Employee or Independent Contractor: Keep Your Agency Out of Trouble

You’ve picked the perfect candidate and you are confident they will accept the job. You know what you can afford to pay. Should this new hire be paid as a W-2 employee or as a 1099 independent contractor? Many employers prefer to use independent contractors since the employer is not:

1. Subject to minimum wage or overtime requirements.
2. Subject to most employment-related tax withholdings, such as Social Security, Medicare, federal and state income tax.
3. Obligated to provide benefits.
4. Subject to federal or state unemployment taxes.

Even if you and the individual both want the relationship to be that of independent contractor, and even if you have an agreement stating this, it’s not enough. It’s the actual characteristics of the relationship that will determine the status if, and when, you go to court.  The distinction between a true employee/employer relationship and that with an independent contractor is not always clear.

The key difference is control. In an employer/employee arrangement, the employer has control. With an independent contractor, the independent contractor has control. There is still more to the story than control. You really need to apply an economic realities test.

According to the U.S. Supreme Court, the “economic realities” test includes six broad considerations:

1. The extent to which the work performed is an integral part of the hiring entity’s business
2. Whether the worker’s managerial skills affect his or her opportunity for profit and loss
3. The relative investments in facilities and equipment by the worker and the hiring entity
4. The permanency of the relationship
5. The nature and degree of control by the employer
6. The worker’s skill and initiative

Most independent contractors in insurance agencies are producers. So, let’s apply some of these tests to an insurance agency producer.

1. Selling insurance on behalf of the agency IS an integral part of the agency’s business.
2. The Producer IS NOT managing revenues and expenses.
3. The agency IS providing facilities (office space, carrier access, etc.) and equipment (computer, cell phone, etc.) in many cases.
4. The relationship IS expected to be long term.
5. The agency usually tells the producer that the producer can ONLY write business through the agency.
6. The level of a producer’s skill and initiative will vary greatly from one producer to the next.

If the answers to all of the above considerations indicates that the employer has no control, you can probably safely assume that the individual is an independent contractor. Conversely, if the employer has complete control, the individual is definitely an employer. But what if the answers fall somewhere in between?  This gray area can be subject to interpretation, and it is strongly recommended you discuss your situation with an employment law attorney.

In most situations, producers should be classified as employees. Remember that the responsibility for correctly classifying a position falls on the employer. In one of the largest misclassification settlements ever, FedEx paid $228 million to resolve a case with delivery drivers who FedEx claimed were independent contractors. Even if your agency has an EPLI policy, it doesn’t cover wage and hour charges such as misclassification of employees. 

The Department of Labor can act on an employee’s behalf through an administrative process or litigation, and seek back wages and an equal amount in liquidated damages and penalties. An employee, who was misclassified, can also opt to file a private lawsuit to recover these funds. While these penalties represent the consequences under the Fair Labor Standards Act, you may also have to deal with the IRS and your state Department of Revenue.

It’s critical for employers to educate themselves on this topic. Whether the misclassification is intentional or not, the financial penalties can put an agency out of business. In the long-run, it’s probably less expensive to pay someone as an employee rather than potentially having to pay a large amount in back taxes, penalties and legal costs.

Agency owners have historically looked at the bottom line.  If you adjust the commission rate paid to the producer to factor in taxes and benefits, the net amount paid out by the agency should be the same.

For more information, contact your Certified Public Accountant, Employment Law Attorney, and/or visit www.irs.gov.