Clearing The Air: Independent Contractor or Employee? Part III

This final column on the issue of how to distinguish an employee from an independent contractor will consider some of the practical steps agency owners and managers can take to shore up their position that particular workers are independent contractors. 

There is general agreement among attorneys in the field that having a written agreement between the agency and the worker is essential. Without such an agreement, you have no formal relationship framework to which you can point, and every worker will look pretty much the same to the government. The agreement must cover all the essential elements of the relationship, so a back-of-napkin one-sheet is unlikely to suffice.

There is also general agreement that an independent contractor should establish a separate legal identity under the laws of the state in which the business of the contractor is located. This might be a corporation but it could take other forms. You should consult local counsel about this issue. The contractor’s business should be required to maintain valid business licenses where it is physically headquartered and seller-of-travel registrations everywhere it does business, which may be different than the places the agency considers that it is doing business. Proper handling of the “places of business” can help establish in an audit that the contractor is in its own business.

The economics of the relationship that are spelled out in the agreement should provide for the payment of fair market prices for every service the hosting agency provides to the contractor. If you do not do this, it will be hard to argue that the contractor has a different relation to the agency than other employees. 

Indeed, all aspects of the relationship set forth in the agreement should reflect an arms-length economic relationship in which the contractor is undertaking to provide selling services, and perhaps client management services, for the agency. Recently industry attorney Mark Pestronk suggested that the relationship should be flipped in the agreement so that it is explicitly clear that the contractor is providing services for a fee/commission to the agency and that the agency is buying those services from the contractor. 

The relationship should closely resemble the structure of other service agreements into which the agency enters, including, for example, bookkeeping, accounting and legal services. In those cases, it is apparent that the agency is the buyer of services. That is the ideal structure for a true independent contractor relationship. As an example, you don’t pay for an independent accountant’s business card—so don’t do it for your “independent sellers.”

Pestronk noted that some readers might consider this a purely cosmetic step, but I think it is a potent idea. Its power arises from the fact that the agency-as-buyer approach aligns correctly with the underlying economic reality of the relationship, and is the customary relationship when procuring services from people who are in business for themselves.

Finally, a liberal dose of common sense is a big help in dealing with this issue. Don’t create a phony arrangement thinking you will outfox the auditors. They will not be fooled so easily. Put yourself in the auditor’s shoes and ask yourself whether you would believe the story you are trying to tell. If not, don’t expect the auditor, whose job it is to be skeptical and look behind the façade, to accept the arrangement as valid.

I realize few agencies want to hear “hire a lawyer to advise you,” but this is one of the situations where do-it-yourself can cost your business serious money, not to mention the distraction of management and employees from what they do best, which is advising consumers about travel. Think of this as part of your investment in the business.