individual who performs the services, both as to the result to be achieved and also as to the details and means by which that result is achieved. An employee is subject to the will and control of the employer, not only as to what should be done, but how it should be done. Note that under the Internal Revenue Code, certain categories of workers are classified as “statutory employees” or “statutory non-employees” for federal tax purposes regardless of how they would otherwise be classified under the traditional concepts (e.g., certain individuals who work at home, certain traveling sales people, direct sellers). A detailed discussion of statutory/nonstatutory employees is beyond the scope of this article. More information regarding the statutory classification of these workers is contained in IRS Publication 15-A.

The IRS has published 20 factors that it will consider in determining whether a worker should be classified as an employee or an independent contractor. No single factor is determinative. In certain situations, certain factors may not apply. Following is a summary of the 20 factors:

Instructions. A worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee.
Training. Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods indicates that the person for whom the services are performed wants the services performed in a particular method or manner.
Integration. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control.
Services Rendered Personally. If the services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.
Hiring, Supervising and Paying Assistants. If the person for whom the services are performed hires, supervises, and pays assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor suggests an independent contractor status.
Continuing Relationship. A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists.
Set Hours of Work. The establishment of set hours of work by the person or persons for whom the services are performed is a factor suggesting control.
Full Time Required. If the worker must devote substantially full time to the business of the person for whom the services are performed, such person has control over the amount of time the worker spends working and impliedly restricts the worker from doing other gainful work. An independent contractor on the other hand, is free to work when and for whom he or she chooses.
Doing Work on Employer’s Premises. If the work is performed on the premises of the person for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises of the person receiving the services, such as at the office of the worker, indicates some freedom from control.
Order or Sequence Set. If a worker must perform services in the order or sequence set by the person for whom the services are performed, that factor shows the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the person for whom the services are performed.
Oral or Written Reports. A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control.
Payment by Hour, Week, Month. Payment by the hour, week, or month generally points to an employer-employee relationship, provided this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates the worker is an independent contractor.
Payment of Business and/or Traveling Expenses. If the person for whom the services are performed ordinarily pays the worker's business and/or traveling expenses, the worker is ordinarily an employee.
Furnishing of Tools and Materials. The fact that the person for whom the services are performed furnishes significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.
Significant Investment. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship.
Realization of Profit or Loss. A worker who can realize a profit or suffer a loss as a result of the worker's services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee.
Working for More Than One Firm at a Time. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.
Making Service Available to General Public. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
Right to Discharge. The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
Right to Terminate. If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship.

Note that these are only factors that the IRS will consider in determining whether a worker should be classified as an employee or independent contractor. The determination is based on all of the facts and circumstances, so it may not be possible to know with certainty how a worker should be classified. Nevertheless, the above factors can be helpful to an employer in determining what position to take with respect to tax reporting and withholding.

Please note also that different standards will often apply for state income tax purposes, so it is possible for a worker to be classified in one category for federal tax purposes and in a different category for state law purposes. This can impact such areas as tax reporting, withholding and payment and workers’ compensation compliance.

If you have questions regarding the classification of particular workers for federal and state tax purposes, you should contact your legal and/or tax advisor.

Proposed Changes to FLSA “White Collar” Exemptions

By Jenna Mooney and Tahl Tyson

This spring, the Department of Labor (DOL) published proposed controversial regulations that include changes to both the salary test and duties test which must be satisfied in order to exempt employees from the minimum wage and overtime requirements of the Fair Labor Standards Act (FLSA).¹ However, it is now very uncertain whether these proposed regulations will be enacted: in an amendment to the appropriations bill for the Department of Labor proposed by Senator Harkin (D-Iowa), the Senate cancelled funding for the rule-making process, which would effectively kill the proposed changes. The Senate bill now must be reconciled with the House bill which allowed the rule-making process to continue. President Bush has threatened to veto the final appropriations bill if it contains the Harkin amendment, and the Senate vote on the Harkin amendment was not sufficient to override a presidential veto.

Even if the proposed federal regulations are ultimately passed, there is no guarantee that state regulations on exemptions would change in a manner consistent with federal law. Thus far, Alaska, Washington, Oregon and California do not have plans to change their regulations.² These states intend to “wait and see” what happens at the federal level, and will then consider changing the regulations at the state level. Therefore, employers should continue to monitor and consider both state and federal law when evaluating the exempt status of their employees. Here is an explanation of the proposed regulations, and how they would differ from the current rules.

New Salary Proposals

Minimum Salary Level Increased. The DOL, recognizing the current minimum salary requirements are outdated, proposes to dramatically raise the minimum salary to qualify for an exempt status to $425 a week or $22,100 a year. It also eliminates the “long test” requirement that prohibits exempt employees from spending more than 20 percent of their time on non-exempt work.

Changes to the Salary Test. The proposed regulations expand the allowable disciplinary deductions. Rather than limiting disciplinary deductions to those resulting from infractions of safety rules of major significance, the employer would now be allowed to make pay deductions for other full day disciplinary suspensions. For example, an employer would be permitted to suspend an exempt employee without pay for reasons such as sexual harassment or workplace violence.

The proposed regulations also clarify the circumstances and extent to which an improper deduction causes an employee or groups of employees to become nonexempt. Under the proposed rule, an exemption would be lost only if there is a pattern and practice of improper deductions, and then only for employees in the same job classification and working for the same manager who is responsible for the improper pay docking decision or policy. In addition, the proposed rule would create a new “safe harbor” provision: If an employer has a written policy prohibiting improper pay deductions, notifies employees of that policy and reimburses employees for any improper deductions, then that employer would not lose the exemption for any employees unless the employer’s policy is repeatedly and willfully violated.

Highly Compensated Employees. Highly paid employees, defined as those who are paid $65,000 or more annually, would not have to meet all the elements of the standard duties tests (described below) to qualify for exemption if they perform non-manual work and if they have at least one identifiable executive, administrative or professional function. For example, a highly paid employee who supervises two workers but does not participate in any hiring or termination decisions in the company would still be exempt because the employee has a function that is identifiable as an executive function. The employer can include any commissions, non-discretionary bonuses or other non-discretionary compensation in arriving at the $65,000 required compensation. If an employee falls slightly short of the required $65,000 annual compensation at the end of the year, the proposed regulation allows the employer to elect to make a one-time supplemental payment to the employee to meet the required compensation level.

Changes to the Duties Test
The proposed regulations not only modify the salary test, but also change the current “duties tests.” Essentially, the proposed rule eliminates the “long” and “short” tests and replaces them with a single test for each exemption.

The Executive Exemption. In addition to earning $425 per week, the proposed rules still require the primary duty to be management of the enterprise or recognized department or subdivision of the enterprise with customary and regular direction of the work of two or more other employees. The proposed rules add the requirement that the employee have the authority to hire or fire other employees or have particular weight given to suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees.

The new regulations add a significant new section for retailers. One difficult issue for retailers has always been the fact that supervisors in retail establishments frequently have both exempt supervisory duties and non-exempt duties. Under this new rule, a retail supervisor can maintain exempt status even though the employee performs tasks such as serving customers, cooking food, stocking shelves, and cleaning the establishment, if the manager’s (or assistant manager’s) primary duties include activities like scheduling employees, assigning work, overseeing product quality, ordering merchandise, managing inventory, handling customer complaints, authorizing payment of bills or performing other management functions. Moreover, the proposed regulation explains that a retail supervisor may be an exempt executive even though the assistant manager spends the majority of the time on non-exempt work.

The Administrative Exemption. Under the proposed regulation, employees would qualify for the administrative exemption if, in addition to earning $425 per week, they: (a) have a primary duty of performing office or non-manual work related to the management or general business operations of the employer or the employer’s customer; and (b) hold a position of responsibility with the employer. The proposed rule provides an illustrative list of the types of work that meet the exemption, including: tax, finance, accounting, auditing, quality control, purchasing, procurement, advertising, marketing, research, safety and health, personnel management, human resources, employee benefits, labor relations, public relations, government relations and similar activities. The most substantial change here is the replacement of the “discretion and independent judgment” test, with a new test that employees must hold a “position of responsibility.” The proposed regulations define a “position of responsibility” involving either work of substantial importance or work requiring a high level of skill or training.

Exempt Professional Employee. The proposed regulations require that the employee, in addition to earning $425 per week, have the primary duty of performing work requiring: (1) knowledge of an advanced type in a field of science or learning customarily acquired by prolonged course of specialized intellectual instruction, but which may also be acquired by alternative means such as an equivalent combination of intellectual instruction and work experience; or (2) invention, imagination, originality or talent in a recognized field of artistic or creative endeavor. The proposed regulations would add a requirement that the employee’s primary duties involve office or non-manual work, but would eliminate the requirement that the exempt employee exercise consistent discretion and independent judgment.

Computer Employee Exemption. The proposed regulation deletes the requirement that the employee consistently exercise discretion and independent judgment. The minimum hourly rate of $27.63 remains the same.

The Outside Sales Exemption. The proposed rule eliminates the 20 percent non-exempt work limitations and substitutes a primary duties test. An employee under the new regulation is exempt as an outside salesperson if their (1) primary duty is to make sales, obtain orders or contracts for services or use of facilities; and (2) the employee customarily and regularly engages away from the employer’s place of business while performing such duties.

Conclusion

If the Harkin amendment is ultimately removed from the appropriations bill, either in committee, or by presidential veto, and the regulations are issued, employers are cautioned that they will still need to comply with requirements of both state and federal law, and it is unclear which, if any, states will follow the DOL’s lead in making these changes. For example, if an employee would be exempt under federal but not state law, the employer must follow state law and pay any applicable overtime to the employee.

FOOTNOTES

1 Under the current requirements for exempt status, employees must be paid on a salary basis and either (i) earn at least $155 per week (executive or administrative exemption) or at least $170 per week (professional exemption) and meet the “long test” requirements which sharply restricts the amount of time employees can spend on non-exempt duties; or (ii) earn at least $250 and meet the “short test” requirements for exempt work.
2 There is currently a bill in the Alaska legislature to change the exemption requirements; however, the bill does not mirror the federal changes and has yet to be adopted.

How to Handle Social Security No-Match Letters

By Christopher R. Helm

Each year, the Social Security Administration (SSA) sends thousands of letters to employers, including some restaurant employers, across the country listing the names and Social Security Numbers (SSNs) of employees whose SSNs do not match their names on the earnings records of the SSA. Some restaurant employers are wondering whether they should terminate the listed employee as an illegal alien. Please keep in mind that the purpose of the so-called “no-match” letter is to properly credit earnings records for future benefits, not to identify illegal aliens. Here are some practical tips about how to respond to an SSA no-match letter, as well as general advice about compliance with I-9 employment eligibility verification rules.

You should not assume or conclude that a listed employee is an illegal alien simply because he or she is listed in a no-match letter. Discrepancies can arise from transcription or typographical errors and name changes. You may violate state or federal law if you take adverse action against an employee based solely on the SSN no-match letter.
You should notify each employee who is listed in a no-match letter and ask him or her to verify his or her SSN, contact SSA to resolve the discrepancy, and notify you of the outcome.
If the employee admits that he or she submitted a false Social Security card in connection with the I-9 employment eligibility form, and if he or she cannot submit valid employment authorization documents as required by form I-9, then you cannot continue to employ such person without being subject to fines and penalties for knowingly continuing the employment of an illegal alien. In such case, termination of the employee is appropriate.
During the I-9 employment verification process, you may (but are not required to) make copies of any documents submitted by an employee as evidence of identification or employment authorization for future reference. Be consistent and follow the same policy for all employees.
You should not ask a new hire to submit extra documents beyond that which are required by form I-9. The new hire is free to choose which of the listed documents to submit.
Be sure that the I-9 form is completed within three business days of hire. If the individual’s employment authorization is temporary, be sure to re-verify his or her employment authorization prior to the expiration date of the document submitted at the time of hire.
It may be advisable to conduct an internal audit of your company’s I-9 files from time to time, rather than waiting until a government audit is requested. Normally you will be given three days notice prior to a government inspection of your I-9 records.

You should consult with your employment or immigration lawyer* if you have any questions about how to respond to an SSN no-match letter, or if you have any other questions about the I-9 employment eligibility verification process.

For additional information, contact the SSA via its website at www.ssa.gov/employer, or call
1-800-772-6270 (7am to 7pm, EST, M-F). Also see IRS Pub. 393 “Federal Employment Tax Forms” and SSA Pub. 31-011, “Software Specifications and Edits for Annual Wage Reporting.” IRS Pub. 15, Circular E, “Employer’s Tax Guide” contains instructions for recording employees’ names and SSNs.

*Contacts at Davis Wright Tremaine LLP: Portland, Jim Mei (jimmei@dwt.com; (503) 241-2300). Seattle, Chris Helm (chrishelm@dwt.com; (206) 622-3150); Rich Rawson (richrawson @dwt.com; (206) 622-3150).

Businesses’ Rights with Regard to Video Surveillance Tapes
By Jeni Lassell and Jim Neill

Video surveillance is becoming increasingly useful to protect businesses from theft and vandalism as the technology becomes cheaper and more versatile. While video surveillance is usually a helpful tool for retail outlets and restaurants, in certain situations it can be problematic.

For example, what if a customer accused an employee of spying on her in the dressing room? Obviously, such behavior would have to be stopped, but would evidence of the employee spying on customers on a video surveillance tape implicate the store itself? What if a fight occurred at a restaurant and the injured party accused an employee of over serving the instigator of the fight? Could a video surveillance tape from that night implicate liability for the employee and the restaurant?

As video surveillance becomes more prevalent, restaurants and retail outlets need to be aware of their rights in regard to videotapes. With knowledge regarding the rights to video surveillance tapes, employers can cooperate with authorities and protect their businesses.

First, it is not necessary for a business to turn over a video surveillance tape to the police, unless they have a warrant. A business may deny requests by the police to turn over tapes and refuse to give consent to a search of the premises. Furthermore, unless a warrant has been issued for a videotape, businesses may destroy or record over videotapes if it is part of a routine procedure. Once a warrant has been issued for the video surveillance tapes, they must be turned over to the police; however, a business should insist on making a copy of the tape before turning it over. If a business does not retain a copy of the videotape, they should petition the authorities to be able to view the videotape after it has been seized and obtain a copy.

On the other hand, a restaurant licensed by the Oregon Liquor Control Commission (OLCC) cannot prevent warrantless searches by the OLCC. Even without a warrant, the OLCC is entitled to examine a licensee’s books after giving 72 hours notice, and may at any time examine the premises in order to ensure that the licensee is in compliance with the statutes and rules regulating licensed premises. The OLCC may examine all enclosed areas at the location, including offices, kitchens and store rooms. Moreover, the search is not limited to public areas and could include any area which holds video surveillance equipment and videotapes. The police do not have this same authority to conduct warrantless searches, even if they are investigating violations of OLCC regulations.

Furthermore, once the licensee knows that a video surveillance tape might contain footage of a potential violation of OLCC regulations, the licensee can not destroy the videotape or refuse to turn over the videotape to the OLCC. Once again, a copy of the tape should be demanded before turning it over to the OLCC.

Finally, both the OLCC and the police can subpoena a video surveillance tape. If authorities violated search and seizure protections, a business may petition for the return of the video surveillance tape.

As stated, video surveillance is here to stay. Know your rights and be careful!

This Retail & Restaurant Advisory is a publication of the Retail & Restaurant Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in retail & restaurant law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

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