Strippers, contractors and employee misclassification

In July 2015, about 120 exotic dancers filed a lawsuit against Christie’s Cabaret, a Phoenix strip club, alleging a variety of unfair labor practices. The suit came on the heels of a $6 million settlement achieved by 4,000 dancers in a similar lawsuit filed in Florida.

At the root of both suits – and other lawsuits filed in several states around the country – is the allegation that clubs illegally classified the dancers as independent contractors, rather than employees, in order to avoid expenses associated with overtime, minimum wage, FICA, unemployment compensation, health insurance, workers’ compensation, sick time, vacation time and other costs and benefits required under the Fair Labor Standards Act (FLSA) and other federal and state laws.

That may sound all too familiar to contractors. Since the FLSA’s passage before World War II, the construction industry – far more than the strip club industry – has consistently attracted U.S. Department of Labor (DOL) scrutiny for dubious employment practices that include employee misclassification (i.e., treating as an independent contractor a worker who should be treated and paid as an employee), abuses of piece work payment, and other violations.

THE SIGNIFICANCE OF WORKER CLASSIFICATION

If a business classifies a worker as an employee, it must pay taxes for Social Security, Medicare, unemployment and payroll. The business must also comply with a whole slew of federal, state and local rules and regulations. And with every additional employee, the business increases its headcount for purposes of complying with the Affordable Care Act (ACA or “Obamacare”), thereby potentially increasing health insurance costs and reporting requirements. The impact of all this is that each employee can cost a business a substantial amount of time and money every year.

However, if a worker is classified as an independent contractor, the business does not have to worry about complying with these burdensome and expensive rules and regulations. Moreover, businesses do not have to provide independent contractors with health insurance, retirement plans, paid vacation and other costly fringe benefits. Thus, there is great incentive to classify workers as independent contractors. The biggest downside is that employers have less control over their day-to-day activities.

EMPLOYEE VS. INDEPENDENT CONTRACTOR: BASIC DISTINCTIONS

To determine whether a worker is an employee or an independent contractor, over the years the DOL and Internal Revenue Service have generally relied on three categories of “control and independence” rules:

• Behavioral. Does the company control or have the right to control what the worker does and how the worker does his or her job?

• Financial. Are the business aspects of the worker’s job controlled by the payer? How is the worker paid? Are expenses reimbursed? Who provides tools, supplies, vehicles, etc.?

• Type of Relationship. Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue? Is the work performed a key aspect of the business?
  

However, as FLSA violations continued to mount, and employers became more creative in dodging the classification rules , the factors described above have proven to be inadequate in ensuring proper classification and payment of employees.

At the very least, an independent contractor relationship is substantiated by an independent contractor agreement between the contractor and the company using his or her services, along with the issuance of a W-9 form by the contractor to the company. However, as strip club operators are learning, the existence of an independent contractor agreement is not a cure-all.

The fact that the worker has signed an agreement stating that he or she is an independent contractor is not the final say, because the reality of the working relationship is far more important than the label given to the relationship in an agreement. In addition, the fact that the worker has incorporated a business or is licensed by a government agency has little bearing on determining the existence of an employment relationship.

If you enter into an independent contractor agreement, include terminology and provisions that affirm the independence of the worker. For example, refer to the worker as a “contractor”; acknowledge that the contractor is free to perform services for other companies; avoid requiring full-time hours or daily presence at the company or job site; make payments due when a project (or a phase of the project) is completed; include a contract expiration date and renewal/extension provision; specify what expenses will be reimbursed and the terms of reimbursement.

ECONOMIC REALITIES TEST

Even if you use an independent contractor agreement, the DOL’s Wage and Hour Division’s new guidance, in connection with an “economic realities test,” could have a big impact on differentiating between employees and independent contractors.

The DOL has stated that “the goal of the economic realities test is to determine whether a worker is economically dependent on the employer (and is therefore an employee) or is really in business for him or herself (and is therefore an independent contractor).” [Emphasis added.]

According to the DOL, the following factors are generally considered when determining whether, under the FLSA, a worker is an employee as opposed to an independent contractor:

• Whether the work is an integral part of the employer’s business. If a worker’s work is integral to the employer’s business, he or she is more likely to be economically dependent on the employer and less likely to be in business for himself or herself. Work is probably integral to the employer’s business if it is a part of its production process or is a service that the employer is in business to provide.

• Whether the worker has a managerial role. This factor focuses on whether the worker has a managerial role, for example, of hiring and supervision of workers, whether the workers managerial skill affects his or her opportunity to advance in the company.

• The relative investments in facilities and equipment by the worker and the employer. To be classified as an independent contractor, the worker must make some investment compared to the employer’s investment (and bear some risk for a loss). That may include investment in tools and equipment, so long as a worker’s investment compares favorably enough to the employer’s that they appear to be sharing risk of loss.

• The worker’s independence and initiative. Both employees and independent contractors may be skilled workers. The DOL focuses on whether the worker’s skills demonstrate that he or she exercises independent business judgment, and whether he or she has personally invested in training, education or development of skills. The fact that a worker is in open market competition with others would also suggest independent contractor status.

• Whether the employer/worker relationship is permanent. A permanent relationship with the employer suggests that the worker is an employee. However, the lack of permanence does not necessarily mean independent contractor status, because the impermanent relationship may be due to industry-specific factors, or the fact that an employer uses staffing agencies.

• The employer’s level of control over the worker. This factor focuses on who sets compensation and hours, who determines how the work is performed, and whether the worker is free to work for others and hire helpers. This is a complex analysis that requires careful review, because the employer may have little control in certain situations involving both employees and independent contractors. In those instances, the DOL will look to who has meaningful, substantial control over various aspects of the working relationship. Thus, a worker can be found to be an employee even if the employer exercises less day-to-day control over the worker. Note that this factor does not hold any greater weight than the other factors.
  

BEWARE FORM SS-8 AND THE DISGRUNTED FORMER WORKER

The IRS allows both businesses and workers to file a Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” The filing of an SS-8 will trigger the IRS to issue its opinion on whether the worker is an employee or an independent contractor – and can alert the IRS to any classification problems your business may have. Not surprisingly, disgruntled former workers often file the form in conjunction with a claim that their employer improperly classified him or her as an independent contractor to avoid paying benefits and taxes. If the IRS believes that your business has classification issues, it may initiate an official audit. Thus, if a former worker files a Form SS-8, it is best for businesses to contact their tax and legal advisors before responding to the IRS.

CONCLUSION

According to a recent statement by the DOL, its Wage and Hour Division “continues to receive numerous complaints from workers alleging misclassification, and the Department continues to bring successful enforcement actions against employers who misclassify workers." As detailed above, there are myriad reasons businesses prefer to classify workers as independent contractors, even if it means less control over a worker's day-to-day activities. But employers must be careful not to misclassify their employees. The DOL is cracking down on improper classification, especially as it tries to stamp out attempts to dodge insurance obligations under the ACA.

If caught misclassifying employees, your company could wind up owing unpaid taxes and employee benefits, and could be assessed significant penalties. Thus, it is best to keep in mind the DOL’s own economic realities test when deciding whether your workers are employees or independent contractors. Doing so will go a long way to ensure that your company stays out of the DOL’s crosshairs.