Mark Pestronk
Q: I have a few questions about whether I can impose certain requirements on my agency's independent contractors (ICs) while still avoiding reclassification of my ICs to employee status. Needless to say, I don't want my ICs to be reclassified as employees by any federal or state government agency or court, and neither do my ICs. For example, can I require certain procedures to deter embezzlement by ICs, such as requiring that all client checks be turned over to my agency instead of being deposited by the IC?
A: Every host of ICs confronts a legal dilemma. On the one hand, to avoid having a government agency reclassify the ICs as employees, you cannot control how they work. On the other hand, to avoid fraud, embezzlement, poaching of clients and staff and theft of trade secrets, you have to have controls designed to deter such practices.
As far as the IRS is concerned, the dilemma exists more in theory than in practice. First, the IRS is so understaffed that it very rarely targets travel agencies for audits of independent contractor status. Even when it does audit, its control criterion is the "degree of control," implying that you can have some controls and still maintain valid IC relationships.
The dilemma becomes much more acute at the state level. Today, the majority of states employ the so-called ABC Test of independent contractor status, under which the relationship must meet three tests. The "A" portion of the ABC test requires that "the worker is free from the control and direction of the hiring entity in connection with the work's performance, both under the contract for the performance of the work and in fact."
Note that, while the IRS focuses on the "degree of control," the ABC Test states that the worker must be "free of control," implying that no control is acceptable. The only way out of this dilemma is to interpret the phrase "in connection with the work's performance" to refer to the work relationship between the IC and their clients, which cannot be controlled, as opposed to the work relationship between the host and the IC, which can be the subject of controls.
In other words, you need to make sure that the IC is totally free to sell however and whatever the IC wants. For example, you cannot require sales of preferred suppliers' products, although you can encourage or incentivize it; you cannot assign a work schedule; and you cannot assign a production quota or the like.
On the other hand, you probably can have rules that do the following:
- Prevent or deter fraud and embezzlement.
- Require compliance with invoicing procedures to ensure accurate and timely commission splitting.
- Prohibit poaching your clients and employees.
- Prohibit transfer of pending bookings to another host.
- Control use of your trademark.
My solution is not supported by any precedent that I could find, but it is the only one that makes sense in the host agency business.