Pitfalls of temporary employment

Employers can enjoy many benefits from hiring independent contractors and workers from temporary staffing or leasing agencies. They can achieve increased efficiency and flexibility; save money on recruiting, training and payroll; and reap other administrative benefits.

However, to unsuspecting employers, the perceived benefits may be far outweighed by the costs of damages, fines and penalties associated with improperly using or classifying such workers. Employers who think they can avoid tax and employment laws by simply shifting the burden to a third party should think twice. The reality is laws relating to employment-related taxes, wages, discrimination, benefits and other matters may cover these workers, as well.

Have you hired workers from third-party agencies? Have you entered into relationships with independent contractors? If so, you should take a closer look at those relationships to make sure they comply with applicable laws.

The question in each of these arrangements is whether a worker is properly classified as one of your "employees," thus triggering their rights and your obligations under employment laws. More often than not, the answer—surprising to most employers—is "yes."

Independent contractors

A true independent contractor is self-employed and hired by a company or individual to perform specified tasks or projects on a contract or fee basis. The contractor is free to perform work for other companies and is issued a Form 1099 by the company for which he or she works to report the income received, none of which is considered wages or salaries by the Internal Revenue Service (IRS).

Many employers prefer to hire independent contractors to avoid payroll costs, expenses associated with employer-provided benefits, and overhead from having to provide space and equipment to employees. Employers also save on not having to pay for workers' compensation insurance, Social Security and Medicare taxes, and unemployment compensation insurance. Independent contractors also are not covered by the minimum wage and overtime pay requirements of the Fair Labor Standards Act (FLSA).

Therefore, employers who hire true independent contractors are, in most circumstances, not subject to claims for employment discrimination, overtime pay, unemployment insurance, workers' compensation or time off under the Family and Medical Leave Act (FMLA).

However, many employers make the mistake of simply labeling someone an "independent contractor" and drafting an independent contractor agreement as evidence of the relationship. This clearly is not sufficient as many employers have recently discovered. Notably, the IRS and local tax authorities have been cracking down on employers who have misclassified employees as independent contractors, resulting in taxes and penalties that far exceed any benefits employers derived from classifying employees as independent contractors.

As a general rule, a worker is an independent contractor if the company for which the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result. Therefore, looking past the worker's label, all information that provides evidence of the degree of control by and independence from the company must be considered.

Control factors

The IRS has articulated several common law "control" factors you should consider when assessing whether a worker is properly classified as an independent contractor for tax purposes.

The first of these is "behavioral control," which refers to facts that show whether there is a right to direct or control how a worker works. A worker typically is considered an employee when a company has the right to direct:

  • When and where work is done
  • What tools and equipment are used
  • What workers are hired to assist with the work
  • Where supplies and services are purchased
  • What work must be performed by a specified individual
  • What order or sequence is followed when performing the work

Also, training and detailed instructions provided to the worker regarding the performance of his or her duties and regular evaluations of his or her performance further point to an employment, rather than contractual, relationship.

Financial control also should be considered and refers to facts that show whether a company has the right to control the economic aspects of a worker's job.

For instance, an independent contractor typically has a significant investment in the equipment he or she uses when working for someone else. Unlike traditional employees, independent contractors typically are not reimbursed for business expenses. As a result, true independent contractors have the possibility of incurring losses if their expenses exceed their incomes whereas a traditional employee will not face such a situation.

An independent contractor also is generally free to seek other business opportunities rather than being limited to providing services for just one company. Finally, whereas a traditional employee is guaranteed wages for a period of time, independent contractors usually are paid flat fees for the jobs they perform.

The type of relationship also should be considered. For instance, independent contractors typically work under written contracts specifying the relationship's nature. They typically do not receive employee benefits such as insurance, pension plans, paid vacation, sick days and disability insurance. And most independent contractors are hired for specific projects or periods rather than for an indefinite time period, as is typical in a traditional employer-employee relationship. Finally, if a worker provides services that are a key aspect of a company's business, it is more likely the company will have the right to direct and control his or her activities and more likely the worker would be considered a traditional employee.

There is no black-and-white test that makes a worker an employee or independent contractor, and no single factor makes this determination. Also, factors that are relevant in one situation may be irrelevant in another. As the IRS advises, the key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and, finally, document each of the factors used in coming up with the determination.

Proper classification

Following are some things you should consider to maintain a proper independent contractor relationship:

  • Assign the contractor isolated tasks that are unrelated to your company's main function.
  • Give the contractor significant discretion in determining how his or her assigned task is performed.
  • Refrain from training the contractor. The contractor should independently acquire the abilities needed to complete the job.
  • Require the contractor to furnish his or her own tools, equipment and supplies.
  • Permit the contractor to work for other companies while working for you.
  • Do not provide permanent space at your facility to the independent contractor.
  • Avoid compensation that resembles a salary—a flat fee is best.
  • Do not provide any employee benefits to the contractor.
  • Keep the relationship at arm's length; however, do not knowingly permit a contractor to violate any laws.
  • If a contractor or his or her employees violate a law, do not intervene; promptly notify the contractor and ask him or her to handle the matter.
  • Enter into a written agreement that clearly and expressly addresses each of the factors and issues mentioned, and explain the contractor bears the responsibility for reporting income and paying taxes.

If you cannot comply with many of these tips, you may wish to consider re-examining whether you have properly classified someone as an independent contractor.

Although there are numerous other tests to determine independent contractor status for purposes of federal and state employment-related laws, most tests will incorporate many of the control factors articulated by the IRS in assessing such relationships.

For instance, though some courts rely on similar common law control factors, others have examined a relationship's "economic realities" to determine whether a worker should be covered by employment-related laws.

The economic realities test also examines the degree of control the company exercises, extent of the relative investments of the worker and company, degree to which the worker's opportunity for profit or loss is determined by the company, skill and initiative required to perform the job, permanency of the relationship, and whether the service rendered is an integral part of the alleged employer's business.

What does this mean for you? Beyond the potentially significant tax liability from misclassifying an employee as an independent contractor, you could be subject to claims for age, disability, race or gender discrimination or other employment discrimination based on some other legally protected characteristic.

In addition, you could be subject to claims for benefits by a misclassified contractor, and if you offer benefits to a properly classified contractor, your benefit plans could lose their tax qualifications because you have covered a nonemployee. Worse yet, you could face a claim for unpaid overtime wages, which will be difficult to defend because you likely will not have kept any records of the number of hours a contractor worked.

Far too many employers treat this classification too lightly—this is truly one area in which you can never be too diligent.

Temporary employees

Usually, temporary employees are placed with a company by a temporary staffing agency that recruits, employs and pays them. More employers are turning to staffing agencies to avoid the costs associated with recruiting and training employees and processing and administering payroll and benefits.

Leased employees, on the other hand, are employed by a professional employer organization or another employment leasing agency and then are leased to client companies looking for workers. In the case of leased employees, the agency becomes the employer of record and assumes responsibility for wages, payroll taxes and other administrative benefits typically administered by a company's human resources department. In essence, the client company outsources its entire human resources and benefits administration functions to the professional employer organization.

The joint employer doctrine

Unlike independent contractors, temporary and leased employees often are under the client company's direction and control despite being hired and paid by the temporary staffing or leasing agency. Often, there is no way to avoid this fact. But there are a number of things you can do to make sure you and the agency have reached an understanding regarding who will assume responsibility for each duty owed to temporary or leased employees.

This is particularly important because a temporary or leased employee may be considered an employee of both the client company and agency if certain factors demonstrate a "joint employer relationship" exists.

According to the joint employer doctrine, the client company and agency can be held jointly liable for each other's workplace law violations though they exercise little or no influence or control over each other.

The test used to determine whether a joint employer relationship exists varies from court to court and case to case. Numerous factors typically are considered, including, for instance:

  • Whether there is an arrangement between the employers to share employee services, such as by interchanging employees
  • Whether one employer acts directly or indirectly in the interest of the other employer in relation to employees
  • Whether the employers share control of employees
  • Whether there is common management of employees

No single factor is controlling, and courts typically look at the "economic realities" of the work relationship rather than follow common law rules to determine whether a joint employment relationship exists. Understanding how joint employer status works under various labor and employment laws is critical if you are using temporary or leased employees.

Your responsibilities

If you are deemed a joint employer, you are affected in various ways. For example, both you and the agency are obligated to provide reasonable accommodations to qualified individuals with disabilities under the Americans with Disabilities Act.

You and the agency also may be liable for complying with workers' compensation laws. Be sure to specify in your contract that the agency is responsible for providing workers' compensation insurance.

In addition, both you and the agency may be liable for unlawful discriminatory or harassing conduct for your conduct (or that of your agents) and for the agency's conduct if you knew or should have known about the unlawful conduct and did nothing about it.

The agency is responsible for inspecting employment eligibility under federal immigration laws; however, if you know of unauthorized workers and do nothing about it, you also could be held responsible.

You could be liable under FLSA for overtime wages the agency fails to pay even though you are not responsible for paying the temporary employees.

Both you and the agency could be liable for obligations under FMLA. Having temporary or leased employees complicates seemingly straightforward FMLA requirements. FMLA regulations state only the "primary" employer is responsible for providing FMLA notice and benefits. The primary employer, which is typically the agency, is the one with the authority to hire and fire, assign, pay and provide benefits. However, the U.S. Department of Labor's regulations specifically state two or more companies may be joint employers for purposes of FMLA liability if each exercises some control over an employee's working conditions.

Although a number of responsibilities and obligations owed to temporary or leased employees indeed belong to their agency, do not assume the agency is fulfilling them. Be sure to seek express written assurances from the agency that it is complying with applicable laws, and consider incorporating broad indemnification language in your contract to protect your interests in the event a temporary or leased employee files a claim.

Also, make sure the agency is a responsible company by checking public records for employment-related lawsuits, judgments or regulatory actions against the agency and see whether there are any liens for unpaid taxes, penalties or judgments.

And for safe measure, to the extent avoiding a joint employment relationship is feasible, consider the following tips when dealing with an agency and its temporary or leased employees:

  • Do not direct or control the temporary or leased employees; the agency should retain that exclusive right.
  • Have the agency provide an on-site supervisor to oversee the temporary employees' work.
  • Do not directly negotiate temporary or leased employees' wages or time off. Rather, work through the staffing agency.
  • Do not routinely include temporary or leased employees in employee functions, perks or facilities intended for traditional employees only.
  • Limit the duration of temporary employees' assignments to within your company.
  • Do not give temporary or leased employees company business cards or employee badges.
  • Do not directly terminate a temporary or leased employee. Contact the agency and ask it to handle any disciplinary issues.
  • Before you enter into a contract with a temporary staffing or leasing agency, review the agency's anti-discrimination and harassment policy and complaint procedure.
  • Verify compliance with laws relating to payroll taxes, income taxes and immigration laws.
  • Verify the agency conducts criminal background checks before assigning an employee to work.
  • Include a clause in the contract that permits you to terminate the relationship if the agency violates the law.
  • Include a clause in the contract that disclaims company control of the temporary employees and the existence of a joint employment relationship (though such a disclaimer alone will not protect you).
  • Impose the obligation to indemnify and defend so the agency must pay damages and your legal costs stemming from the agency's noncompliance.
  • Conduct internal audits of agency contracts to ensure contracts properly define your relationship with the agency and each party's responsibilities.

Finally, once you have finalized the details with an agency, make sure employees know how to administer their relationship with the agency. Developing a written procedure for handling temporary or leased employees can help.

For example, it is important not to let your managers discuss and handle discrimination or harassment issues; if they learn of inappropriate conduct, they should notify your company's human resources representative and the agency for resolution. You also may need to review and revise your own employee handbook to ensure policies are reworded to expressly apply to or exclude, where appropriate, your temporary and leased employees.

Be vigilant

The benefits of hiring independent contractors and employees from temporary staffing or leasing agencies are plenty. By being vigilant and taking certain precautions, you can minimize or avoid the liability that would otherwise plague an unsuspecting employer.

When in doubt regarding your liability toward a temporary or leased employee, it is best to seek the advice of professional counsel.

Nineveh Alkhas is an associate and Jason C. Kim is a partner in the labor and employment practice group of the Chicago-based law firm Neal, Gerber & Eisenberg LLP.

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