Neither Fish Nor Fowl: The Status of Real Estate Agents as Independent Contractors and Employees Under California Law
Real Estate Newsletter
An important issue in the real estate industry is the extent to which real estate agents can properly be classified as independent contractors. Brokers cannot limit their liability to third parties for the agent’s actions by seeking to classify their agents as independent contractors. But brokers can agree with their agents that the agents are independent contractors and not employees for other purposes.
As a general matter, the most significant factor under California law for determining whether a worker is an employee rather than an independent contractor is the right of the company to control the manner and means by which the work is performed to accomplish the desired result: if the person to whom the worker renders services retains the right to exercise such control, even if it is not exercised, then the relationship is one between an employer and an employee. (See S. G. Borello & Sons, Inc. v. Department of Indus. Relations, 48 Cal.3d 341, 350 (1989); see also Cal. Code Regs., tit. 22, § 4304-1 (2007).) Additional factors considered in making this determination include: (1) the right to terminate the worker at will; (2) engagement in a distinct occupation or business; (3) 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; (4) the skill required in a particular occupation; (5) who provides the “instrumentalities,” tools, and place of work (by statute, this factor will not be considered for unemployment insurance purposes); (6) the length of time for which the services are to be performed; (7) method of payment by time or by job; (8) whether the work is part of the general business of the principal; (9) whether the parties believe they are creating an employer-employee relationship; and (10) the realization of profit or loss by the worker. (See Information Sheet DE 231 Rev. 7 (12-06) (INTERNET); see also Section 220 of both the Restatement of Agency and the Restatement Second of Agency; Empire Star Mines Co. v. California Employment Commission, 28 Cal.2d 33, 43 (1946), overruled on other grounds by People v. Sims, 32 Cal.3d 468, 480 n.8 (1982); Tieberg v. Unemployment Ins. App. Bd., 2 Cal.3d 943, 949 (1970); S. G. Borello & Sons, Inc. v. Department of Indus. Relations, 48 Cal.3d 341, 350-351 (1989).)
For purposes of social welfare legislation, such as workers’ compensation coverage, courts focus on whether the worker is truly established as a business entity that can realistically provide the benefits required by law. Federal law uses various tests to determine independent contractor status, which generally mirror the tests under California law. For example, the Internal Revenue Service (IRS) uses a 20-factor test to determine employment for federal tax withholding purposes. (See Rev. Rul. 87-41, 1987-1 C.B. 296; Revenue Service Manual, 4600 Employment Tax Procedures, Exhibit 46401.)
Traditionally, both California courts and the IRS had a difficult time applying these factors to determine whether real estate salespersons qualified as employees or independent contractors. (See Grubb & Ellis Co. v. Spengler, 143 Cal.App.3d 890, 398 (1983); Resnik v. Anderson & Miles, 109 Cal.App.3d 569, 572-573 (1980); Gipson v. Davis Realty Co., 215 Cal.App.2d 190, 206-207 (1963).) Courts and administrative agencies were concerned that if they held a real estate salesperson to be an independent contractor, the broker for which the salesperson worked could try to insulate himself from liability to the public for fraud or ethical violations by a real estate salesperson acting under the direction of the broker. The IRS was concerned with the assignment of tax liability.
By statute, both California and the federal government adopted legislation applicable specifically to the real estate industry. Under these special laws, real estate salespersons can, under appropriate circumstances, be recognized as independent contractors for tax and certain other purposes. Because these statutes are limited in scope, a real estate salesperson can qualify as an independent contractor for certain purposes while simultaneously qualifying as an employee for other purposes.
The California legislature adopted a statute, effective 1991, which allows real estate salespersons to contract with a broker on either an employee or independent contractor basis. California Business and Professions Code section 10032 provides that, for statutory purposes other than eligibility for workers’ compensation benefits (and for purposes other than liability to third parties such as customers), a worker will be considered an independent contractor if he or she:
(1) Is licensed as an agent under the Business and Professions Code;
(2) Obtains substantially all of his or her payments for services directly related to sales or output rather than the number of hours worked; and
(3) Performs work under a written contract that provides that the individual will not be treated as an employee with respect to those services for state tax purposes.
The statute further provides that it shall not be interpreted or applied to affect the obligation of a broker to maintain workers compensation insurance, or to be responsible for the illegal acts of a salesperson licensed under the broker. Real estate salespersons cannot be classified as independent contractors for purposes of liability to third parties, such as members of the public.
The federal statute (26 U.S.C.A. § 3508(b)) allows real estate agents to be treated as independent contractors whose earnings are not subject to payroll tax withholding so long as they meet the following three tests:
(1) The worker is licensed as a real estate agent;
(2) Substantially all of the payments for the services performed as a real estate agent are directly related to sales or other output (including the performance of services) rather than to the number of hours worked; and
(3) The services are performed under a written contract that provides that the worker will not be treated as an employee with respect to his or her services for federal tax purposes. So long as these requirements are met, the real estate salesperson will not be subject to federal tax withholding regardless of whether he or she qualifies as an employee under the common law. (See Self-Employment Tax; Liability of Direct Seller, 1985-1 C.B. 292, Rev. Rul. 85-63, 1985 WL 286757 (1985).) However, the fact that the real estate salesperson is not an employee for tax withholding purposes will not preclude a finding that he or she is an employee for other purposes – such as the application of federal wage and hour law. (See, e.g., Esquivel v. Hillcoat Properties, Inc., 484 F.Supp.2d 582, 584 (W.D.Tex. 2007); see also Luther v. Z. Wilson, Inc., 528 F.Supp. 1166, 1172-1173 (S.D.Ohio 1981) and 29 C.F.R. §§ 779.316 and 779.317 (2007) (providing that the real estate industry is not subject to a “retail concept” for purposes of qualifying for the federal inside sales exemption.))
In summary, licensed real estate salespersons with written contracts can qualify as independent contractors for tax purposes under federal and California law and certain other statutory purposes under California law, while potentially qualifying as employees for purposes of workers’ compensation coverage, broker liability to third parties such as customers, and certain other federal employment laws. Accordingly, brokers and salespersons must exercise care in structuring their working relationships, and are advised to consult with qualified counsel regarding risk management based on the different treatment of the real estate salespersons for different purposes.