by: David G. Jensen, former Staff Attorney
The Therapist
(November/December 2004)

---

In recent years it has become more and more fashionable for organizations, including private practices, nonprofit agencies, and professional counseling corporations, to use independent contractors, as opposed to employees, to provide counseling services to their clients. This strategy appears attractive for organizations because it allows them to lower, oftentimes substantially, their personnel costs. But, the trend could backfire against an organization and end up costing it more money, much more money, in the end. Why? A government agency, such as the Internal Revenue Service or the Employment Development Department, may determine that the worker should have been classified as an employee and not as an independent contractor. If an organization classifies someone as an independent contractor, and a government agency determines that the person really should have been classified as an employee, the organization may be assessed fines, penalties, interest, and unpaid taxes. When you add attorney fees to the mix, the grand total of this bill will be onerous and likely to exceed what the organization would have paid had it hired the person as an employee. Moreover, the person in the organization responsible for making the misclassification may be subject to personal liability and criminal penalties.¹ When dealing with independent contractor issues, the legal current is swift and dangerous and organizations can be swimming in deep legal water before they know it. I am not so sure, however, that organizations utilizing independent contractors appreciate the magnitude of this danger.

My suspicion, after reviewing some "Independent Contractor Agreements" submitted by members of CAMFT is that many organizations are currently running afoul of federal and state laws concerning the classification of independent contractors. They are violating these laws by classifying individuals as independent contractors when the individuals are really being controlled as employees. In terms of the organization's fiscal health, this is dangerous. Consequently, it is very important for all concerned to understand the fundamental concepts pertaining to independent contractors. What makes someone an independent contractor? What can independent contractors do? How is an independent contractor different from an employee?

It is also important to have access to a knowledgeable attorney who can review your particular situation and draft an appropriate independent contractor agreement. In the next issue of The Therapist, we will publish a model independent contractor agreement that can be used as a starting point for these issues, but this model agreement should be analyzed and modified in light of your organization's particular circumstances. But, in terms of classifying workers as employees or independent contractors, we think you should understand the following three things.

Don't Retain an Independent Contractor Just Because It Seems Easier To Do Than Hiring An Employee
The decision to retain an independent contractor or to hire an employee is a decision that must be made in light of the particular circumstances of the organization involved. What is good for one organization is not necessarily good for another. And, there are both advantages and disadvantages to retaining independent contractors. Of course, there are also advantages and disadvantages to hiring employees. The key idea here is that there is no "free lunch" or easy solution to these issues. The prudent organization makes a determination about retaining an independent contractor or hiring an employee after carefully considering the advantages and disadvantages of choosing one option over another. For instance, one legal commentator believes that there are at least nine potential advantages to retaining independent contractors, eight of which may be applicable to organizations utilizing therapists:

1. Cost savings from mandated contributions for state unemployment taxes, Social Security, and federal unemployment taxes.
2. Cost savings from discretionary fringe benefits such as medical insurance, vacation leave, sick time and pregnancy leave, and retirement benefits.
3. The organization can choose whether to provide workers' compensation coverage.
4. Inapplicability of labor laws concerning employees.
5. Reduced risk of discrimination claims.
6. Minimized potential for wrongful termination actions and unemployment benefit claims.
7. Greater flexibility to enter new lines of business. (This is highly unlikely to occur in a private practice, nonprofit organization, or professional counseling corporation).
8. Highly specialized personnel available on a contract basis.
9. Savings of administrative time and expenses.²

Such commentator also believes that there are at least five disadvantages to retaining independent contractors:

1. Loss of control.
2. Cannot terminate the independent contractor without cause.
3. Need to monitor the legality of the relationship.
4. Loss of continuity and ongoing relationship.
5. Organization, not the independent contractor, bears the risk of misclassification.³

Again, for clarity's sake, we cannot stress enough that the decision to retain an individual as an independent contractor versus hiring that individual as an employee is one that needs to be made after much analysis. Do not retain someone as an independent contractor just because it seems easier to do than hiring that person as an employee, or just because another organization has retained an individual as an independent contractor.

The Classification Of An Individual As An Independent Contractor Is A Decision That Could Be Reviewed By A Host Of Federal & State Government Agencies
There are many federal and state government agencies that could be interested in the question of whether a worker is an employee or an independent contractor. For instance, at the federal level, the Internal Revenue Service may be interested in back taxes; the National Labor Relations Board may be interested in possible violations of the National Labor Relations Act; the Equal Opportunity Employment Commission may be interested in possible violations of discrimination laws.

At the state level, the Employment Development Department may be interested in violations of unemployment insurance or disability insurance laws; the Department of Industrial Relations, through its workers' compensation and labor standards divisions may be interested in violations of workers' compensation laws or wage and hour laws. The bottom line is that one or more of these government agencies could review your organization's policies, procedures, and practices with a fine-tooth comb to determine whether the worker is an employee or an independent contractor.

How likely is it that your organization would be subject to review? I wish I had a crystal ball, but I don't so there is no way of predicting how likely or unlikely such an event is of occurring. It has been our experience though that trouble in the form of complaints to government agencies can come to a practice from many directions: disgruntled ex-clients; disgruntled ex-employees; even "friends" and "colleagues." Another likely scenario is this: client sues independent contractor for malpractice but the independent contractor does not have malpractice insurance or enough malpractice insurance. Client's attorney will want to examine the nature of the relationship between the organization and the worker to determine if the worker is an employee or independent contractor because if the attorney can convince a judge or a jury that the worker was really an employee and not an independent contractor, the attorney can then tap into the employer's malpractice insurance.

Moreover, from time to time, government agencies may even target specific industries to examine. For instance, according to the Economic Development Department, it is currently focusing its investigative efforts on couriers. In the past, the IRS has investigated physicians and nurses. It is not out of the realm of possibility for a particular government agency to decide to investigate psychotherapists.

The Title "Independent Contractor" Is Basically Useless
Labeling someone an independent contractor does not automatically make that person an independent contractor. Moreover, the intent of the parties is also irrelevant to a determination of whether someone is or is not an independent contractor.⁴ The ultimate determination about whether someone is or is not an independent contractor will be the result of analyzing how much control the organization has over the person. Does the organization control the manner and means of accomplishing the desired result? If the organization has too much control over the person, the person will likely be classified as an employee; if the organization has minimal control over the person, the person will likely be classified as an independent contractor. Employers exercise their control of employees in many ways. For instance, they assign employees specific duties and responsibilities; they establish start and stop times for work, breaks, and lunch; they provide equipment and supplies so that employees can complete their assignments; they require employees to attend meetings; they discipline employees through suspensions; and they can terminate the employment relationship at will, with or without cause.

Independent contractors, on the other hand, are individuals who have contracted with an organization to provide certain services for that organization. If the person is truly an independent contractor, then that person, and not the organization, determines the manner and means of accomplishing the desired result. The organization cannot establish the independent contractor's start and stop times for work, breaks, or lunch because that evidences control over the individual, which would make that person an employee. The organization cannot provide the independent contractor with equipment or supplies because that evidences control over the individual, which, again, would make that person an employee. The organization cannot suspend the independent contractor because that evidences control over the person, which, again, would make that person an employee. The organization cannot require the independent contractor to attend training sessions and meetings because that evidences control over the worker, which, again, would make that person an employee. And, the organization cannot terminate the independent contractor at the will of the organization because that evidences control over the person, which, again, would make that person an employee.

This does not mean that the services of independent contractors cannot be terminated. They can; it just means that the termination of the services has to be done in accordance with the terms and conditions of the independent contractor agreement. The services of independent contractors can usually be terminated for breaching a provision of the independent contractor agreement or by conveying the notice required by the agreement to the other party. But, what if there is no agreement? The absence of a written agreement is a big problem for a couple of reasons. One, the written agreement serves to govern the relationship between the organization and the independent contractor. Two, the absence of a written agreement is compelling evidence for the creation of an employer-employee relationship. The government believes that independent contractors enter into contracts with organizations.

By now it should be clear that the issue of whether someone is or is not an independent contractor hinges on the amount of control that the organization exercises over the person. The concept of control is fundamental to resolving these issues. But, how is control measured or assessed by the courts and government agencies?

This is where the law governing independent contractors gets as muddied as a dirt road after a torrential rainstorm. Unfortunately, there is not just one test for determining control. Different government agencies utilize different tests for determining control. For instance, at the state government level, the Employment Development Department utilizes the California common law test, but the Department of Industrial Relations for workers compensation and wage and hour cases utilizes a test set forth in S.G. Borello & Sons, Inc. v. Department of Indus. Relations (1989) 48 C3d 341.

At the federal government level, the Internal Revenue Service utilizes the 20 common-law factor test, while the Equal Employment Opportunity Commission utilizes an "economic realities" test. Courts and administrative agencies may even utilize a "smell test" to ferret out whether someone is or is not an independent contractor. Other government agencies utilize still other tests, but the tests set forth above appear to be the most common ones used. Although there is some overlap among these tests, a prudent practitioner should have a working knowledge of each of them. These tests are summarized as follows.

The IRS Twenty Common-Law Factor Test
In Revenue Ruling 87-41, the Internal Revenue Service set forth 20 factors that indicate whether sufficient control is present to establish an employer-employee relationship. The importance of these factors will vary depending on the occupation of the person involved and the factual context in which the services are rendered. No one factor is determinative. The 20 factors and the accompanying analysis is taken from the IRS Training Manual on Worker Classification:

1. Instructions. If a worker is required to follow instructions about when, where, and how he or she is to perform the service, the worker is ordinarily an employee and not an independent contractor.
2. Training. If a worker is required to be accompanied by an experienced employee or required to attend meetings and trainings, the worker is ordinarily an employee and not an independent contractor.
3. Integration. If the worker's services are integrated into the organizations business operations, this generally shows direction and control, which would tend to make the worker an employee and not an independent contractor.
4. Services Rendered Personally. If the worker must render the services personally, the organization is presumably interested in the methods and results, which tends to evidence employee status.
5. Hiring, Supervising, and Paying Assistants. If the worker hires, supervises, and pays assistants, this fact tends to indicate independent contractor status.
6. Continuing Relationship. If the worker has a continuing relationship with an organization, this tends to indicate an employer-employee relationship.
7. Set Hours of Work. If the worker's hours are set by the organization, this evidences control of the worker and employee status.
8. Full-Time Requirement. If the worker is required by the organization to work full time, the organization impliedly restricts the worker from engaging in other gainful employment. The IRS believes that this implied restriction makes the worker an employee because the organization has control over the amount of time that the worker works. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
9. Doing Work on Organization's Premises. If the work is to be performed on the organization's premises, this factor suggests a finding that the worker is an employee; conversely, if the work is performed offsite, this suggests that the worker is an independent contractor.
10. Order Or Sequence Set By Organization. If the worker must perform services in the order or sequence established by the organization, the worker is not free to set his or her own schedule, which evidences control of the worker by the organization and employee status.
11. Oral Or Written Reports. If the worker is required to submit written reports to the organization, control, and hence employment status, is indicated.
12. Payment By Hour, Week, Or Month. If the worker is paid by the hour, week, or month this tends to point towards the formation of an employer-employee relationship.
13. Payment Of Business Or Travel Expenses. If the organization pays for the worker's business or travel expenses, the worker is most likely an employee.
14. Furnishing Of Tools & Materials. If the organization furnishes the worker with tools and materials, an employer-employee relationship is probably established.
15. Significant Investment In The Organization's Facilities. If the worker invests in facilities that he or she uses, i.e., rent for an office at fair market value, that factor tends to indicate independent contractor status. However, if the worker utilizes an office provided by the organization, the worker is dependent upon the organization and the employer-employee relationship is probably created.
16. Realization Of Profit & Loss. If the worker can realize a profit or suffer a loss as a result of his or her services, the worker is typically an independent contractor.
17. Working For More Than One Firm At A Time. If the worker performs similar services for more than one organization, the worker is most likely an independent contractor.
18. Making Services Available to the General Public. If the worker makes his or her services available to the general public on a regular and consistent basis, the worker is most likely an independent contractor.
19. Right To Discharge. If the organization can fire the worker, with or without cause, the worker is an employee; if the services of the worker can be terminated for breaching a term or condition of the independent contractor agreement, the worker is most likely an independent contractor.
20. Right To Terminate The Relationship. If the worker can end his or her relationship with the organization at any time without incurring any liability, an employer-employee relationship has been established.

The Borello Test
The Borello test is essentially a hybrid of some of the other tests. It reaffirms the idea that the right to control the details of how the work is performed is a critical factor in determining whether a worker is an independent contractor or an employee. But Borello also emphasizes that the common law factors of agency, which factors essentially duplicate the IRS's list of factors, and the "economic realities" of the situation must also be incorporated into the analysis. Borello strives to take into account the facts and circumstances of each particular case. Borello is typically used in workers' compensation cases.

The Economic Realities Test
This test also looks at whether the organization controls the means and manner of the worker's performance. The economic realities test also takes into account some of the factors that the IRS's 20 factor test takes into account, but the economic realities test also looks at the kind of occupation involved, whether annual leave is afforded; whether the worker accumulates retirement benefits; and, whether the worker is an integral part of the organization's business.⁵

The Smell Test
In addition to the tests set forth above, courts or administrative agencies may also apply a "smell test" to determine independent contractor status. This test takes into account the totality of the circumstances. The court or agency involved will assess whether the parties have acted as though they have had an independent contractor relationship. The key factors seem to be: the language of the parties used to describe the relationship; whether the worker received any benefits that the organization provides; whether the organization filed 1099s for the workers; and, whether the workers filed estimated tax returns.

Conclusions
It should be pretty clear, from reviewing these tests, that the issue of whether a worker is an independent contractor or an employee is fairly complicated stuff. But, the financial and legal ramifications of getting these issues wrong are potentially dire. These are issues that we want you to get right to avoid such consequences. We do not want you or the organization you work for to be in a position where you have to justify yourselves to a court or government agency later. We want you to be proactive and to plan ahead. Along this line of thought, there are a couple of things that you can do to help get these issues right. Talk with a lawyer who specializes in business planning and have that attorney draft a comprehensive independent contractor agreement that takes into account your particular circumstances. You can also file form SS-8 with the IRS to have the IRS make the determination about whether the worker is an employee or independent contractor. If you file, or if your organization files, the SS-8 form, or if you or your organization have filed such form before, CAMFT would appreciate hearing how these issues were resolved by the IRS. This information would be useful in helping us advise the profession about using licensees as independent contractors.

 

---

David Jensen, J.D., is CAMFT's General Counsel. David is available to answer member calls regarding business, legal, and ethical issues. Check with your local chapter to see when he will be presenting Best Practices: Legal and Ethical Issues in your area.

 

---

REFERENCES

1. IRC Sections 7203 and 6672
2. Chinski, Arthur, "Independent Contractors," p. 143, Advising California Employers, Second Edition, California Continuing Education of the Bar (2004)
3.Chinski, p. 143
4.S.G. Borello & Sons Inc. v. Department of Indus. Relations (1989) 48 C3d 341; Santa Cruz Transportation, Inc. v. Unemployment Ins. Appeals Bd. (1991) 235 CA3d 1363, 1371; and, Kowalski v. Shell Oil Co. (1979) 23 C3d 168, 176 Spirides v. Reinhardt (DC Cir 1979) 613 F2d 826, 832; see also Real v. Driscoll Strawberry Assoc., Inc. (9th Cir 1979) 603 F 2d 748, 754

 

---

This article appeared in the November/December 2004 issue of The Therapist, the publication of the California Association of Marriage and Family Therapists, headquartered in San Diego, California. The information contained in this article is intended to provide guidelines for addressing difficult business and legal dilemmas. It is not intended to address every situation that could possibly arise, nor is it intended to be a substitute for independent advice or consultation. When using such information as a guide, be aware that laws, regulations, and technical standards change over time, and thus one should verify and update any references or information contained herein.