On Jan. 8th, the U.S. Department of Labor issued its final rule (“Final Rule”) clarifying the standard for employee versus independent contractor status under the Fair Labor Standards Act (see https://bit.ly/371n8rp). The new rule was set to go into effect on March 8th, however, the Biden administration has delayed the rule’s effective date to May 7th. It may ultimately be withdrawn altogether. Whether or not the Final Rule goes into effect, it is important to review it and the independent contractor versus employee analysis as it relates to the real estate industry.
In New York, and nationwide, it is a widely accepted practice for real estate salespersons to be treated as independent contractors. Over the years there has been litigation brought against brokerage firms because agents have been requested to fulfill mandatory office hours, complete mandatory training and undertake other office responsibilities (e.g., answer phones, attend to the reception desk, etc.) that have traditionally been fulfilled by office staff rather than salespersons. This article will address the state of the law, particularly federal and New York law, as it applies to employment classification.
The U.S. Department of Labor’s Final Rule
The U.S. Department of Labor issued a press release (see https://bit.ly/3de6Nnd) wherein it summarizes the salient features of the Final Rule as follows:
• Reaffirms an “economic reality” test to determine whether an individual is in business for him or herself (independent contractor) or is economically dependent on a potential employer for work (FLSA employee).
• Identifies and explains two “core factors” that are most probative to the question of whether a worker is economically dependent on someone else’s business or is in business for him or herself:
• The nature and degree of control over the work.
• The worker’s opportunity for profit or loss based on initiative and/or investment.
Identifies three other factors that may serve as additional guideposts in the analysis, particularly when the two core factors do not point to the same classification. The factors are:
• The amount of skill required for the work.
• The degree of permanence of the working relationship between the worker and the potential employer.
• Whether the work is part of an integrated unit of production.
The actual practice of the worker and the potential employer is more relevant than what may be contractually or theoretically possible.
• Provides six fact-specific examples applying the factors.
Review of the ‘Eleven Factor’ IRS Independent Contractor Test
Although the Internal Revenue Service (the “IRS”) had previously used the “Twenty Factor” test, for purposes of determining whether a worker should be classified as an employee or an independent contractor, in an attempt the streamline the test, the IRS now uses the “Eleven Factor” test. These factors are also known as the “common law” rules (i.e., rules that have come into existence through the years from the case law and are not actual statutory rules passed by Congress or a state legislative body). The “Eleven Factor” test is organized into three categories: “behavioral control, financial control and the relationship of the parties.” (See https://www.irs.gov/pub/irs-pdf/p15a.pdf). Below are relevant excerpts taken from Publication 15-A issued by the IRS entitled “Employer’s Supplemental Tax Guide,” which detail and explain the 11 factors.
In the “behavioral control” category there are two distinct factors an employer needs to consider when determining whether there is an “employee” or “independent contractor” relationship:
1. Instructions that the business gives to the worker.
2. Training that the business gives to the worker.
The IRS explains that “[t]he key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.”
The next category focuses on “financial control.” In this category, an employer must assess whether the business has a “right to control” the business aspects of the worker’s job and the extent to which those controls exist. An employer must consider the following:
3. The extent to which the worker has unreimbursed business expenses.
4. The extent of the worker’s investment.
5. The extent to which the worker makes services available to the relevant market.
6. How the business pays the worker.
7. The extent to which the worker can realize a profit or loss.
Finally, an employer must determine the “type of relationship” that exists, based upon the following remaining factors:
8. Written contracts describing the relationship the parties intended to create.
9. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay.
10. The permanency of the relationship.
11. The extent to which services performed by the worker are a key aspect of the regular business of the company.
Every employer, including Brokers, should review each of the above factors carefully when determining how a particular worker is classified.
IRS: Licensed Real Estate Agents Are ‘Statutory Nonemployees’—What Does This Mean?
In Publication 15-A, the IRS also points out that licensed real estate agents are “statutory nonemployees.” It provides that licensed real estate salespersons are treated as self-employed for all federal tax purposes, including income and employment taxes, if the payments to them are based on sales, rather than hours works, and there is a written contract for their services which provides that they will not be treated as employees for federal tax purposes.
The fact that the IRS designates licensed real estate salespersons as “statutory nonemployees” does not mean that they are automatically deemed to be independent contractors. Brokers must still apply the “Eleven Factor” test in determining whether the salesperson is an employee or an independent contractor.
New York State ‘Carve Out’ Under Section 201(6) of Workers’ Compensation Law
New York State provides for an important “carve out” under the Workers’ Compensation Law (see https://bit.ly/2Z9Havw). Section 201(6) that specifically provides that the term “employment” will not include the services of a licensed real estate broker or sales associate if three requirements are met: “…(a) substantially all of the remuneration (whether or not paid in cash) for the services performed by such broker or sales associate is directly related to sales or other output (including the performance of services) rather than to the number of hours worked; (b) the services performed by the broker or sales associate are performed pursuant to a written contract executed between such broker or sales associate and the person for whom the services are performed within the past 12 to 15 months; and (c) the written contract provided for in subparagraph (b) of this paragraph was not executed under duress….” Section 201(6) further requires that in connection with subsection (c) above, the written agreement include additional provisions summarized as follows:
• the person, whether broker or salesperson (the “agent”), is engaged as an independent contractor associated with the firm for services performed in accordance with Article 12-A of the RPL, for all purposes, including among others, federal and state taxation, withholding, unemployment insurance and workers’ compensation;
• the agent shall be paid a commission for the gross sale, without deducting taxes, shall not receive any remuneration related to the number of hours worked; and shall not be treated as an employee, but as an independent contractor for federal and state tax purposes;
• the agent shall be permitted to work any hours he or she chooses;
• the agent shall be permitted to work from home or the office of the person for whom services are performed;
• the agent shall be free to engage in outside employment;
• office facilities and supplies may be provided by the firm for the use of the agent, but the agent shall otherwise bear his or her own expenses (i.e., automobile, travel, entertainment expenses, etc.);
• that the firm and the agent shall comply with the requirements of Article 12-A of the RPL, but such compliance shall not affect the agent’s independent contractor status nor will it be deemed that agent is an employee of the firm for any purpose whatsoever; and
• that the agreement and relationship may be terminated by either party thereto at any time upon notice given to the other.
While New York law does provide for this specific “carve out,” brokers must be sure to adhere to the requirements outlined above and also be sure to comply with the IRS “Eleven Factor” test.
New York City ‘Freelancers’ Clarification and the Independent Contractor Agreement
For brokers operating in New York City, it is recommended that additional language be added to the independent contractor agreement pursuant to New York City Administrative Code Title 20: Consumer Affairs, Chapter 10: Freelance Workers (FIFA) (see https://on.nyc.gov/374AjaT). Any independent contractor agreement should clarify that the term “Sales Associate” or “Licensed Real Estate Salesperson” shall be deemed to mean “Freelance Worker” and the term “Broker” shall also mean “Hiring Party” as defined in §20-927 of the New York City Administrative Code.
The New York State Association of Realtors, Inc. also recommends that the following additional provisions be added to the form of independent contractor agreement:
• The Sales Associate/Freelance Worker will provide the following services for the Broker/Hiring Party: lists for sale, sells, at auction or otherwise, exchanges, buys or rents, or offers or attempts to negotiate a sale, at auction or otherwise, exchange, purchase or rental of an estate or interest in real estate, or collects or offers or attempts to collect rent for the use of real estate, or negotiates or offers or attempts to negotiate, a loan secured or to be secured by a mortgage, other than a residential mortgage loan, as defined in §590 of the Banking Law, or other incumbrance upon or transfer of real estate, or is engaged in the business of a tenant relocator, as defined in §590 of the Real Property Law or who, notwithstanding any other provision of law, performs any of the above stated functions with respect to the resale of condominium property originally sold pursuant to the provisions of the General Business Law governing real estate syndication offerings. In the sale of lots pursuant to the provisions of Article 9-A of the Real Property Law employed by or on behalf of the owner or owners of lots or other parcels of real estate, to sell such real estate, or any parts thereof, in lots or other parcels, and who shall sell or exchange, or offer or attempt or agree to negotiate the sale or exchange, of any such lot or parcel of real estate.
Sales Associate/Freelance Worker shall be paid:
a. a commission on Sales Associate/Freelance Worker’s sales, if any, without deduction for taxes, which commission shall be directly related to sales or other output;
b. when the Sales Associate/Freelance Worker is the “procuring cause” of the transaction;
c. within 30 days of the receipt of the full commission paid to the Broker/Hiring Party for the transaction; and
d. pursuant to a separate “Commission Agreement” between the Sales Associate/Freelance Worker and Broker/Hiring Party.
• Broker shall not threaten, intimidate, discipline, harass, deny a work opportunity to or discriminate against a Sales Associate/Freelance Worker, or take any other action that penalizes a Sales Associate/Freelance Worker for, or is reasonably likely to deter a Sales Associate/Freelance Worker from, exercising or attempting to exercise any right guaranteed under this chapter, or from obtaining future work opportunity because the Sales Associate/Freelance Worker has done so.
Additionally, language should be included clarifying that the “Sales Associate/Freelance Worker” is an independent contractor and that nothing contained in the agreement shall be construed to create an employer/employee relationship of any kind, directly or inferred.
Real Estate Salespersons as Independent Contractors
While real estate salespersons have been traditionally characterized as independent contractors, federal law and state laws all vary. Therefore, before hiring any salesperson it is important for a brokerage firm to determine what the salesperson’s duties and functions will be. If, after a careful review of the IRS factors, applicable state laws and the case law, there still remains a question as to whether a salesperson should be classified as an employee or independent contractor, or in some circumstances both, then the broker should engage legal counsel. It is crucial for brokers to be aware of any changes in the independent contractor laws.
If it is found that a worker has been misclassified, the penalties and interest may be severe. However, even where an employer may have misclassified its workers, all hope is not lost, at least on the federal level. There is a “safe harbor” provision under Section 530 of the Internal Revenue Code and also the “Voluntary Classification Settlement Program” offered by the IRS, which may provide some relief to employers provided certain conditions are met (see https://bit.ly/3aOYVFI).
