Redefining the Employee-Employer Relationship

Will the New Law Simplify or Complicate the Worker (Mis)Classification Issue?

How can your clients appropriately classify most workers as independent contractors in Tennessee? How can you argue that workers who want to be protected by wage regulations and other labor laws are “employees?” The answer to the former question may be easier and the answer to the latter may be more challenging as new amendments to Title 50 redefine what it means to be an “employee” in Tennessee.

Effective Jan. 1, 2020, the new provisions will replace the broader “ABC” and Tennessee common law tests to determine whether a worker is an “employee” based on 20 factors described by the IRS in a 1987 Revenue Ruling. Companies may find it easier to classify its workers as independent contractors, reaping cost savings by excluding workers not only from unemployment, but also from state OSHA and wage regulations. However, the changes do not create uniform standards for companies doing business in Tennessee: Workers’ compensation law will retain its seven-factor test and special carve-outs exist for certain technology companies. This article will explore the new Tennessee definition of an employer-employee relationship, consider other key tests affecting worker classification, and identify unanswered questions to aid attorneys representing companies and workers in Tennessee.


Redefining What It Means to Be an ‘Employee’ in Tennessee

Effective Jan. 1, Tennessee law will redefine whether an employer-employee relationship exists under the Tennessee Employment Security Law,1 the Occupational Safety and Health Act of 1972,2 the Wage Regulations,3 and the Drug-Free Workplace Programs4 based on 20 factors described in Internal Revenue Service Revenue Ruling 87-41.5 The 20 factors will replace Tennessee’s seven-factor common law test,6 as well as the “ABC” test used for unemployment insurance purposes.7 Replacing these tests may make it easier for a company to classify its workers as independent contractors in Tennessee.8 These changes have important implications for both Tennessee businesses and workers. The success of a new business may depend on low start-up costs, especially costly labor expenses. A business model followed by many new start-up companies is to classify most of their workers as independent contractors, rather than employees. Companies that can classify its workers as independent contractors may be able to reduce labor costs and will not have to comply with the wage and OSHA regulations. Conversely, companies that must (or choose to) classify workers as employees may exercise more control over their workers but may incur higher labor costs. While workers classified as independent contractors may have more control over their working arrangements, they will forego labor protections they would be entitled to if they were “employees” under Tennessee’s wage regulations, unemployment and OSHA laws. Thus, the role of attorneys in structuring new and existing entities and arrangements between workers and companies is immensely important.

Despite adopting the IRS 20 factors, determining proper worker classification will remain complex in Tennessee as companies and workers must still consider a variety of tests within and outside of Tennessee. The Tennessee’s Workers’ Compensation Law was excluded from the changes and will retain its seven-factor test.9 In addition, technology companies may qualify for the special carve-out provisions under the Transportation Network Companies (TNC) law10 effective in 2015 or the Marketplace Contractors law effective in 2018.11 Employers will still need to consider other federal laws with different tests, possibly yielding conflicting classification results. This article will consider the new 20-factor test and other key worker classification tests affecting Tennessee businesses. We will conclude with key takeaways for attorneys advising companies or workers in Tennessee.


A Mix of Tests in Tennessee

Tennessee, like many other states, applies different worker classification tests for different laws within the state. For instance, the workers’ compensation law applies Tennessee’s seven-factor test,12 whereas the current unemployment insurance law includes both Tennessee’s seven-factor common law test and the ABC test.13 The new Tennessee amendments, adopting the IRS 20-factor test, will replace both the seven-factor and the ABC tests for unemployment purposes but will not amend Tennessee’s Workers’ Compensation law.

Tennessee’s New 20-Factor Test. Beginning Jan.1, Tennessee will base the determination of whether services performed by an individual qualify as anemployer-employee relationship with an employer “based upon consideration of” the 20 factors set forth in Rev. Rul. 87-41 for purposes of Tennessee’s employment security, wage regulations, OSHA, and drug-free workplace laws. The IRS developed these factors based on an examination of cases and rules as an aid in determining whether an individual is an employee under the common law rules. Thus the 20 factors incorporate several key questions to aid in this determination. Some factors indicate employee status, whereas others indicate independent contractor status. For instance, one factor is whether the worker must comply with the company’s instructions about when, where, and how the work is performed. If so, the worker is ordinarily an employee. Another factor considers whether the worker works for more than one firm at a time. If so, this generally indicates independent contractor status. The factors are designed only as guides and no one factor is determinative. These factors are summarized in the chart below.

The Tennessee amendments, however, make no mention of the common law right to control test specifically discussed in Rev. Rul. 87-41. Although the right to control and direct how services are performed is not specifically mentioned in the new Tennessee law, one can reasonably argue that it is implied. In fact, some of the 20 factors mention control in the description of the factor. On the other hand, a company classifying its workers as independent contractors could argue that the 20 factors are exclusive per the statutory language. Moreover, a company might argue that any one factor is persuasive without considering the substance of the total relationship. This latter view may make it easier for a company to claim that it meets the test for independent contractors since the common law control rules would not apply.


Tennessee’s Common Law
Seven-Factor Test and Workers’ Compensation. Tennessee common law considers seven factors including:

  1. the right to control the conduct of the work,
  2. the right of termination,
  3. the method of payment,
  4. the freedom to select and hire helpers,
  5. the furnishing of tools and equipment,
  6. self-scheduling of work hours, and
  7. being free to offer services to other entities.14

The above factors are a guide to analysis and not absolutes.15 These seven factors are codified in Tennessee’s Workers’ Compensation Law16 and will not be changed by the new amendments to Title 50.

Digital Company Carve-outs in Tennessee. Two Tennessee laws provide special carve-outs for companies that meet their qualifications. The first, effective in May 2015, governs transportation network companies that use a digital network to connect riders to drivers. The Transportation Network Company law provides that companies using a digital network to connect riders to drivers in a personal vehicle are “not deemed to control or manage transportation network company drivers.”17 The law further exempts TNCs from any regulations passed by a municipality or other governmental entity governing private passenger for-hire vehicles, from the authority of the department of safety to regulate passenger operations, and from the requirements relating to commercial driver licenses or commercial vehicles.18
The second law, Marketplace Contractors, which became effective in July 2018, enables companies operating a marketplace platform to classify its workers as independent contractors for all purposes under state and local laws, rules, ordinances, and resolutions by means of a written agreement under certain conditions.19


 A “marketplace contractor” is any individual corporation, partnership, sole proprietorship or other business entity that enters into an agreement with a “marketplace platform” to use the platform in order to receive connections to third-parties seeking services in Tennessee.20
A “marketplace platform” is a business entity operating in Tennessee that offers an online-enabled application, software, website, or system that enables the provision of services by marketplace contractors to third-parties seeking such services and neither directly or indirectly through any related party derives any benefit from work performed by marketplace contractors other than a subscription or use fee for placing marketplace contractors in assignments or otherwise providing connection.21


In order to be considered an independent contractor and not an employee of the marketplace platform under this law, the written agreement must set forth the conditions shown in Figure 2.



A Confusing Landscape of Other Worker Classification Tests

Businesses in Tennessee must still consider other classification tests after the new amendments to Title 50 take effect. While not a comprehensive list, three important tests include the following:

The IRS 20-Factor “Common Law” Test. The IRS applies common law rules to determine whether a worker is an employee or an independent contractor. Under the common law, the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services. In Rev. Rul. 87-41, the IRS describes 20 factors that can be used “as an aid in determining whether an individual is an employee under the common law rules.” The right to control is the essence of the test. More recently, the IRS has categorized these factors into three broad categories of behavioral control, financial control, and relationship of the parties for guidance.22 As such, these categories are to assist employers and workers in determining the substance of the relationship. The essential question is still whether the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result but also as to the details and means by which that result is accomplished. See Figure 3.

The Economic Realities Test. The U.S. Department of Labor applies the “economic realities test” under the Fair Labor Standards Act. Derived from U.S. Supreme Court precedent, a six-factor test seeks to assess the economic dependence of the worker by considering:
 the nature and degree of the potential employer’s control;

  • the permanency of the worker’s relationship with the potential employer;
  • the amount of the worker’s investment in facilities, equipment, or helpers;
  • the amount of skill, initiative, judgment, or foresight required for the worker’s services;
  • the worker’s opportunities for profit or loss; and
  • the extent of integration of the worker’s services into the potential employer’s business.23


The “ABC” Test. A company doing business in another state may have to comply with its laws such as worker’s compensation or unemployment. One widely used test for unemployment purposes is the “ABC” test.24 The “ABC” test considers three primary factors:

  • The individual has been and will continue to be free from control and direction in connection with the performance of the service, both under any contract for the performance of service and in fact;
  • The service is performed either outside the usual course of the business for which the service is performed or is performed outside of all the places of business of enterprise for which the service is performed; and
  • The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

The taxpayer must prove all three factors are present to classify a worker as an independent contractor; if the employer cannot prove any one of the ABC prongs, the worker is considered an employee. Thus, the “ABC” test is broader and more favorable to employee classification.25
 

Implications for Tennessee Companies and Workers

Despite the legislature adopting 20 factors described by the IRS 20-factor test, worker classification in Tennessee will be challenging for at least three reasons:
1. The IRS Does Not Exclusively Rely on 20 Factors.

  • New Tennessee legislation specifically states that worker classification will be based upon “consideration of the… twenty (20) factors as described in the twenty-factor test,” but makes no mention of the right to control, which is the fundamental principal behind Rev. Rul. 87-41. This leaves open the question of whether, or to what extent, the right to control is to be used as a determinative factor in applying the 20 factors in Tennessee. Although Rev. Rul. 87-41 is still valid, the IRS has refined its worker classification test by categorizing the factors determinative of worker classification into three categories – behavioral control, financial control, and type of relationship.26
  • While adopting the 20-factor test appears to provide consistency between worker classification for IRS and, except for Worker’s Compensation, Tennessee purposes, the right to control language and the categories used by the IRS to refine and clarify its own test are not incorporated in the language of the Tennessee amendments. Depending on the statutory interpretation, this could be a critical distinction because the IRS considers its factors as indications of the right to control, not as an exclusive list. If Tennessee’s list of 20 factors is interpreted as exclusive, other evidence of control could be excluded and the true substance of the relationship ignored.27

2. Different Standards Still Apply in Tennessee.

  • Workers’ Compensation Law. While a draft bill proposed amending the worker’s compensation law to adopt the IRS 20-factor test, the final bill did not include the worker’s compensation statute. Thus, the seven-factor test will be used for workers’ compensation purposes. This test aligns with the IRS common law control test because the first factor addresses “the right to control the conduct of the work.” As new types of work arrangements emerge, a central question will continue to be whether the employer has the “right to control” the worker.
  • Carve-outs for TNCs and Marketplace Contractors.28 As discussed earlier, the Transportation Network Company law effective in May 2015 provides that companies using a digital network to connect riders to drivers in a personal vehicle are “not deemed to control or manage transportation network company drivers.”29 In addition, Tennessee has adopted a gig company carve-out for “marketplace platform” companies. Under this provision, a marketplace platform need only have a written agreement satisfying the 10 conditions shown in Figure 2 to classify its workers as independent contractors for all purposes under state and local laws.
  • Federal Law. Federal agencies apply their own tests to laws within their purview. A determination under Tennessee law that a worker is an independent contractor may or may not result in the same determination for purposes of other federal laws. Therefore, a company still needs to analyze its worker classification under other applicable tests.

 

(3) “ABC” Test No Longer Applies for Tennessee Employment Security Purposes.

  • The “ABC” will no longer be used. It is considered to be broader than the IRS 20-factor test. The 20-factor test may result in fewer workers being classified as employees.
  • A company doing business outside of Tennessee must consider whether the company is subject to other state law classification standards. Other states may still utilize the “ABC” test. Other states may not provide special carve-outs for digital companies.30
  • Five Key Take-aways for Attorneys
  • In light of the 20-factor test, review existing agreements or draft new agreements to clearly specify the duties of each, the extent of control, and the type of relationship. Advise the business if restructuring the relationship may be necessary to meet the desired classification.
  • Consider worker classification tests from all applicable state and federal agencies affecting the worker or business to determine whether workers qualify as independent contractors or employees. Enlist the assistance of a tax professional as needed.
  • Consider the relatively recent Marketplace Contractor and TNC laws in advising technology companies.
  • Independent contractors need to understand the implications of being self-employed, such as necessary tax filings. Costs, such as social security, unemployment taxes, supplies, insurance and other work-related expenses are paid by the worker, and not the company.
  • A company may misclassify a worker. Issuance of a 1099 by the employer does not automatically make the worker an employee. Advise the business of potential penalties for misclassification under various state laws, such as Tennessee’s Workers’ Compensation law.31

 

SANDRA S. (SANDY) BENSON graduated from Vanderbilt with a double-major in economics and business and received her law degree from the University of Georgia. She practiced law for more than 12 years before joining the Jones College of Business at Middle Tennessee State University where she is a professor of Business Law teaching corporate governance and fraud, health law, commercial law, and Dale Carnegie® Human relations courses. She was invited as a legal scholar to be on an episode of CNBC’s American Greed. Her work has been recognized by The Federal Research Division of the Library of Congress and she is a recipient of numerous teaching and research awards, including MTSU’s Outstanding Teaching and the NYSSCPA Max Block awards. She may be contacted at (615) 848-3525.


 

TIMOTHY R. (TIM) KOSKI is a professor of accounting at Middle Tennessee State University.  He received his law degree from the University of North Dakota, an LL.M in taxation from Southern Methodist University, and a Ph.D. from the University of Missouri. Before entering academia, he worked as a CPA for both a national and regional accounting firm and has several years’ experience as a practicing tax attorney. Dr. Koski specializes in taxation and has published more than 50 articles in a wide range of academic and professional journals.

 

The authors are grateful for research by graduate assistant Andrew Hughes. The views expressed herein are strictly those of the authors and should not be relied upon for any legal, accounting, or tax return position

 

NOTES

1. Tenn. Code Ann. § 50-7-207(b)(2)(B) as amended effective 1/1/2020 (“Any individual who performs services for an employer for wages if the services are performed by the individual qualify as an employer-employee relationship with the employer based upon consideration of the following twenty (20) factors as described in the twenty-factor test of lnternal Revenue Service Revenue Ruling 87-41,1987-1C.B. 296:”).

2. Tenn. Code Ann. § 50-3-103(7) as amended effective 1/1/2020 (“Employee”: (A) Means an individual who performs services for an employer for wages under a contract of hire if the services performed by the individual qualify as an employer-employee relationship with the employer based upon consideration of the following twenty (20) factors as described in the twenty-factor test of lnternal Revenue Service Revenue Ruling 87-41,1987-1C.B. 296:”).

3. Tenn. Code Ann. § 50-2-111(a) as amended effective 1/1/2020 (“This chapter only applies to an individual if the individual performs services for an employer for wages and the services performed by the individual qualify as an employer-employee relationship with the employer based upon consideration of the following twenty (20) factors as described in the twenty-factor test of lnternal Revenue Service Revenue Ruling 87-41,1987-1C.B. 296:”).

4. Tenn. Code Ann. §50-9-103(9) as amended effective 1/1/2020 (“Employee” means any individual who performs services for a covered employer for wages if the services performed by the individual qualify as an employer-

employee relationship with the employer based upon consideration of the following twenty (20) factors as described in the twenty-factor test of lnternal Revenue Service Revenue Ruling 87-41,1987-1C.B. 296:”).

5. Rev. Rul. 87-41, 1987-1 C.B. 296.

6. See Beare Co. v. State, 814 S.W.2d 715 (Tenn. 1991) (in determining whether the workers were employees, the Supreme Court stated that the same seven common law factors it established for workers’ compensation also applied to Tenn. Code Ann. § 50-7-207(b)(2)(B) related to worker classification for employment security taxes).

7. Tenn. Code Ann. § 50-7-207(e) as amended effective 1/1/2020.

8. See Tenn. General Assemble Fiscal Review Committee, Fiscal Memorandum SB 466-HB 539, Mar. 20, 2019, http://www.capitol.tn.gov/Bills/111/Fiscal/FM0747.pdf.

9. See Tenn. Code Ann. § 50-6-102(D).

10. Tenn. Code Ann. § 65-15-303(b)

11. Tenn. Code Ann. § 50-8-101 et seq.

12. Tenn. Code Ann. § 50-6-102(12)(D).

13. See Tenn. Code Ann. § 50-7-207(b)(2)(B) and Tenn. Code Ann. § 50-7-207(e).

14. See Masiers v. Arrow Transfer & Storage Co., 639 S.W.2d 654, 655 (Tenn. 1982).

15. Id.

16. Tenn. Code Ann. § 50-6-102(D)(i).

17. Tenn. Code Ann. § 65-15-302(b).

18. Tenn. Code Ann. § 65-15-302(c).

19. Tenn. Code Ann. § 50-8-101 et seq.

20. Tenn. Code Ann. § 50-8-101(1).

21. Tenn. Code Ann. § 50-8-101(2).

22. IRS Publication 15-A. Employer’s Supplemental Tax Guide.

23. Keith E. Sonderling, FLSA2019-6 Whether a service provider for a virtual marketplace company is an employee of the company under the FLSA or an independent contractor, (Dep’t of Labor April 29, 2019) https://www.dol.gov/whd/opinion/FLSA/2019/2019_04_29_06_FLSA.pdf.24 U. S. DEP’T OF LABOR EMP’T & TRAINING ADMIN, ST. L. INFO., COMPARISON OF S. UNEMPLOYMENT INS. LAWS

24. U. S. DEP’T OF LABOR EMP’T & TRAINING ADMIN, ST. L. INFO., COMPARISON OF S. UNEMPLOYMENT INS. LAWS 2019 1-5, https://oui.doleta.gov/unemploy/pdf/uilawcompar/2019/complete.pdf.

 

25. TENN. GENERAL ASSEMBLY FISCAL REVIEW COMMITTEE, FISCAL NOTE SB 466-HB 539, Feb. 21, 2019, http://www.capitol.tn.gov/Bills/111/Fiscal/SB0466.pdf. California recently enacted a law, effective 1/1/2020, applying the “ABC” test to California wage orders (covering minimum wages, maximum hours, and other basic working conditions). This law is expected to make it harder to classify workers as independent contractors. See John Myers, Johana Bhuiyan, & Margot Roosevelt, Newsom signs bill rewriting California employment law, limiting use of independent contractors, LA Times, Sept. 18, 2019.

 

26. IRS Publication 15-A. Employer’s Supplemental Tax Guide.

 

27. Platform companies have a variety of ways to arguably “control” workers, such as limiting the time to accept a job or terminating workers from the app if they fail to maintain top ratings. See Kristine M. Kuhn & Amir Maleki, Micro-Entrepreneurs, Dependent Contractors, and Instaserfs: Understanding Online Labor Platform Workforces, 31 Acad. of Mgmt Persp., no. 3, 2017 at 187–192.

 

28. In addition, carve-outs that previously existed and will remain in place for individuals who provide services as a leased operator or an owner-operator of motor vehicle under contract to a common carrier conducting an interstate business while engaged in interstate commerce. These individuals are deemed to be an excluded service for the purposes of this section, regardless of whether the common law relationship of master and servant exists. See Tenn. Code Ann. §§ 50-2-11(b) and 50-7-207(e)(1), as amended effective 1/1/2020.

 

29. Tenn. Code Ann. § 65-15-302(b).

 

30. See Maya Pinto, Rebecca Smith & Irene Tung, Rights at Risk: Gig Companies’ Campaign to Upend Employment as We Know It, Nat’l Emp. L. Project (Mar 25, 2019), https://s27147.pcdn.co/wp-content/uploads/Rights-at-Risk-4-2-19.pdf at 3 (according to this report, gig company carve-outs were part of a legislative strategy by certain companies and allies which by mid-2018 had passed in Tennessee and six other states, but failed or stalled in Georgia and North Carolina following concerns about the negative impact on small businesses that could not meet the special conditions).

 

31. The Tennessee Bureau of Workers’ Compensation concluded in its February 2019 report that the failure of employers to follow workers’ compensation laws to maintain workers’ compensation insurance coverage is a serious issue in Tennessee. From 9/17 -10/18, the Bureau assessed 260 employers for either not maintaining workers’ compensation insurance or misclassifying their employees, totaling more than $5.7 million in penalties, representing an increase of over 43% in monetary assessments from the prior year. See TENN. BUREAU OF WORKERS’ COMPENSATION, ANNUAL REPORT OF EMPLOYER COVERAGE COMPLIANCE, Feb. 1, 2019), https://www.tn.gov/content/dam/tn/workforce/documents/injuries/2019Compl....

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