ADA Case Helps Clarify Independent Contractor Status

Employers Must Apply Three Tests, Not Just One

Employers may be tempted to save benefit costs and payroll taxes by designating workers as independent contractors. However, government agencies fine employers that incorrectly label employees as independent contractors. This case illustrates a correct use of independent contractor status.

A Seventh Circuit Court of Appeals decision provides guidance to employers that classify workers as independent contractors. In Aberman v. J. Abouchar & Sons, Inc., No. 97-1423 (11/18/98), an outside salesman sued for discrimination under the Americans with Disabilities Act (ADA) when the company terminated him after he announced his wife had cancer. The court decided that the salesman was an independent contractor, not an employee, and thus not protected by the ADA. In reaching its conclusion, the court focused on five factors to determine independent contractor status.

Salesman Alleges Wife’s Cancer Triggered Termination

According to the facts of the case, the salesman joined the company in December 1994 and received $2,500 per month under an oral contract. About two and one-half months after his starting date, the salesman informed the company that his wife had cancer. The company terminated him three days later. The salesman claimed the company violated the ADA by terminating him for his association with a disabled person, his wife. The district court determined that the salesman was an independent contractor, not an employee, and therefore was not covered by the ADA, and granted summary judgment to the company. The salesman appealed to the Seventh Circuit.

Court Looks at "Right to Control"

To determine whether workers are employees or independent contractors, courts typically use a test that focuses on which party has the "right to control" the workers’ activities. In this case, the court focused on five factors. The first, most significant factor the court considered was the amount of control the hiring organization exerted over the worker’s activities. Although the salesman and the company president had 68 phone conversations, the court found that the salesman exercised extensive control over how his work was to be accomplished and worked for other organizations at the same time. The second factor the court examined was the responsibility for the costs of operation, such as equipment and supplies. In this case, even though the company split some costs, the salesman appeared to be an independent contractor because he paid many operating expenses, such as computer, mobile phone, and travel costs. Next, the court considered a third factor, the method and form of payment and benefits. The company did not pay any benefits or withhold any payroll taxes for the salesman as it would for an employee, so he was treated as an independent contractor. Fourth, the court examined the length of the job commitment the company made to the salesman. Since the salesman could not prove he was hired permanently, he was an at-will worker, not an employee. The court also identified a fifth factor, the nature of the occupation and skills required, but did not specifically address this factor. Based on these five factors, the court determined that the salesman was an independent contractor and thus not an employee protected by the ADA.

Employers Must Apply Three Tests, Not Just One

As this case demonstrates, employers that use independent contractors must be able to prove that they classified the workers properly. If they do not, they may face claims under the many laws that protect employees, including discrimination laws like the ADA, the Fair Labor Standards Act (FLSA), and payroll and benefit laws. Determining independent contractor status, however, is no easy task since three different standards may be used, depending on the nature of the challenge.

The common law "right to control" test is used by courts, such as in this case, to determine whether a worker is an employee who is protected by various employment laws, including those prohibiting discrimination. The Internal Revenue Service applies a 20-factor independent contractor test to decide whether an organization correctly classified a worker for purposes of wage withholdings. Finally, the Department of Labor uses the "economic reality" test to determine worker status for purposes of compliance with the minimum wage and overtime requirements of the FLSA.

Employers must be familiar with all of the tests and meet the specific criteria used by the investigating agency or the courts to prove a worker is an independent contractor. Generally, misclassification of workers for purposes of federal tax withholding can cause the employer the most harm because the IRS is very aggressive at questioning independent contractor status and has severe penalties for noncompliance. Although these tests differ, they share several common factors. The most important one, and the one this court gave the greatest significance, is the amount of control the hiring party exercises over the work relationship.

An interesting sidenote to this case is that the salesman’s discrimination claim was based on association with a disabled person. Many employers may not know that in addition to protecting disabled employees or those perceived to be disabled, the ADA also specifically prohibits discrimination based on association with a disabled individual. Thus, for example, an employer may violate the ADA by terminating an employee because his disabled dependent needs expensive medical care that increases the employer’s health insurance premiums.