Ban The Label "Freelancer": Avoiding The Pitfalls Of Improperly Classifying Your Workforce


Companies today often designate a portion of their workforce as "freelancers", as part of their efforts to create a flexible workforce and reduce costs. In fact, however, the word "freelancer" has no legal meaning, and even its "ordinary" meaning is up for debate. If employment lawyers have our way, the word "freelancer" will forever be banned, and replaced by one of two legally recognized designations of workers: employees and independent contractors. Within the "employees" category, there may be regular full-time employees, regular part-time employees, temporary employees, and/or leased employees. Independent contractors are not employees at all, but persons in business for themselves who provide services for a client-company. To help alert employers to factors relevant to workforce classification, and the importance of getting it right, this article will clarify the common and legal meanings of the categories of workers comprising a typical company's workforce – "regular full-time," "regular part-time," "temporary," "leased," and "independent contractors" – and will summarize the legal and practical effects of the different categories.

REGULAR FULL TIME EMPLOYEES

For most companies, "regular full-time" employees comprise the bulk of the workforce. This is the "traditional" or "common law" employee. While there is no precise legal definition of a regular full-time employee – this is the "default" category, so that unless an employee meets the criteria for a leased employee or independent contractor as described below, he or she is a "regular" employee – typically, regular full-time employees are scheduled to work at least 30 hours per week, and are eligible for coverage under the company's group health insurance and other benefit policies. All standard tax withholdings and deductions are taken from these employees' paychecks. (e.g., federal, state and local taxes, FICA, unemployment, and social security). Moreover, a multitude of employment laws – anti-discrimination, wage and family and medical leave laws, to name a few – govern an employer's relationship with its regular full-time employees.

REGULAR PART TIME EMPLOYEES

As this term is commonly understood, part time employees are those who are regularly scheduled to work less than 30 hours per week (though companies can define "part-time" to mean even fewer hours, as do some employment-related laws). Regular part-time employees' wages are subject to the same withholdings and deductions as those of regular full-time employees. While entitlement to benefits is governed by the terms of a company's benefit plans in the first instance, part-time employees often work too few hours to be covered by group health insurance and other benefit plans. However, be aware that, even though part-time employees are not typically eligible for coverage, employees who work 1000 hours or more in a 12-month period may be eligible for certain pension benefits (e.g., 401(k) benefits) under federal law. Moreover, certain state benefit laws, like the New York Disability Benefit Law, cover part-time employees.

TEMPORARY EMPLOYEES

Employers typically use the term "temporary employees" to mean all workers hired for short-term assignments. However, this term commonly refers to two sub-categories of short-term employees with very different legal positions – those employed by the company, and those employed by an outside agency, properly known as "leased employees."

Temporary employees who are employed by the company are typically hired for a specific project, with the understanding that the employer expects the employment relationship to end when the project ends. Companies often misclassify these employees as "independent contractors" or "freelancers" because of the anticipated short duration of their employment, but, unless they meet the criteria for "independent contractors" set out below, they must be treated like regular full-time or part-time employees with respect to wages and benefits. Like part-time employees, if they work 1000 hours or more in a year, they may become entitled to benefits. The only real difference between a temporary employee and a regular full-time or part-time employee is that the temporary employee is advised when hired that he or she cannot expect his or her employment to last beyond a particular time or event. Employers should be careful when hiring temporary employees to advise them that they are not guaranteed a job for the life of the project, i.e., they are employees at will.

LEASED EMPLOYEES

Often, companies hire personnel through leasing agencies whose business is to place individuals at companies. Leased employees may be leased for short or long-term positions. Those who are leased for short-term assignments (e.g., to fill in for an employee who is on leave), are often referred to as "temporary" employees. But leased employees can also fulfill a company's long-term needs. For instance, a company may lease a team of individuals to staff its mailroom or technical support function on an ongoing basis.

The key difference between leased employees and regular employees is that leased employees are employees of the leasing agency. Be aware, however, that the company where they perform their work (the "client-company") might be deemed a "joint employer" with the leasing agency under the gamut of workplace laws. To help avoid this result, the client-company should have the leasing agency take actions regarding the leased employee's employment status (e.g., training, disciplining, transferring, dismissing) whenever possible. Typically, these responsibilities are delineated by a contract between the client-company and the leasing agency. However, even the most cautious client-company cannot prevent the leased employee from naming it as a joint employer in a work-related lawsuit. Therefore, as a further safeguard, companies should negotiate a contract with the leasing agency that specifically addresses the consequences of legal action by a leased employee and, most importantly, obtain an indemnification provision from the leasing agency.

INDEPENDENT CONTRACTORS

This is perhaps the most misused, misunderstood category of a company's workforce, and getting it wrong can open a company to significant liability. Though there are many "tests" used by the courts to determine who is an independent contractor, the Department of Labor, the IRS, and other government agencies, each attempt to zero in on one key aspect: whether the purported "contractor" is really in business for him or herself, or whether the person is dependent on the employer for his or her livelihood. New York Courts focus primarily on the degree of control exerted by the alleged employer over the results produced and the means used to produce those results. Some of the other factors considered by the courts and government agencies include: the worker's opportunity for profit or loss; the worker's investment in the business (i.e., did the worker purchase equipment, or did the company provide it?); the permanence of the working relationship; the degree of skill required to perform the work; the extent to which services rendered are an integral part of the employer's business; and the degree of initiative, judgment and foresight exercised by the individual who performs the services.

The consequences of miscategorizing employees as independent contractors can be significant. True independent contractors are paid like any vendor, without withholding taxes, unemployment insurance, benefits, etc. At year-end, independent contractors will receive a 1099 tax form, not a W-2. Thus, if an employee is misclassified, the employer may be responsible for paying back wages for overtime pay with interest, social security taxes, unemployment insurance, the value of group health and other benefits, taxes and workers' compensation for a miscategorized employee. Inevitably, the employee will seek liquidated damages and penalties under New York's Wage Payment Law. Criminal penalties are even available under the same statute. Finally, as was the case in seminal Microsoft decision, for companies who grant employees stock options, improperly classified independent contractors could seek the value of stock options they should have received. This could result in significant liability.

Thus, it is critical to analyze the true nature of your company's relationship with so-called "independent contractors." Do not take comfort in the fact that a worker agrees to be or even wants to be or insists on being an "independent contractor." Unfortunately, if the relationship sours – or if the government audits – the worker may turn against the company, and his or her earlier agreement will not prevail over the realities of the working relationship. Given the risks involved and the multitude of working arrangements, each situation should be reviewed carefully on an individual basis.