By Adam Atlas
Attorney at Law
Danger: Many sales agents and other payments professionals working with you as independent contractors might actually be employees. This is an issue that all ISOs and other payments businesses should seriously consider. The customary line drawn between independent contractor (IC) and employee can be quite different from the legal line.
Businesses that get this wrong can be in for a rude awakening from state departments of labor, employees or other interested parties. The purpose of this article is to inspire ISOs and other payments businesses to take a fresh look at their sales teams to make sure they have been properly classified. The classification is relevant under both federal and state law.
An employee is a person (actual human) hired by an organization to perform specific responsibilities in exchange for compensation. An employer directs the employee in the performance of their duties, such as how, when and where they are performed. While many employment relationships are evidenced by a written agreement; there is no legal requirement for employment agreements to be documented.
Employment income is reported on the IRS Form W-2. Employees pay tax on their employment income as personal income. As a general rule, employees are not allowed to deduct their personal expenses incurred in the course of performing their work as employees.
Also as a general rule, employers provide employees with the tools (for example, a computer) they need to carry out their work, but there may be other arrangements. Employees are not incorporated entities; they are individual people.
Employees are entitled to whatever benefits the employer has made available to them. Employers are obligated to make certain deductions from payroll to the IRS and state departments of revenue.
Independent contractors, sometimes called freelancers or self-employed individuals, are people who work autonomously on defined tasks in exchange for agreed payment. ICs usually use their own tools to carry out their work. ICs are usually paid on IRS Form 1099, and they are able to deduct expenses for their own business operations from their income taxes.
ICs report their IC revenue as business income. An IC can operate as an individual person, a sole proprietorship or an incorporated entity. Some states will, however, presume that an individual providing services to a business is an employee if they do not operate through an incorporated entity. Businesses that engage ICs do not generally make deductions from payments to ICs as they would for employees.
No. The form of contract is relevant to determining the type of working relationship, but it does not offer the final word on the relationship. Instead, state and federal authorities will look to the actual substance of the relationship. There are a handful of factors to look at; the following are the three leading indicators:
Another factor in the ISO world is that agents are required to comply with ISO training and sales manuals as well as the Visa and Mastercard rules. These industry-specific rules could tip the relationship into employment if they are perceived as giving the business substantial control over how the person carries out their sales activity.
The most common error by businesses is to incorrectly characterize an employee as an IC. Businesses and employees alike are tempted to make this mistake—each for their own reasons. Businesses enjoy fewer expenses and less paperwork for ICs versus employees. Meanwhile, employees sometimes prefer to be characterized as ICs because then they can deduct expenses (computers, gas, phone bills etc.) from their taxable income.
Despite how tempting it is to let this slide, businesses must make a sincere effort to get this right. The consequences of getting it wrong can be costly for the business because it may have to pay fines as well as back payments of deductions together with interest etc.
The consequences for employees can also be costly because they may retroactively lose the benefit of deductions from their taxes made for expenses that were actually personal expenses.
Payments businesses, such as ISOs, have assumed for years that anyone who signs an IC agreement is an IC. This is not correct. In a number of states, including Massachusetts, California and Washington, the definition of "employee" has been widened by new law. These changes could substantially impact ISO and other payments business operations.
Labor law varies from state to state. For the best advice on the line between employee and IC, a business should consult a local lawyer in the state where they are located as well as in the states where they propose to have ICs or employees.
All businesses take risks. Many payments businesses take risks when deciding whether a worker should be classified as an IC or an employee. It's OK to take risks, but it's best to take them with the benefit of legal advice on what those risks actually are and what their repercussions are likely to be. 
In publishing The Green Sheet, neither the author nor the publisher are engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law email: atlas@adamatlas.com, Tel. 514-842-0886.
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