Employment Classification — Practical Considerations for Studio Owners.
One of the decisions that any studio owner will need to make when they open their doors is whether to classify their instructor team as employees or independent contractors. In the 3 years I spent teaching at pole dance studios before I opened San Francisco Pole and Dance, I was hired as an independent contractor. When I opened my studio, I looked to the left and looked to the right and simply did what everyone else wad doing, hiring my team as independent contractors as well. Indeed, use of the independent contractor status seems to be the default classification used by most small fitness studios across the Bay Area.
The classification of workers is a hot topic in employment law today because of a shift in the way apps and technology are changing worker autonomy. One notable example is the ride sharing industry where Uber and Lyft are reaching settlements worth millions of dollars in employment status misclassification class action lawsuits. To date there are still not yet bright line rules for classification of workers in the sharing economy, where workers maintain a higher degree of control over their own schedules and the tools that they use to do their jobs than in previous eras.
After digging into the case law and regulatory statements passed down by the IRS, it became clear to me that the independent contractor status was likely the wrong designation for my business and so I decided to transition my instructor team from independent contractors to employees. Here, I’ll walk through the legal analysis that I undertook to reach this decision and the practical logistics of transitioning independent contractors to employees.
Note that this blog post should not be construed as legal advice and you reading this blog post does not create a legal relationship between me as the writer and you as the reader. Enjoy!
According to the IRS, the determination of whether to classify a worker as an independent contractor or an employee generally comes down to a question about how much control the employer has over someone who works for them. The more control, the more likely the worker should be classified as an employee.
The IRS defines three broad categories of control: (i) Behavioral — does the company have the right to control how the worker does his or her job, (ii) Financial Control — does the company provide the tools, space and systems that allow the worker to do their job, and (iii) Relationship Type — is the work performed a key aspect of the business?
On the behavioral prong, a level of control is clearly established at my business. The San Francisco Pole and Dance schedule dictates exactly which classes the instructors teach and the schedule is established before the instructors are hired. While I don’t tell my instructors exactly what moves and how to teach their classes, I do require them to work within a framework that provides a consistent customer experience for students regardless of which instructor is teaching.
For instance, instructors are required to do introductions and a warm up at the beginning of class that focuses at leasts 15 minutes on warming up the upper body and core muscles needed to do pole work, and to spend a minimum of another 15 minutes on flexibility. Exact movements are not listed but the structure is tight. The only autonomy truly granted is the decision about what specific tricks and spins and conditioning moves to work on, which on the whole, is a small piece of the business. Behavioral control — check.
In Dole vs. Snell, the court highlights a few of the elements that determine whether a business maintains financial control over their workers. In this case, a group of cake decorators argued that they were incorrectly misclassified as independent contractors. The Federal court agreed with them, finding that financial control was established because the employer cake company’s investment in the tools, rent for space, and advertising costs was significant in comparison to the cake decorators’ $400 investment in decorating tools. Financial control is similarly established at my business in the sense that San Francisco Pole and Dance provides the studio space, the poles, the mats, advertising, and the booking software that the instructor’s classes depend on. Financial control — check.
On the third prong, ‘Relationship control’, the test for control is whether the worker’s core business is related to the core business of the company. This one seems to be the most obvious one to me. At San Francisco Pole and Dance, our core business is the provision of pole, dance, aerial and mat classes. Similarly, the value provided by our instructors, who are all established and expert level teachers in the instruction of pole dance, aerial, flexibility and handstands classes is by the services’ nature the key aspect of the business. Relationship control — check.
Another test, developed by the California Supreme Court, is called the ‘Economic Realities Test’, originally introduced in a 1989 case, S. G. Borello & Sons, Inc. v. Department of Industrial Relations (“Borello”). Here, a family of farmers contracted to work as cucumber harvesters with a company that classified them as independent contractors. The court found that the workers were incorrectly classified as independent contractors, because “In no practical sense were [the farmers] acting as entrepreneurs operating independent businesses for their own accounts.”
The court in Borello came up with a list of 8 factors to determine the level of control that the company had over the harvester’s work. Again, evidence of control acts as proof that the workers should be classified as employees and not independent contractors. These factors include;
(a) whether the one performing services is engaged in a distinct occupation or business;
(b) the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
(c) the skill required in the particular occupation;
(d) whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work;
(e) the length of time for which the services are to be performed;
(f) the method of payment, whether by the time or by the job;
(g) whether or not the work is a part of the regular business of the principal; and
(h) whether or not the parties believe they are creating the relationship of employer-employee. This factor was explicitly stated to hold less weight compared to the other factors because it had no bearing on the actual legal definition of the employment relationship, just the company and harvester’s interpretation of their legal relationship.
The Borello factors may seem familiar because they closely align with the IRS’ categories of control. Applied to my business, these factors also strengthen the evidence that my instructors are less like entrepreneurs who rent space and work in my studio (a relationship that would make for an appropriate independent contractor designation) and more like employees, whose work is dependent on San Francisco Pole and Dance.
Thus, it became very clear to me that the independent contractor designation was incorrect for my instructors. Their services are the essential, core service that my business is built on, and the essential element of San Francisco Pole and Dance’s regular course of business. Too, these services are ongoing. They are not time-banded, unlike, for instance, workshops taught by a visiting instructor. Employment is at will and like most studios, the teaching instruction is necessarily taught at the studio’s physical location according to set, scheduled hours. Thus, the balance tips towards the employee designation.
Once I determined that my instructors were more correctly classified as employees, it was easyish to make the classification change relatively quickly. In order to transition my instructors from independent contractors to employees, I needed to make two big changes to the way that I was running my business; (i) payroll processing, and (ii) workers compensation insurance.
While relatively easy, it was unfortunately also relatively expensive. The expensive part is why the distinction between independent contractors and employees is such a hot topic right now. As a small business less than one year old, additional costs felt like the last thing that I needed. But on the whole, making the switch was likely the less expensive in the long run because I no longer run the risk of IRS penalty costs and back-taxes for incorrect classifications. A very wise tax law professor once told me that the IRS always finds you. It’s only a matter of time.
When my instructors were still classified as Independent Contractors, I didn’t need to worry about payroll taxes because Independent Contractors are required to pay that themselves. My workflow was as simple as generating a weekly payroll report through Mindbody and then Venmo-ing my instructors the money, using emojis to indicate services rendered. It was fun and simple but Venmo is not a service conducive to paying employees.
After comparing the product offerings between Zenefits and Zenpayroll, I decided to go Zenefits’ payroll processing service because it offers robust employee management tools for free in addition to payroll services. Another perk of automating the payroll processing through a company like Zenefits is that they generate the quarterly tax filings, saving a ton of administrative time.
Total cost for this service is an annual one-time payment of $1200. The cost in additional taxes for employee payments ends up being about 20% per hour per employee….so, substantial.
Note: Workers Compensation at a pole studio will end up being more expensive than workers compensation at a white collar office. This may seem to go without saying but I’ve consulted other studios who have been surprised by the high premiums.
I originally applied for workers compensation through Zenefits but their affiliated company refused to provide me with a quote due to the inherently risky nature of pole dancing and aerial sports. They referred me to The Hartford, one of the biggest insurance companies on the block. For a small business, workers compensation insurance is not cheap. I may have cried and briefly considered Libertarianism when I saw the quote. My annual premium is over $5,000 and after a $1600 down payment, I pay the remainder in $400 monthly installments. I wish it was cheaper, but it’s not. Since there are not very many companies that provide insurance for pole dance studios, it was one of only three options that I found.
Et voila! This is a relatively quick summary of my journey to transition my studio’s independent contractors to employees. Given the case law and IRS regulations, I believe that it was legally the right thing to do. The fees and penalties for incorrect classification are very expensive so the cost of not making this switch is really the risky decision in my mind. If you have had a similar experience or have any feedback generally, I’d love to hear it! Feel free to leave comments below. ❤