Employee or independent contractor?

Real Estate Weekly, March 10, 2004 by Paul Salvatore, John F. Fullerton, III

One question we are often asked in our practice is whether a particular individual working for a company should, as a legal matter, be treated as an employee or an independent contractor.

The question arises with equal frequency regarding real estate agents, and there have been numerous legal decisions on the issue.

The consequences of mischaracterizing agents can be quite onerous for a brokerage, in terms of overtime compensation and other benefits that might be owed to employees unlawfully categorized as independent contractors, and income, unemployment insurance and social security taxes that might be owed to the government.

Under the common law standard, the essence of the distinction between an employee and an independent contractor is the degree of control the employer exercises over the manner and means in which the individual performs his or her duties.

Some very important aspects of the analysis, however, are fairly obvious and unrelated to the work itself: is the individual paid for certain periods of time or on a periodic basis?

Does the individual receive benefits that other employees receive, e.g., vacation, personal leave, health, pension, business/travel expenses? Are income taxes, FICA and state unemployment insurance withheld? Can the employer discharge the individual, and/or can the individual quit, before the project is completed? If the answer to these questions is yes, the person is more likely an employee.

In several recent court decisions, however, real estate agents were found to be independent contractors rather than employees based on a number of important factors. The agents in one case from Pennsylvania worked their own hours, were not required to be present in the office, did not receive formal performance evaluations, covered certain costs such as special advertising and licensing fees, paid their own taxes and insurance, and worked strictly on a commission basis.

In another case in Massachusetts, the agent received only commissions, had no taxes withheld, did not receive any fringe benefits, paid her own licensing fees, and worked independently, by setting her own hours and developing her own sales leads.

No single factor in these cases was determinative, nor is there a threshold number of factors which, if satisfied, renders an individual an independent contractor. Instead, the courts weigh various factors and render a determination based on the "totality of the circumstances."

Under the Fair Labor Standards Act, however, which governs minimum wage/maximum hour issues, an even broader interpretation of the term "employee" is used. An "economic reality test" is applied to determine that status.

The most important factor in that test is whether the individual is in fact in business for him- or herself, or instead, is economically dependent upon the company.

Is there an assumption of "entrepreneurial opportunity" for profit and risk of loss by the individual? Many independent contractors, for example, achieve greater profits in their business the faster they can complete each project.

If there is no entrepreneurial aspect and the individual is economically dependent on the company, the individual is more likely an employee.

Paul Salvatore is a partner at Proskauer Rose LLP John F. Fullerton III is a senior associate. This article does not, and is not intended to, constitute legal advice. Readers are advised not to take, or refrain from taking, any action based on this article without consulting legal counsel.