Classifying employees: You can’t judge drivers by their title or contract alone

By Lisa D. Cooper

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The trucking industry relies heavily on owner-operators, and, more often than not, companies classify them as independent contractors. While that is not necessarily improper depending on the facts, some companies mistakenly assume that a driver qualifies as an independent contractor merely because he is an owner-operator under contract and an IRS Form 1099 is used. The determination of whether an owner-operator is an independent contractor or employee is actually a very fact-specific inquiry, and no one particular fact controls. Because the risks associated with misclassification can be very costly, carriers should carefully evaluate the exact nature of the relationship as well as their contracts with owner-operators.

Independent Contractor Tests

There are several tests used to evaluate independent contractor status. And while the tests share common factors, each test places emphasis on different factors. The oldest test for independent contractor status is the “common law” test which focuses on the degree of control the employer has over the worker. Under the common law, if the company has significant control over the manner and means by which the worker accomplishes the work, the worker is an employee. The degree of control, however, is just one of the factors that must be considered when classifying owner-operators.

For example, the Internal Revenue Service (IRS) 20-Factor Test focuses on the degree of control exerted over the worker but utilizes twenty different factors to do so. This test addresses these factors:

1. Instructions. Workers who are required to comply with others’ instructions about when, where, and how they are to work are ordinarily employees.
2. Training. Training workers indicates that employers exercise control over the means by which results are accomplished.
3. Integration. When the success of a business depends on the performance of certain services, the workers performing those services are subject to a certain amount of control by the owners of the businesses.
4. Services rendered personally. If services must be rendered personally, employers control both the means and the results of the work.
5. Hiring, supervising, and paying assistants. Control is exercised if employers hire, supervise, and pay assistants.
6. Continuous relationships. Continuing relationships between workers and employers indicate that employer-employee relationships exist.
7. Set hours of work. The establishment of set hours of work by employers indicates control.
8. Full-time required. If workers must devote their full time to employers’ businesses, employers have control over workers’ time. Independent contractors are free to work when and for whom they choose.
9. Doing work on employers’ premises. Control is indicated if the work is performed on employers’ premises.
10. Order or sequences set. Control is indicated if workers are not free to choose their own patterns of work but must perform services in the sequences set by the employers.
11. Oral or written reports. Control is indicated if workers must submit regular oral or written reports to employers.
12. Payment by hour, week, or month. This points to employer-employee relationships, provided that this method of payment is not just a convenient way of paying a lump sum agreed on as the cost of a job. Independent contractors are usually paid by the job or on straight commission.
13. Payment of business and/or traveling expense. Employers paying workers’ expenses of this nature shows that employer-employee relationships usually exist.
14. Furnishing tools and materials. If employers furnish significant tools, materials, and other equipment, employer-employee relationships usually exist.
15. Significant investments. Workers are independent contractors if they invest in facilities that are not typically maintained by employees. Employees depend on employers for such facilities.
16. Realization of profits or losses. Workers who can realize profits or losses (in addition to profits or losses ordinarily realized by employees) are independent contractors. Workers who cannot are generally employees.
17. Working for more than one firm at a time. If workers perform services for a number of unrelated firms at the same time, they are usually independent contractors.
18. Making services available to the general public. Workers are usually independent contractors if they make their services available to the general public on a regular and consistent basis.
19. Right to discharge. The right of employers to discharge workers indicates that the workers are employees.
20. Right to terminate. Workers are employees if they have the right to end their relationships with their principals at any time without incurring liability.

More recently, the IRS has grouped these twenty factors into three primary categories: behavioral control, financial control, and the nature of relationship. With regard to behavioral control, the IRS considers the type and degree of instructions given to the worker, the training provided, and how the employer evaluates work performance. The more a carrier provides instruction about how, when and where the work is performed, the more likely the driver is an employee as opposed to a contractor. Ongoing training and evaluation or feedback about how the work is performed also weighs in favor of the employer-employee relationship. Under this test, a contractor also needs to have financial investment in the relationship such as owning his own tools, equipment, etc., and he should generally be responsible for his own expenses without reimbursement from the employer. The contractor should also be paid on a per-trip or flat-fee basis and not by-the-hour like a regular employee. Finally, the IRS looks closely at whether the work performed is a “key activity” of the company and whether there is permanency to the relationship. The long-term nature of the relationship can tip the scales in favor of finding the employer-employee relationship.

The broadest test is what is known as the “economic realities” test under the Fair Labor Standards Act (FLSA). Under the FLSA, an employee is any worker who is “suffered or permitted” to work for an employer. The FLSA test balances six different factors to determine whether or not a driver is an independent contractor or an employee, including: (1) the degree of control the company has over the driver; (2) the relative investment of facilities or equipment by the respective parties; (3) the driver’s opportunity for profit and loss; (4) the permanency of the parties’ relationship; (5) the skill required by the position; and (6) whether the driver’s services are integral to the company’s business.

In July 2015, the Department of Labor (DOL) issued a comprehensive administrative interpretative guidance embracing the economic realities test and explicitly stating that, in its view, “most workers are employees.”  Under the economic realities test, the focus is on “whether the worker is economically dependent on the employer or truly in business for him or herself.”  The guidance further emphasizes that a worker is most likely an employee if he or she performs work which is integral to the business of the employer. The DOL specifically downplayed the significance of an existing contract classifying the worker as an independent contractor. Similarly, the IRS and Alabama courts oftentimes look past the contract language altogether to evaluate the underlying nature of the relationship. See e.g., Jenkins v. Am. Transp., Inc., 195 So. 3d 996, 1001 (Ala. Civ. App. 2015) (“The designation of an individual as an independent contractor in a contract is not necessarily controlling with respect to the issue whether that individual is an independent contractor.”).

The DOL’s shift to the economic realities test is somewhat problematic for the trucking industry, because a stable owner-operator model requires some permanency to be workable.  In addition, the services provided by drivers are clearly integral to the trucking business. Companies are also reluctant to allow owner-operators to drive for other companies while under contract. However, the more financially dependent the owner-operator is on the carrier, the more likely he or she will qualify as an employee not an independent contractor.

The 2015 administrative guidance is tangible evidence of the DOL’s push in recent years to pursue what it views to be the widespread misclassification of workers. In fact, the DOL and IRS (and their state counterparts) have specifically targeted certain industries, including the trucking and transportation industry, in their enforcement efforts. The DOL’s wage and hour division has been actively pursuing enforcement through memorandums of understanding with a number of states, including Alabama, in order to refer cases and share information. While it is possible that the Trump administration will scale back enforcement activities, the industry should continue to carefully evaluate its driving workforce because of the potential consequences of misclassification.

The Risks of Misclassification

There are numerous advantages of using owner-operators as contractors such as the avoidance of taxes and insurance obligations. However, the penalties for misclassification can be significant. A company which misclassifies an employee as an independent contractor may be liable for back wages and overtime pay, back taxes, workers’ compensation, and unemployment compensation obligations. For a longtime misclassified owner-operator, that would mean repayment of years of unpaid federal, state, and local tax withholdings, Social Security and Medicare contributions (FICA), and unemployment insurance premiums including federal unemployment taxes under FUTA. In addition, both the DOL and IRS impose interest and hefty penalties for misclassification.

The Affordable Care Act (ACA) is another area of significant exposure. In many instances, compliance with the ACA depends on the number of full-time employees on the payroll. For example, the ACA’s employer mandate provides that large companies, i.e., employers with at least 50 full-time employees, must offer health coverage and failure to do so results in considerable financial penalties. Thus, if an owner-operator is misclassified and ultimately determined to be an employee, a company could be facing a claim regarding the failure to provide coverage to the driver as well as a financial penalty.

Tips for Proper Classification

The transportation industry clearly is under increasing pressure to ensure the proper classifications of independent contractors and employees. Therefore, carriers must evaluate each owner-operator relationship with these principles in mind and classify accordingly and/or reclassify, if necessary. Suffice to say, a driver is not necessarily an independent contractor just because he is an owner-operator and/or under contract.

A company seeking to maintain independent contractor status for its owner-operators must ensure the owner-operator has economic independence from the company. For example, to properly classify a driver as a contractor, a carrier should not demand that the contract or the relationship be exclusive. A true independent contractor should have ability to work for other companies at his discretion. In fact, the exclusive and long-term nature of the relationship with an owner-operator weighs heavily in favor of finding the driver to be an employee by the DOL or the equivalent state agency. In the same vein, the driver should have the ability to hire his own employees as well as the ability to reject or accept a load in order to be genuinely independent.

Likewise, an owner-operator should be responsible for his own operation costs, e.g., maintenance, repair, fuel, and licensing, etc. The contractor should also be required to obtain liability and workers’ compensation insurance, and the company’s contract should require that these certificates of insurance be provided.

Even under the economic realities test, the degree of control is still important. The company should avoid controlling the manner and means by which the driver performs his work. For example, while a company can set a general work schedule, it should not dictate driving routes or how the driver secures his load. The company should not require that owner-operators leave their trucks at the company yard so other drivers can use them; otherwise the company is exerting the type of control normally associated with employee status.

The manner in which the driver is paid is also important. Employees are paid hourly while contractors are generally paid on a per trip or load basis. Notably, if the pay rate is subject to some negotiation, the more likely the driver will be found to be a contractor. Companies should also resist the urge to treat owner-operators like employees in other areas as well. For example, performance evaluations, uniforms, and the like should be reserved for employees not independent contractors.

Finally, a written independent contractor agreement specifically outlining all the terms of the relationship should be in place that reflects the relationship that actually exists. The DOL, the IRS, and a court will always look beyond the contract to determine if the day-to-day reality of the relationship reveals an employment relationship.

Lisa D. Cooper, Esq. is a partner with the law firm of Hand Arendall’s labor and employment and litigation practice groups. She concentrates her practice in all aspects of employment law representing management in matters including employment discrimination charges and cases, harassment, retaliation, wage and hour, Family and Medical Leave Act, OFCCP or Department of Labor audits, misappropriation of trade secrets and confidential information, unfair competition, labor-management disputes, contract disputes, defamation and all employment-related torts. She may be reached at ldcooper@handarendall.com.