Agency owners have an unfortunate tendency to assume all agents paid on commission are automatically independent contractors. This assumption can become an expensive legal mistake; mislabeling employees as independent contractors leads to fines and judgments against you. You can avoid the independent contractor trap by knowing the difference between independent contractors and employees and understanding the wage and overtime laws regarding commissioned agents.
Independent Contractor vs. Employee
Two tests gauge whether an agent is an independent contractor or employee. The federal government test arises from the Fair Labor Standards Act (FLSA) and the California test from Dynamex Operations West, Inc. v. Superior Court (hereafter “Dynamex.”)
Under federal law, employees may receive the benefits of minimum wage and overtime. However, independent contractors do not benefit from these policies, and many companies hire them to avoid obligations under the FLSA.
Determining whether a worker is an independent contractor depends on the “economic realities” test codified in the act. This test focuses on the monetary risk of the worker; independent contractors face more risk as they often have business expenses and no guaranteed income, while employees typically receive a regular paycheck.
Economic reality risk factors include:
- Whether the agency owner controls agent performance, including discipline, hiring, and firing
- Whether the agent receives wages
- Who invests in computers and other equipment–the agent or the agency worker
- Relationship permanency
- Required skills (higher-skilled professions tend to fall into independent contractor status easier)
- Whether work is integral to the business
In addition, the Department of Labor also looks into:
- Payroll deductions
- Who controls payroll
- Who completes tax forms
- Who keeps records and books for the agent
- Whether the agent has an economic interest in the work
- Whether the agent performs work in one location
The problem often arises because agency owners assess agent performance, keeps track of earning records, and sometimes even hire employees to work for an agent. A federal case, Hopkins vs. Cornerstone America, swatted down an insurance company because of the control it held over its “independent” agents. In that case, the company controlled payment, commission amount, promotions, and employees, even though sales agents determined their work hours and other daily affairs. The court ruled that the Cornerstone America agents were employees even though a formal work agreement indicated they were independent contractors.
In Dynamex, the court adopted the ABC test for determining whether a worker is an independent contractor and a presumption that all workers are employees. This case placed the burden of proof regarding independent contractor status on the company.
Under the ABC test, a worker is an independent contractor if the employer establishes all of the following:
- The worker is free from the control and direction of the company when it comes to performance. This element should be transparent in the contract and apparent in the everyday routine of the business relationship.
- The worker performs work that is outside the usual course of the hiring company’s business.
- The worker independently engages in a trade, occupation, or business that is of the same nature as the work performed for the hiring company.
Here is how this plays out. If you hire a plumber to address issues with the company bathroom, that individual is an independent contractor. They run their own business, do not sell insurance, and their contract only covers one transaction.
But when it comes to agents, it becomes more complex. Agents perform work that is within your business, and they may not necessarily run independently. If you maintain the authority to assess and reward performance, your relationship with the agent may appear like an employment contract rather than an independent contractor one.
Effects on Insurance Companies
How do you know if you are in trouble? California law does not address insurance agencies and companies directly. But the Hopkins case above provides clarification in federal law that can apply to state law.
In Hopkins, the court determined that Cornerstone’s sales leaders and agents were employees, not independent contractors. It based this conclusion because Cornerstone controlled the following:
- Hiring, firing and promoting team members
- Advertising and types and price of insurance products sold
- Territory, office, and lead assignments
- Investment in offices, brochures, accounting services, and underwriting
- Assessment of profit and loss.
- A permanent relationship where team members worked exclusively for Cornerstone
If you are concerned about misclassifying agents, compare your practices to those described above. Many agency owners discover that they enforce more control over independent contractors than they realized. If you discover the same, you may need to change the status of these workers to employees or change your practices.
Commissions & The Independent Contractor Test
So, limiting the pay to commissions is not enough to establish an independent contractor relationship. The type of payment is never dispositive on its own; you need to pass the tests above first. Once you determine your agents’ status, you can assess whether you handle commissions correctly under wage and hour laws. As mentioned above, if your agents are employees, you may owe them overtime.
But even if your agents are employees, you may be exempt from paying overtime. However, for that to work, you must meet these conditions:
- The employee’s regular pay rate exceeds one and one-half times the applicable minimum wage for every hour in a workweek when they work overtime; and
- More than half the employee’s earnings consist of commissions.
If you already pay agents solely in commissions, you meet the second condition. For the first condition, the employee’s pay must exceed $21 an hour–the amount that is one and half times the California minimum wage of $14 per hour. You can determine that by dividing the commission earned in a week by the hours worked by the employee. If the average wage is below $21 per hour, you must pay overtime.
Employment and independent contractor law can be a morass, and it is often a dense and challenging subject. But you can manage this balance, and avoid mistakes, by implementing these best practices:
- Audits: Use the conditions explained in this article to create checklists and schedule audits of your employment and independent contractor practices. Include elements like performance reviews, hiring, and even recordkeeping. If you find a manager or other worker enforces excessive control over independent contractors, call it in. You do not want to create confusion that later turns into a lawsuit.
- Written policies: Create clear guidelines regarding who is an employee and who is an independent contractor. Include how company representatives should interact with each type of worker and set defined rules.
- Start at the beginning: When you hire independent contractors, make that relationship clear in job descriptions and contracts. While contracts will not be decisive in defining this relationship, they should still clarify the nature of the hiring relationship and the status of all workers.
- Training: Managers must know the difference between interacting with independent contractors versus employees. Training should cover topics like control, performance assessment, recordkeeping, and general communication.
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