Are Your Agents Employees or Contractors? (and what does it matter?)
The current federal administration has been on a campaign to classify workers as employees rather than independent contractors so that more workers will qualify for mandated employment benefits. This has resulted in an onslaught of federal and state employment audits, investigations and class action law suits, which now have included the real estate industry – once a safe haven for agents as independent contractors. As a result of this new initiative, brokers should be aware of the relevant factors for classification and review the company handbooks, policies and practices to evaluate if their agents and other workers are properly classified.
Independent contractors, as opposed to employees, are people or companies that are contracted to perform a specific trade or business by the job or project for which they already have the qualifications to perform. They set their own hours and work location, possess their own tools and equipment and arrange for their own insurance. Independent contractors are paid by the contract for the job or project and, if unincorporated, must be provided an IRS Form 1099 for Miscellaneous Income for more than $600.00 in a year.
Employees, on the other hand, take training and direction from their employer. The employers determine the time, place and manner of the employees’ performance, as well as provide the tools and equipment and insurance. Employees are protected by federal and state wage and hour laws and must be paid by the hour for every portion of an hour they are permitted to work, (unless they satisfy the federal criteria as salaried employees, which is limited to executive, administrative, professional, outside sales and employees in certain computer-related occupations with certain minimum income levels). Employers must provide worker’s compensation, unemployment insurance, and health insurance as required by the Affordable Care Act and must withhold federal and state taxes. Employees are also protected by non-discrimination laws and are entitled to equal treatment for other employee benefits, such as pension, vacation and sick leave, and state taxes.
Historically, in the United States, real estate agents have been treated as independent contractors. Agents obtain their own educational requirements and are licensed directly by State. The IRS 3-factor test to determine that agents are independent contractors and that the broker need not collect withholdings from the agents’ income (or anyone else classified as a non-employee by statute) is as follows:
The agent is a licensed real estate professional;
The agent’s payment is directly related to sales or output rather than hours worked; and
The agent and broker have a written contract stating that the agent is not an employee for federal tax purposes.
However, the written contract is not definitive. The Department of Labor is spending millions of dollars to reclassify workers to extend them employee protections and benefits and to capture billions of dollars of tax revenue. The federal government looks at the “economic realities” to determine if the workers are in business for themselves or if they are economically dependent on the employer. The focus is on the employer’s right to control the “manner and means” of employment. Rather than a set formula, the agent’s status is ultimately determined by the totality of the circumstances; however, to provide guidance, the IRS has developed its “simplified” eleven factor “IRS Independent Contractor Test”, grouped into three categories. The factors include:
Behavioral control factors
- The extent and type of instructions given to the worker – directions for time, place and manner of performance
- The training given to the worker
Financial control
- The extent the worker has unreimbursed business expenses
- The extent the worker has a financial investment in performing services
- Whether the worker makes his or her services available to others in the relevant market
- How the worker is paid
- Whether the worker can realize a profit or risks a loss
Relationship factors
- Whether there is a written contract describing the relationship between the business and the worker
- Whether the worker receives employee-type benefits, such as insurance, pension plan, vacation pay or sick leave
- The permanency of the relationship
- The extent the services the worker performs is a key aspect of the regular business of the company.
- IRS Publication 15-A (2016).
Clear as mud, right?!
In recent court cases in other industries:
Fed Ex drivers in California settled in June 2015 for $228,000,000, after the 9th Circuit Court of Appeals ruled that the drivers were independent contractors in name only. The drivers were required to use branded uniforms, trucks, scanners and company fuel, maintenance, insurance. Once the Court found the workers to be employees, the only remaining issue was the damages for the class of 2300 drivers. Uber drivers filed suit under a California statute that requires employers to reimburse employees for business expenses. The trial is scheduled for June 2016. Uber recently won in Florida on a similar issue but with different state statutes. Lyft drivers in California settled with the company for $12.5 million in January 2016; also a compromised settlement.
As for real estate cases, the one that garnered the most attention nationally was Bararsani v. Coldwell Banker in California. California has a statute which provides that real estate brokers and agents may contract as to whether the agents shall be independent contractors or employees. Although contracted as independent contractors, the Coldwell Banker agents alleged that their broker exercised significant control over factors such as designated work locations, mandatory training, and they were precluded from working for any other company or broker; however they had no employee benefits – wages, overtime pay, payroll tax withholding, or reimbursement of business expenses. The covered period for the action was November 2008 to May 2014. Coldwell Banker argued in defense that it met the IRS 3-factor test, which also applies in California. However, when the California Court held that it would apply the IRS 11-factor test instead, Coldwell Banker limited its exposure by offering arbitration to agents, thereby reducing the size of the class in the action, and then mediated a settlement. Coldwell Banker settled for $4.5 million, with $1.5 million designated as attorneys’ fees, $25,000.00 for expenses, $5,000.00 to Bararsani as the named plaintiff and the 5600 agents in the class received only $535.00 each.
Another highly publicized case regarding real estate agents is Monell v. Boston Pads, LLC, in Massachusetts. The agents alleged that their broker exercised significant control in mandatory training front desk hours, mandatory office hours, dress codes, cell phone requirements, specific daily planners, and productivity goals. Nevertheless, the Court ruled that the real estate statute is specific in permitting agents as independent contractors and controls over general statute for independent contractor status and, therefore, the real estate agents may be independent contractors.
So how does this apply to Arizona?
We have no specific exemption statute like Massachusetts or an option statute like California. The only statute mentioning the status of real estate agents relates to worker’s compensation and applies the same IRS 3-factor test. A.R.S. §23-617(14). The Department of Revenue statute on withholding taxes provides that if a worker is exempt under federal law, then the worker is exempt for Arizona purposes as well. A.R.S. §43-104(A). The Department of Economic Security requires independent contractors to have a written contract signed by both parties and, unless otherwise provided by law, requires that the business:
1. Does not require the independent contractor to perform work exclusively for the business. This paragraph shall not be construed as conclusive evidence that an individual who performs services primarily or exclusively for another person is an employee of that person.
2. Does not provide the independent contractor with any business registrations or licenses required to perform the specific services set forth in the contract.
3. Does not pay the independent contractor a salary or hourly rate instead of an amount fixed by contract.
4. Will not terminate the independent contractor before the expiration of the contract period, unless the independent contractor breaches the contract or violates the laws of this state.
5. Does not provide tools to the independent contractor.
6. Does not dictate the time of performance.
7. Pays the independent contractor in the name appearing on the written agreement.
8. Will not combine business operations with the person performing the services rather than maintaining these operations separately.
However, the Arizona real estate statutes and regulations do “otherwise provide by law”. A.R.S. §32-2101 defines brokers as employing salespersons and that salespersons must be employed by a broker to be active. A.R.S. §32-2151 defines brokers’ record keeping requirements for their salespersons. Then Arizona regulations require brokers to exercise reasonable supervision and control over brokers, salespersons and others in their employ, including providing policies, procedures and systems (R4-28-1103(A)), and require brokers to be responsible for acts of all associate brokers, salespersons and other employees acting within the scope of employment. (R4-28-1103(D)). So it is unclear how the 8 factors above would be applied to real estate agents in litigation. However, under Arizona case law, for liability purposes, despite any written contract, the objective nature of a relationship or “totality of facts and circumstance” will determine if a broker will be liable for the negligence of their agents and, therefore, the broker is frequently held responsible.
The bottom line is that the determination of whether real estate agents in Arizona are independent contractors will be subject to the “sniff” test based on the degree of control. I recommend that all brokers (yes, even for small companies) maintain and update written independent contractor agreements and written policy and procedures manuals. The Arizona Department of Real Estate website has recommended topics for all manuals to address. Brokers are cautioned to modify their language such that specific training and meetings, etc. are not mandatory, but rather “recommended” or “best practices.” The independent contractor agreement should include conflict resolution language to be separately initialed or signed to require mediation and/or arbitration, prohibit class actions and confidentiality of the conflict resolution. And finally, since Arizona law requires brokers to supervise agents, yet mandatory training and procedures may convert agents into employees, brokers should carefully consider their relationship with agents who do not engage in appropriate professional business practices.