As noted in the preceding blog post on this site (see below), Congress has now introduced in this session of Congress two bills seeking to crack down on misclassification of employees as independend contractors: the Employee Misclassification Prevention Act (EMPA) and the Fair Playing Field Act of 2010.  Although those  two bills, if enacted, would dramatically change the landscape of federal IC legislation, neither should end the use of legitimate independent contractors.  Rather, businesses would be able to continue to use ICs provided that the legal tests are satisfied for independent contractor status under federal and state laws.  This blog post discusses the ways  by which businesses can enhance their compliance with existing and proposed IC laws, including two alternatives to the costly and often unacceptable alternative of reclassifying independent contractors as employees.

Two Additional Compliance Options for Employers, Using IC Diagnostics™

For businesses using independent contractors, and especially companies that are highly reliant on independent contractors, there are a number of alternative means to enhance compliance with the tests used to determine independent contractor status. While the proposed legislation in Congress is likely to cause many businesses to wonder if they should immediately reclassify some or all of their independent contractors, companies can take at least two other measures to minimize or avoid the risk of future liability: bona fide restructuring of the relationship between a company and its independent contractors, and use of an employee leasing or staffing firm to employ the workers directly.

Where bona fide restructuring is feasible, the business need not discard its independent contractor business model. Using  a process such as IC Diagnostics™, a business can determine the extent that restructuring of the independent contractors’ positions will minimize or avoid future misclassification liability. IC Diagnostics refers to a process starting with an examination of whether the position in question would pass the applicable independent contractor tests under governing state and federal laws, using each of more than 48 factors used by different decision-making bodies in determining independent contractor status.

With the exception of a few state laws, most tests used by the courts and administrative bodies are based in whole or part on whether the hiring party has the “right to control the manner and means” by which the worker accomplishes the end product of his or her work. For companies interested in maintaining their use of independent contractors but eager to minimize or avoid future misclassification liability, the first step in restructuring their independent contractor relationships is to consider what adjustments they are prepared to make to their present level of control over the manner and means by which their independent contractors accomplish their work.

At the end of the IC Diagnostics process, the company’s degree of compliance with each of the applicable laws can be measured on an IC Compliance Scale.™ This process can provide a company with an informed means by which to determine the extent that the restructuring alternative may minimize or eliminate future misclassification liability. If IC Diagnostics indicate that the bona fide restructuring option is a sound choice, the business can memorialize its bona fide restructuring in a modified independent contractor agreement. Businesses must ensure that the independent contractor agreement will actually be implemented in the field and is not merely an empty recital of policy, which the law disregards.

Companies also may review and revise company operating manuals and procedures, document the implementation of certain of the provisions in the independent contractor agreement, and institute safeguards to ensure that actual business practices conform to the terms of the modified independent contractor agreement. If, however, IC Diagnostics suggest that, even with restructuring, the workers will not likely pass the governing tests for determining independent contractor status when measured on the IC Compliance Scale, the business has at least two other alternatives to avoid or minimize future risks of misclassification liability.

Employee leasing or other staffing alternatives can reduce the risk of misclassification liability. When an employee leasing or staffing organization hires some or all of a company’s independent contractors as their employees, the leasing company withholds income taxes, makes Medicare and Social Security contributions, pays workers’ compensation and unemployment insurance premiums, provides an array of benefits to the former independent contractors, including health insurance under a plan maintained by the leasing company, and handles the employee relations of the leased employees.

Although use of an employee leasing or staffing company can substantially lessen the risk of future misclassification liability if all legal documentation and procedures are carefully observed, it is by no means a panacea. For example, a business that contracts with an employee leasing or staffing organization may still need to account for the leased employees in the employer’s benefit plans’ language and perform “nondiscrimination” testing required under the Employee Retirement Income Security Act (ERISA).

If the Fair Playing Field Act and/or EMPA are enacted as expected, companies will be obligated to notify all independent contractors that they have the right to a governmental determination as to whether they have been properly classified as an independent contractor. Voluntary reclassification is likely to be far less painful and costly than being forced by a government agency or court to reclassify in connection with an order to make payment of back taxes, unpaid Social Security and Medicare contributions, and unpaid unemployment insurance and workers’ compensation premiums.

Reclassification requires businesses to consider relevant federal and state tax, employee-benefits and employment laws, and can be labor-intensive if done properly. Reclassification does not, however, require that all workers previously excluded from an employee benefit plan be included in the future. Exclusions are permissible if the governing documentation for the company’s plans is drafted properly and the exclusion does not violate applicable tax or ERISA rules.

If and when enacted, the Fair Playing Field Act and EMPA would constitute a two-pronged federal legislative scheme to curtail misclassification.  In view of the current legislative landscape, inaction may be the only unacceptable alternative.


Written by Richard Reibstein.