Federal employee or contractor employee? How the law distinguishes between the two ... and why...

Federal law provides a number of tests that distinguish between employees and contractors. As the proportion of contractors in the federal workplace grows and the jobs done by federal employees and contractors sometimes merge, it becomes critical to make the correct distinction. If you err, you

Reasons for the Growth in the Number of Contractor Employees

"Doing more with less!" This is the proverbial mantra of each elected administration, especially in presidential election years. Achieving this stated goal often compels an administration to reduce the number of government employees by whatever means is most readily available: hiring freezes, buyouts, competitive sourcing, and other techniques. Each approach has made its rounds, and each has enjoyed a measure of success.

Yet, at the same time, as the number of civil servants in the Department of Defense has declined, the duties performed by these government employees have usually expanded. Moreover, paralleling the decline in the numbers of civil servants has been the steady migration of military personnel to more traditional military duties. With fewer hands to perform the duties generated by each new law and policy, other personnel resources have arisen to fill the expanding void caused by the disappearance of civil servants and the reassignment of military personnel. The source is primarily from the private sector, that is, contractor employees in the federal workplace.

The number of contractor employees working in the federal workplace has grown exponentially over the last decade. This phenomenon has provided exploding employment opportunities for both younger workers as well as retirees from civil service and military workforces. No one is surprised today that during one pay period, civil servants or military personnel are serving in mufti or in uniform and, in the next pay period, are contractor employees who often return to their former positions and perform identical duties in the same manner as they did before they "retired."

Although nothing may seem to have changed during such transitions, in fact, a tectonic shift has occurred. The fundamental difference is that the allegiance of the employee has swung from the United States of America to that of a business interest.

All military personnel and civil servants swear an Oath of Allegiance to the United States before they undertake the duties of their positions. On the other hand, employees who work for a business firm give their allegiance to that business--and the primary purpose of a business is to produce a profit. While it is entirely appropriate for a business to seek a profit, that goal is far removed from the purposes of government.

Central to the difference between public and private sectors is the approach that federal workers must employ with respect to their official duties. This is contrasted with employees from the private sector, whose motivations are vastly different. Before government employees may act, they first must identify the legal authority for their actions, and they must do this before they commence the action. It is their oath to the United States that compels this requirement to identify the legal basis for what they do each and every time. On the other hand, the employee of a contractor has no such duty; rather, a contractor employee must ascertain only that whatever is undertaken violates no legal prohibition or restriction.

The distance between these two approaches can be measured only in light years. To suppose that there is no real difference, that the distinction between a federal employee and a contractor employee is only marginal, is to suggest that infusing Type B negative blood into a person with Type A positive blood will have no deleterious consequences, when, in fact, it is fatal.

Although some contractor employees in the federal workplace present no issues to the federal government, others who work in the federal workplace are cause for concern. While there may be no issue with those contractors who perform custodial, clerical, maintenance, food service, and construction duties, there are major issues with any contractor employees who are placed in positions of responsibility where they may give direction or assign tasks to federal employees. There is also an issue for the federal government and its supervisors in directing, controlling, and supervising contractor employees in the federal workplace.

The reason for a lack of concern with respect to the former type of contractor employees is that their performance of contractual duties is of a nonpersonal services nature. Cause for concern with respect to the latter type of contractor employees is that their performance of contractual duties may involve personal services, thus giving rise to personnel, fiscal, and ethics issues that are discussed in greater detail later in this article.

How to Distinguish

The status of a nonfederal worker sitting next to you should never be determined by his or her title alone. Administrative boards and federal courts usually ignore labels, focusing instead on the facts and circumstances of each situation. These boards and courts analyze specific characteristics--such as behavioral and financial control and the relationship between the employer and the individual performing the services--before making a determination whether the individual is classified as an employee or as an independent contractor under common law rules.

Because of the tax implications inherent in the distinction between an employee and an employee of an independent contractor, the Internal Revenue Service (IRS) issues many of the regulations that govern the decision--employee or independent contractor. In the past, the IRS has employed a list of 20 factors. (For a more complete treatment of this and other topics, please refer to the article on the ASMC Web site--www.asmconline.org.) Recently, however, the IRS has increasingly employed three key factors in determining whether an individual is an employee or an independent contractor.

Behavioral Control

Does the government have the right to direct or control how the worker does the work? A worker is likely to be deemed a federal employee when the federal government has the right to direct and control the worker. If, for example, an individual receives extensive instructions from the federal government on how work is to be done, this suggests that the individual may be acting as a federal employee. Also, if the federal government provides the individual with training about required procedures and methods, this suggests that the federal government wants the work done in a certain way and, consequently, the individual may be deemed an employee.

Financial Control

Is there a right to direct or control the resourcing aspect of the work? For example, if the individual has made a significant investment in tools or other aspects of the work, then an independent contractor status may exist. While there is no precise dollar test, the amount of dollars invested must have some significance, although a significant investment alone is unnecessary to establish an .independent contractor status. Also, if the federal government refuses to reimburse a worker for some or all of his or her business expenses, then the worker may be an independent contractor, especially if the unreimbursed business expenses are significant. Finally, if the individual worker realizes a profit or incurs a loss, this suggests that he or she may be in business for himself or herself and, thus, may be an independent contractor.

Relationship of the Parties

How do the federal government and the individual worker perceive their relationship? For example, if individual workers receive benefits, this is an indication that they are employees. If, however, they receive no benefits, they could be considered either as federal employees or as employees of an independent contractor. A written contract may also indicate what the individual and the federal government intend. The existence of a contract may be critical, particularly if it is difficult, or impossible, to determine status based on other facts.

For a federal supervisor attempting to distinguish between a federal employee and an independent contractor, the list of four questions contained in the accompanying sidebar provides a guide. If the answer to any of the four questions is Yes, then the individual providing the service in question most likely could be classified as an employee of the federal government. If the answers to all four questions are No, then an independent contractor relationship may be established.

Why the Distinction Matters

There are many reasons why it is important to determine whether an individual is acting as an employee of an independent contractor or as a federal employee. Included are Antideficiency Act (ADA) implications, benefits and tax consequences, and the nature of restrictions on individual behavior in the workplace.

ADA Implications

One of the ADA statutes prohibits acceptance of personal services except when specifically authorized by law. For that reason, acceptance of unauthorized personal services from a contractor employee could result in an ADA violation, if determined under a formal investigation.

Benefits and Tax Consequences

Proper classification is important because if the veil of independent contractor status is pierced and an administrative or judicial determination is made that the contractor employees in fact are federal employees, such a determination may allow for these individuals to recover some of the plethora of benefits available to federal employees that had been denied them during the entire period during which they were misclassified. Considering the burgeoning number of contractor employees in the workplace, the costs to agencies that misclassify contractor employees could be massive.

Also, as soon as an employer-employee relationship is established--and unless otherwise exempt under law--the federal government is required to withhold certain deductions from its employees' salaries and wages. If, however, the individual is classified as an employee of an independent contractor, the federal government has no responsibility for withholding income and employment taxes; that duty falls to the independent contractor. Even so, the federal government is responsible for reporting to the Ins on compensation over $600 paid to individuals who are classified as employees of independent contractors on Form 1099-MISC, Miscellaneous Income.

In theory, the Ins may assess penalties for misclassification of an individual providing service to the federal government. However, liability for federal employment taxes may be relieved under some circumstances. (See the complete article on the ASMC Web site for more details.)

Restrictions on Conduct

The law imposes a series of restrictions on the workplace conduct of both federal employees and independent contractors. Misclassification--classifying an individual as a contractor employee rather than a federal employee--may cause an individual to violate some of these restrictions. These restrictions are discussed in more detail in the complete article on the ASMC Web site, to include the legal citations. A brief list of these restrictions includes the following:

* Acceptance of gifts: Federal employees face strict limits on gifts they may receive.

Post-government employment restrictions: Federal employees have limits on work they may accept after leaving federal service.

* Inherently governmental functions: Certain functions may be performed only by federal employees.

* Civil service laws apply to federal employees but never to contractor employees.

* Awards: Monetary and nonmonetary awards may be given to federal employees, within established limits, but there is no provision to give awards directly to contractor employees.

* Conflicts of interest: Many rules apply to federal employees.

What You Should Do

If you supervise contractor personnel, this article may have raised questions about the status of the individuals who work for you. If you wish, you can seek guidance from the IRS. If an individual believes that the federal government has made an inappropriate determination, he or she may submit to the IRS a Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding. During the pendency of the IRS's determination (which, the IRS notes in Form SS-8 instructions, may require approximately four months), the individual provider should be paid as an employee. If the IRS determines the correct classification to be an independent contractor, then the taxes withheld will be remitted to the individual.

While you can seek IRS guidance, you first should speak to your local legal counsel regarding the status of those who work for you. Together, you and your counsel may be able to arrive at a proper classification. You also may want to change some of your personnel policies in order to arrive at the desired classification.

Whatever you do, the author hopes that this article has convinced you of one thing. The difference between a federal employee and a contractor employee constitutes a distinction that makes a difference!

Remember: The essence of clear thinking is to make the right distinctions.

Questions that determine whether an individual is a federal employee or a contractor employee:

Does this individual provide essentially the same service as an employee of the federal government?

Has the individual previously been paid as a federal government employee to perform essentially the same tasks?

Does the federal government exercise control in establishing how the individual will perform or accomplish the service?

Will the individual supervise or direct federal government employees as part of the service provided?