COMPLIANCE HOT TOPIC

Independent Contractors vs. W2

QUESTION:

Is my "independent contractor" really a W-2 employee?

ANSWER:

The IRS and some states, such as California, are auditing businesses who report their workers as independent contractors.  This is an area of increasing concern for the mortgage industry as there are several factors to consider in addition to the labor law issue, such as Agency requirements and licensing implications.

IRS Rule "Understanding Employee vs. Contractor Designation” Guide: FS-2017-09, July 20, 2017, established the following categories and Common Law Rules to assist in providing evidence of the degree of control or independence when evaluating a business relationship:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)?  Will the relationship continue and is the work performed a key aspect of the business?

States have also begun to adopt their own evaluation methods.  For example, in April, 2018, California Supreme Court’s adopted an “ABC Test".  Under the “ABC test”, workers are presumed to be employees, and employers may classify workers as independent contractors only if they can prove these three elements of the test:

1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of such work and in fact;
2. The worker performs work that is outside the usual course of the hiring entity's business; and
3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

As a Best Practice, a business should have documentation to establish a clear separation between a business and an independent contractor including but not limited to some of the following:

• Ensure the independent contractor has his/her own state business license and professional license(s) required for his/her area of service or specialty, business and/or liability insurance.
• An independent contractor should have the ability to set his/her own hours and workdays.
• An executed business contract should be in place, similar to a third-party service contract that outlines the services contracted, the compensation rate and the legal stipulation that the independent contractor is not an employee of the company.  Liability and indemnification provisions should also be addressed in the agreement between the business and the independent contractor.
• The business should not collect payroll tax or offer employee benefits to an independent contractor.
• The independent contractor should work under his/her own license(s) and bear the risk of malpractice or business suit.

With regard to the mortgage industry specifically, HUD Handbook 4000.1 I.A.6.j.i and ii detail how mortgagees may use contract support for administrative, human resources, and clerical functions, but cannot contract out management or underwriting functions.  Further, most states generally require independent processors and underwriters to maintain licensure through NMLS.

Organizations should fully understand state employment and licensing requirements, in addition to Agency guidelines prior to categorizing and retaining an individual as an independent contractor.

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