Employee Benefit Plans - The Importance of Classifying Individuals Properly
Business Law Articles
Written By: Bernard G. Peter, Esq.
Kubasiak, Fylstra, Thorpe & Rotunno, P.C.
Chicago, Illinois
Whether an individual is properly classified as an employee or independent contractor can have a very significant impact on the employee benefits plans that an employer sponsors. Employers often believe that they do not have to provide employee benefits to casual, part-time, seasonal or temporary employees or employees who are rehired after retiring. Sometimes employers categorize these special or contingent workers as independent contractors when they may not meet the criteria to be an independent contractor. The case which makes very clear how significant this issue can be is the case of Vizcaino v. Microsoft in which Microsoft argued in the courts for ten years that it was not responsible for providing benefits under the Microsoft 401(k), medical, stock purchase and other employee benefits plans to a certain group of employees that Microsoft had misclassified as independent contractors. The individuals had signed agreements that they were independent contractors and were responsible for their own insurance and other benefits. Also the individuals were paid by the accounts payable department and not carried on the Microsoft payroll. The individuals made their claim after an IRS audit had determined that the free-lance personnel were actually employees for federal withholding and payroll tax purposes. Ultimately after the third adverse decision in the Ninth Circuit, Vizcaino v. Microsoft Corp, 173 F. 3d 713 (9th Circuit, 1999) and the refusal of the Supreme Court to hear the case, Microsoft settled with the misclassified employees for approximately ninety seven million dollars ($97 million).
As Microsoft found out, hiring an individual through a leasing agency or designating the person as an independent contractor will not necessarily protect the employer from a claim that the individual actually is a common law employee of the employer, and thus has a right to employee benefits. Instead the employer should review the criteria for determining whether an individual would be considered a common law employee as set forth by the U.S. Supreme Court in the case of Nationwide Mutual Insurance Co., et al. v. Darden, 503 U.S. 318 (March 24, 1992). According to the Supreme Court, the following criteria should be considered (some examples of the criteria are provided):
1. The right of the hiring party to control the manner and means by which the work is completed.
In the 1992 case of Renda v. Adam Meldrum & Anderson Co., 806 F. Supp. 1071 (W.D. New York, 1992), the individual claiming benefits worked in the jewelry department of a department store. The jewelry department was operated under a lease with the store which set forth the right of its department store to contract the manner and method under which the jewelry department was to operate. The court found that the individual was a common-law employee of the department store despite her designation as a “leased employee” because the department store exercised a substantial amount of control over the individual including the right to discharge the employee. Consequently, the individual had the right to participate in the pension plan of the department store.
2. The skill required to carry out the work.
The IRS would more likely consider the person to be an independent contractor if he or she has a skill that normally is offered to many different clients or customers or that is provided through a third party. Some examples of this type of individual would be an actuary or immigration attorney, an insurance agent, a plumber and a security guard. In Rumpke v. Rumpke Container Service, the U.S. District Court for the Southern District of Ohio (“Rumpke Case”) found that duties of driving trucks, the picking up and dumping garbage and supervising a work crew of drivers that picked up garbage from residential and commercial customers were low skill tasks that weighted in favor of classifying the plaintiffs as an employee.
3. The source of the instrumentalities and tools that the hired party uses in undertaking the assignment.
An individual who provides his or her own equipment is much more likely to be considered an independent contractor than an individual for whom the company provides the apparatus needed to carry out the assignment. An example of an individual who could be an employee or could be an independent contractor is an auditor. If the company gives the auditor a calculator, a computer, a telephone and writing materials, like pens and paper, it is likely that the individual would be considered to be an employee. On the other hand, if the auditor provides his own calculator, computer, telephone and writing materials, he or she likely will be considered to be an independent contractor.
4. The location of the work.
In the Rumpke Case discussed above, plaintiff for twelve (12) years of his employment was required to report to the main office every day and for the last five (5) years of his employment had to report in daily to the main office and call in daily. Part of the work day of the plaintiff was on the company-owned landfill and part of the day was in the main office. Plaintiff was assigned a mailbox in the office of the defendant that contained notes, new starts, cancellations, missed stops and the like. The company told the plaintiff which days he should collect from customers and some days the President of the company told the plaintiff to go back and pick up garbage from a missed stop. The court found that the defendant exercised significant control over the direction, scheduling and timing of off-premises activities and these facts together with the reporting requirements indicated that the plaintiff was an employee.
5. The duration of the relationship between the hiring party and the hired party.
The fact that an individual is designated as a “casual employee,” a “seasonal employee” or a “temporary employee,” will not exclude the employee from being eligible for the retirement and benefits plans of the employer. If an individual who is so designated meets the eligibility requirements of a retirement or benefit plan of the employer, he or she would be eligible to participate in the Plan and receive benefits. Therefore, if an employer has non-regular employees the employer wants to exclude, the employer either must exclude these employees by classification (i.e., all employees in the IT department) or by providing that they will not become eligible for the benefit plan until they complete 1,000 hours of employment or some other standard. Under the Internal Revenue Code of 1986, as amended (“Code”), and Internal Revenue Service regulations generally if an employee completes one thousand (1,000) hours of service in a retirement plan in a year he or she will be eligible to participate in the plan.
6. Whether the hiring party has the right to assign additional projects to the hired party.
In Lawdry v. Georgia Gulf Corp., Fifth Circuit Court of Appeals (2004), the plaintiffs were employed by Gulf Coast Engineers and Maintenance and Construction. Gulf Coast and subsequently Master Maintenance supplied workers on a contract basis to Georgia Gulf. In 1996, two of the plaintiffs filed requests to be included in the employee benefit plans of Georgia Gulf on the basis that they were common-law employees of Georgia Gulf and as such were entitled to employee benefits.
After administrative review, Georgia Gulf concluded that the two plaintiffs were not common-law employees and thus not eligible for benefits. On appeal, both the U.S. District Court and the Fifth Circuit Court of Appeals upheld the administrative decision. The Fifth Circuit court looked at the Darden factors and found the Darden factors, including the skill required, the right to assign additional projects, method of payment, role in hiring and paying assistants and the employees benefits and tax treatment supported the conclusion that the two plaintiffs were not common-law employees.
7. The extent of the hired party's discretion over when and how long to work.
The court in the Rumpke Case found that the company set the days when trash pickups would take place and spoke with the alleged independent contractor about his employees arriving too late at the landfill. Also, the company gave the individual minimum starting times and earliest reporting times. The court found that these facts indicated the control of the company over the individual as an employee.
8. The method of payment.
In the case Capital Cities/ABC, Inc. v. Radcliff, 141 F.3d 1405 (16th Cir. 1998), involving the Kansas City Star newspaper, the facts were similar to Microsoft, but the with an opposite result. The newspaper carriers for the Star had entered into an agreement with the Star that they were independent contractors for federal, state and local tax purposes and that they had no right to benefits. The newspaper carriers filed a class action suit seeking benefits under two retirement and two welfare benefit plans. As the language of the benefit plans clearly excluded individuals like the newspaper carriers and as the newspaper carriers were not carried on the payroll of the Star, the court found that they were not eligible for the benefits plans.
9. The role of the hired party in hiring and paying assistants.
If a worker hires, supervises and pays assistants pursuant to a contract under which the worker is responsible for the attainment of a result, this factor indicates independent contractor status. On the other hand when the party who hires a worker supervises and pays the assistants of the worker, this factor shows control over all the workers on the job and indicates that the worker is an employee
In the Rumpke case while the alleged independent contractor route supervisor hired, paid and fired assistant drivers, the company retained a high degree of control over those drivers. The company set forth in writing and maintained a hiring system over which the route supervisor had no control. Also, the company dictated wage levels for new hires and retained the right to discipline and terminate drivers hired by the route supervisor. As a result the court found that the role of the company in hiring and paying the assistant drivers demonstrated that the route supervisor and drivers were employees of the company.
10. Whether the work is part of the regular business of the hiring party.
A manager of a McDonald’s restaurant is an example of an individual who almost always will be an employee. A McDonald’s manager could be employed by McDonald’s Corporation or by a franchisee of McDonald’s Corporation. Regardless, the job of the manager is to carry our the business of McDonald’s of providing quickly to customers relatively low cost ready to eat food. Thus, as the work of a McDonald’s manager involves implementing the business of McDonald’s, a manger for a McDonald’s restaurant will be an employee.
11. Whether the hiring party is in business.
A painter who is used by a company to paint the walls of the premises of the company generally is going to be an independent contractor. Most painters have their own business and then will hire other painters to carry out the work of painting the premises of their customers. The painter and those working for the painter will go from one company to another company handling the various painting assignments in each particular company. The painter and his crew will come and go as they please within the parameters of the agreement with the company as to when the assignment must be completed. However, the company will not set the hours when the painter and his crew must be on the premises and what work must be completed on a particular day. Thus, the work of the painter is not controlled by the company and the painter would be properly classified as an independent contractor.
12. Does the hired party receive employee benefits from the hiring party?
When a company provides a worker employee benefits it is an indication of an employment relationship and evidence of a longer term employment. Also, employee benefits are a form of compensation that is not tied to a commission or the completion of a particular project. In the Rumpke case the court found that the fact that the route supervisor and the drivers who worked for him were covered by the health care plan of the company was evidence that the route supervisor was an employee and not an independent contractor. The court further stated that a hiring party normally would not cover an independent contractor under its health care plan.
13. Is the hired party treated for tax purposes as an employee or independent contractor?
The tax treatment of the worker also can shed light upon the nature of the relationship between the hiring party and the worker. In the Rumpke case the route supervisor made a request to the Internal Revenue Service by filing a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) for a determination that he was an employee. As the company supplied the route supervisor a truck and equipment, reserved the right to discharge him at any time and controlled his work, the IRS determined that he was an employee. Based on this determination by the IRS the court found that the determination by the IRS was an indication that the route supervisor was an employee in ultimately reaching the conclusion that as an employee he was eligible to participate in the pension plan of the company.
To summarize, if an individual will be performing work for the employer as an independent contractor:
- The work should be performed on an irregular basis without supervision or requiring compliance with detailed orders or instructions.
- The employee should not be given an established work schedule for performing services and should not be required to ask for permission of the employer to be absent from work.
However, there is nothing in the Code or under the Employer Retirement Income Security Act of 1994, as amended, which prevents the employer from including language in documents of the employer which excludes certain employees from plan participation as long as the exclusion is neither entirely arbitrary nor based on impermissible criteria. Properly drafting plan documents to make it clear that only those individuals the employer considers to be employees are covered by the employee benefit plans of the employer is probably the most important action the employer can take to exclude from its plans individuals the employer does not want to cover.
For more information about Bernard G. Peter at Kubasiak, Fylstra, Thorpe & Rotunno, P.C. or information concerning employee benefits law, please visit www.kftrlaw.com or the International Society of Primerus Law Firms.