Across the country there are independent insurance agents and brokers whose producers are either fully employed as employees by the agency/broker, or are affiliated with the firm through an independent contractor producer relationship. Agency and broker owners should review their independent contractor producer relationships currently in place to ascertain if the firm risks having a governmental agency reclassify the independent contractor producer as an employee. The risk of this reclassification occurring falls to the agency and its owners and can cost hundreds, if not thousands, of additional expense and tax dollars.
This article will explore the independent contractor producer role found in insurance agencies and brokers, attempt to analyze the risks and potential problems these independent contractor relationships can develop, and compare the required 'tests' for an independent contractor status employed by various state and federal governmental agencies with the everyday procedures, controls and management needs an agency has and desires over its producer sales force.
WHY BE CONCERNED IF A PRODUCER IS AN INDEPENDENT CONTRACTOR?
If you have an agency and pay other people (producers) to do work for you, or on behalf of your business, you may be faced with the risk of unanticipated tax liabilities if the individual you consider as an independent contractor files a claim for unemployment, disability insurance, or fails to pay his/her own employment taxes. Producers providing services to, or on behalf of, your agency in reality may be your employees (per employment classification and tax purposes), even though you (and they) believe they are independent contractor producers.
Agencies that hire independent contractor producers avoid responsibility for:
- Social Security taxes and/or Medicare premiums
- Workers' Compensation insurance premiums
- Unemployment insurance
- Health insurance and retirement benefits
- Liability for a worker's actions or results
These items may vary on a state by state basis.
If the independent contractor producer is injured, he or she cannot collect disability or workers' compensation insurance benefits, and independent contractor producers are not eligible for unemployment insurance. Independent contractors can be held liable for their own actions and results, instead of being protected by the insurance agency and its own insurance coverages (automobile, general liability, errors and omission coverages).
A large agency risk pertains to potential tax liabilities. Independent contractors must pay quarterly income tax and Social Security self-employment taxes on their net taxable income. Adding federal income tax and state income taxes, the payout can be quite large. If independent contractor producers spend this money elsewhere rather than remitting it to the proper tax authorities, there can be trouble. Upon investigation and application of 'common law' factors, if the 'independent contractor producer' happens to be reclassified and declared an employee by a governmental agency (for whatever reason), the risks and liabilities for these tax liabilities, payments (and penalties) become the agency's responsibility.
A CLEAR DEFINITION OF AN INDEPENDENT CONTRACTOR
As business owners, agency owners must understand the very basic concepts required by an independent contractor relationship and needed for this designation to be successfully defended and upheld. These concepts apply regardless of the type of business:
One mistake can cause an independent contractor to be reclassified into the employee status. Any action taken by the firm or the firm's employees to control independent contractors can cause this conversion. The key is who has the right to control the worker and dictate how the work is to be accomplished. If the firm only has control over the results of the activity, the worker can be correctly designated as an independent contractor. (Examples of this right to control are explored further in this article.)
Should an agency control or attempt to control an independent contractor's work, such as the enforcement of requirements to abide by procedures, adhere to certain business rules or programs, etc. Most likely, the status of the worker will be reclassified as employee and the agency can be held liable for employment taxes, benefits and other liabilities.
If the agency has the right to terminate a producer if they breach their contract or their work is unacceptable, then most likely the relationship will be deemed an independent contractor. However, if that agency can fire the producer at will, his or her legal status more likely will be declared as an employee. Those agencies who declare producers as independent contractors, yet have no contracts in place, have no contracts which can be breached!
These firms therefore face higher risk than those firms with contracts. Any agency with independent contractor producers working under 'oral agreements' will have a great deal of difficulty defending and explaining investigations into grounds for termination, inquiries regarding work standards (what is acceptable and not acceptable work?), and agreements regarding compensation, expenses responsibilities and liabilities for activities/work performed.
Many agencies are known to have a number of producers employed as employees and other producers designated independent contractors. Just because an independent contractor producer has the same job, title, or performs the same type of work as the employee producer does not mean their status cannot be different. The defining criteria is based on how the agency treats the producer. The test for liability is whether the agency (owners, employees, management) either directly or indirectly has the right or ability to supervise or otherwise control the time, place, and manner in which the producer carries out his or her job.
Unless the agency owners and management clearly do not have the right to supervise and control the producer, either directly or indirectly, an employment relationship probably exists. Here again, any sign or indication of control or supervision can trigger an investigating governmental agency's decision to reclassify an independent contractor producer as an employee producer. From there, liabilities, payments and penalties become the responsibility of the agency.
Government rules (state and federal) determine if a worker is an independent contractor. The IRS, federal and state laws are the entities which judge the relationship. Although the agency or broker might even have formal contracts in place (or oral agreements), these are not proof of an independent contractor relationship.
As court decisions and/or legislation will significantly change the rules governing independent contractor relationships it is key agency owners consult with their legal counsel or experts familiar with such requirements to make sure current rulings and laws are understood and adhered to. When it comes down to the final analysis, workers (producers) are employees unless the agency or broker can prove themselves differently.
THE IRS, GOVERNMENTAL AGENCIES AND YOUR AGENCY
Should the Internal Revenue Service ever audit an agency or broker, and independent contractors producers are in place, the IRS will potentially reference 20 'common law' principals to test for fraud or misclassification. In addition to the IRS, various federal and state governmental agencies are also involved in determining whether workers are independent contractors (or employees). These include employment development departments, workers compensation appeals boards, immigration and naturalization services, departments of labor and various labor commissions, and state tax/revenue services.
Like the IRS, these agencies use the same determining factors to detect if the business firm has no right to control the work of the worker. The IRS audit of independent contractor producers in an agency or broker can conclude the agency failed to satisfy the requirements, and such failure may result in additional audits for the past three years, with the risk that agency owners will be potentially penalized for each misclassified producer, whether it was done deliberately or was an honest mistake. One mistake can cost the firm dollars in liabilities, back taxes, and penalties.
COMPARE YOUR AGENCY TO THE 'COMMON LAW' PRINCIPALS
As stated previously, the IRS and various state and federal governmental agencies use 20 'common law' principals or tests for the employment relationship between employee and independent contractor. While each governmental agency may have developed its own list of factors to reference, for the most part they have much in common with the IRS factors. A number of the more important factors are listed below. After each factor, questions or issues are poised to test the realities of independent insurance agencies' and brokers' operations and to assess how well these practical operational issues match up to the 'common law' tests.
1. No instructions: Independent contractors (producers) are not required to follow instructions to accomplish their tasks. Clearly this factor is contrary to the needs agency owners and managers have to ensure their producers (whether employees or not) follow guidelines which are designed and needed to control how business is produced. The need to have fully completed applications and underwriting/pricing information, the desire for producers to follow work-flow procedures for new business and renewals, and the requirements for placing/marketing business with specifically targeted carriers and markets, are ignored if the agency is unable to compel (control) producers to follow instructions.
The very need to have agency procedures and rules in place and correctly followed by producers may simply be enough to have any independent contractor producer reclassified as an employee by a governmental agency, as these rules and procedures give the agency the right to control the producer and how he or she works. If an agency has producers who are employees and others who are independent contractor producers (and there are agencies that have this), then the solicitation, information development, marketing and service of clients would have to be accomplished in a completely different manner if performed by an employee producer compared to an independent contractor in order to defend and preserve the independent contractor producers' status.
2. No training: Independent contractors rarely receive training to perform a task. Here too, a reality check would show training, retraining and educational upgrading is essential to attaining and maintaining successful agency staff and work force efficiency and productivity levels. To have independent contractor producers not be required to meet standards of education and training would be unacceptable.
3. Service (or portions thereof) can be rendered by others, i.e., independent contractor producers should have the ability to hire others to do their work for them. It is doubtful any agency or broker would welcome the involvement of a third party (unrelated or not connected with the agency) to perform the marketing, placement, sales and service activities for clients. To meet this test, an independent contractor potentially must also be able to have his or her own CSRs, claims people, etc.
In addition, the independent contractor must be able to hire, supervise and pay assistants independent of the agency/broker employer. Last, the independent producer should have control of and determine the sequence of duties and activities necessary to finishing a job. Here too, this requirement flies in the face of an agency's need for adherence to standardized systems and procedures and an agency's willingness or allowance to have non-agency representatives contacting and servicing clients and customers.
4. The independent contractor decides when and where the work is performed.
Again, for an agency or broker, this flexibility 'test' is clearly opposed to the need for work to be performed at the agency's office premises.
5. Independent contractors may work for more than one firm. What agency would feel comfortable allowing an independent contractor producer to solicit, quote, market, and service clients through a number of agency outlets, especially other local competing agencies? By failing this 'common law' factor, the independent contractor producer may be reclassified as an employee.
6. Independent contractors must be able to show they have made investments in their trade allowing them to work independently of the agency's facilities. This requirement is contrary to most producer relationships: agency producers (independent contractors or employee producers) rarely have their own markets, their own information and financial systems, etc. In fact, rarely do independent contractor producers have any investments in their business beyond an automobile, cell phone and a briefcase! While an 'investment' might have been made by the independent contractor producer in developing his or her own book of business, the day-to-day sales and service activities cannot function without markets, carriers, a service staff and information and financial processing capabilities.
Most agencies supply their independent contractor producers with the same facilities as employee producers (office, staff, phones, automation, markets, etc.), and the only differences which may exist between the two types of producers is solely related to compensation differences and 'ownership' in the book. Here too the practical inability for an independent contractor producer to operate without an agency affiliation may cause failure of a 'common law' test.
7. Independent contractors are liable for any expenses and liabilities they might incur in performing their duties. 'Street level' reality shows most independent contractor producers paying their own sales expenses (auto, gas, client entertainment, etc.), but in most cases the independent contractor is covered under the agency's errors and omission policy. Rarely do the producers have their own general liability coverages (outside of automobile insurance) and errors and omission insurance. Having an agency cover any expenses and/or liabilities may trigger another 'common law' test failure.
8. The type of work the independent contractor performs is not the hiring business' primary work. Here a major conflict exists in agencies and brokers relative to successfully defending any independent contractor producer status. Outside of service, what more do agencies and brokers (i.e., through its producers) do besides sell insurance products and coverages and provide customer service to clients?
9. Independent contractors cannot be dismissed at will; otherwise they are automatically declared employees. Whether an agency has an independent contractor relationship spelled out in writing, or not, the independent contractor cannot be fired so long as he or she produces a result stated in their 'contract.' Any poorly written contract and/or a vague 'oral contract' will put the agency at risk and the independent contractor producer status will be potentially disallowed.
Although the above list is not inclusive of all 20 'common law' factors applied to test for independent contractors, agency and brokers must recognize the failure of meeting the test of any one or more of these factors can potentially have an independent contractor producer reclassified and declared as an employee. With this declaration, agencies and brokers are potentially faced with increased liabilities, requirements for payment of back taxes, and an assessment of penalties.
INDEPENDENT CONTRACTOR PRODUCERS: ARE THE RISKS WORK IT?
With clear governmental criteria in place to define and test for true independent contractor relationships versus employee classifications, all agency and broker owners must compare their own operations and judge for themselves if their businesses are at risk.
Owners should meet with their legal counsel and/or experts (governmental agencies representatives, personnel consultants) who work closely with businesses regarding independent contractors and walk through each 'common law' factor to ensured that their agency would not fail any one or more of the tests and subsequently be at risk for and suffer financial penalties. It may be that the era of independent contractor producers in insurance agencies and brokers has come to an end. The need to develop consistent and thorough underwriting information, control the marketing and placement of business, and adhere to standard methods, procedures and automation criteria, plus increased demands for owners to become better and stronger business managers all may far outweigh the benefits of safely declaring producers as independent contractors; rather, they may require producers to become pure employees.