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Legal Matters: Preserving the Direct Seller & Independent Contractor Status
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Direct Selling Companies Donate $10.5 Million in Products to “Today” Show Toy Drive

The holidays will be brighter for thousands of children and families across the country this year, thanks to the efforts of direct selling companies whose pooled resources, collected through the Direct Selling Association (DSA), have accumulated just over $10.5 million in products and cash for the “Today” show Toy Drive.

Thirty-three companies, all members or applicant members of the DSA, donated items from stuffed animals and books to children’s jewelry and toiletries. The DSA made the official donation live on the “Today” show on November 28.

“The outpouring of support for this effort has been truly amazing,” said DSA President and CEO Neil Offen. “Our companies help people every day through the nature of the opportunities they offer, but their giving reaches far beyond their sales force and customers—it touches the lives of millions of others in need.”

Companies from the smallest, newest member applicants to the largest, most established companies participated in this effort. Donations ranging from a handful of products to more than $2.3 million in cosmetics and personal care products were received.

The following direct selling companies donated products and/or a monetary gift to the Toy Drive:

Avon Products Inc.
Bead Retreat
Cookie Lee Inc.
Creative Memories
Do Re Mi & You!
Essential Bodywear
Freelife International
The Happy Gardener
Home and Garden Party
Home Interiors & Gifts
The Longaberger Co.
LRL Books By You
Mary Kay Inc.
National Companies Inc.
Nu Skin Enterprises
Our Own Image
Oxyfresh Worldwide
The Pampered Chef
PartyLite Gifts Inc.
Premier Designs Inc.
Princess House Inc.
Quiet Places
Quixtar Inc.
Shaklee Corporation
Signature HomeStyles
Silpada Designs
Stampin’ Up!
Sunrider International
Tanner Companies
TARRAH Cosmetics
The Southwestern Co.
Tupperware Corporation
Weekenders USA Inc.

In 2004, direct selling companies donated more than $2.2 million in products and cash to the Toy Drive. According to representatives of the Toy Drive, the DSA is the only trade association participating in the program.
The “Today” show toy drive is a project of the Today Show Charitable Foundation Inc., a 501(c)(3) non-profit organization. Donations are matched with the needs of more than 200 organizations with which the Today Show Charitable Foundation works.

Last holiday season, “Today” viewers, Web site visitors and corporate contributors teamed up to provide a record $32.6 million worth of toys, books, games, clothing, toiletries, electronics, musical instruments, CDs, videos, cosmetics and other suitable gifts to more than 3 million children. .

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Legal Matters:
Preserving the Direct Seller & Independent Contractor Status of Your Sales Force
by Lew Janowsky

Direct selling companies have by and large always classified their salespersons as independent contractors, and not employees. The independent contractor classification appeared to be appropriate for salespersons engaged in direct sales to consumers for a variety of reasons. First and foremost, direct selling companies do not exercise the degree of control over salespersons that employers ordinarily do. Distributors or consultants sell product when they wish to engage in sales, with no set working hours. They have always been viewed by direct selling companies as running their own businesses and encouraged to thrive as entrepreneurs.

As the direct selling industry expanded and evolved, state and federal taxing authorities mounted numerous legal challenges to the independent contractor classification. These challenges continue to this day but, fortunately, with the passage of a federal “direct seller” statute in 1982, and the adoption by 32 states of direct seller statutes that parallel the federal law, the industry is certainly in a far better legal position to defend certain kinds of challenges that may be brought by a an individual salesperson, state taxing authority, and/or the U.S. Internal Revenue Service. This article will focus on how companies can preserve the direct seller and independent contractor status of their sales force and provide some general guidelines about when and how to effectively defend a legal challenge.

Salespersons Must Meet All the Elements of State and Federal Direct Seller Statutes to be Exempt from Payroll Withholding Taxes
There are three basic requirements for a company’s sales force to qualify as “non-employees” for purposes of state and federal withholding taxes. All three elements must be satisfied and they are as follows:

1. Salespersons sell consumer products (tangible or intangible products) in the home or from any other place that does not constitute a permanent retail establishment.
2. Salespersons’ compensation is based on product actually sold rather than on hours worked.
3. Salespersons perform services under written contract with the company where contract states salesperson “will not be treated as an employee with respect to such services for federal tax purposes.”

Faced with an audit by the U.S. Internal Revenue Service or state agency that collects withholding taxes, a direct selling company should always assert that its salespersons fall within the statutory definition of direct sellers. The same holds true for every company that must respond to a state agency that receives an unemployment claim from a salesperson. The direct seller exemption cannot be asserted, however, when a company is being audited by a state taxing authority or defending an unemployment claim in a state that has not adopted the direct seller statute. In the 18 states without direct seller statutes, companies have no choice but to assert the salespersons are independent contractors. As will be explained in more detail below, the 18 states without direct seller statutes apply either the common law or “abc” tests to determine whether the salespersons are exempt as independent contractors.

Over the years, direct selling companies have been assessed for payroll withholding taxes when they could have been avoided. For example, unless a company asserts the direct seller exemption, the IRS or state auditor is under no legal obligation to apply the statutory exemption on behalf of the company. There are, of course, instances when an auditor or state unemployment investigator will apply the exemption even though the company did not claim the exemption, but this is the exception, rather than the rule. Too many direct selling companies, especially those that have not had experience responding to tax audits or unemployment claims, will claim that the salespersons are exempt as independent contractors. The auditor will then apply the more difficult elements of the independent contractor test to the salespersons, and often conclude that the company’s salespersons failed to meet the test. The assessment can usually be reversed on appeal but only after a lengthy and costly appeals process.

Companies Remain at Risk for Remittance of State Withholding Taxes in States That Have Not Adopted Direct Seller Statutes
Over the years, the Direct Selling Association (DSA) has spearheaded the legislative efforts that resulted in the enactment of direct seller statutes in 32 states. The DSA’s resources are not unlimited and, moreover, there are certain states that have been particularly resistant to enacting the legislation, with New York being the prime example. Unless or until direct seller statutes are adopted in all 50 states, direct selling companies must always be concerned about meeting either the common law or “abc” test, depending on the particular state’s law.

States that apply the “common law” test for determining the independent contractor status of the salespersons will examine a variety of issues, and some factors are more important than others in the final analysis. It should be noted that some of the factors are generally not applicable to salespersons. Below is a list of factors that most common law states will consider, along with comments on each factor.

1. Instruction— Independent contractors are not required to follow instructions on how to perform services.
2. Training— An independent contractor possesses the skills necessary to perform the task and does not need additional training. Direct selling companies should “minimize” references to training in their business guides and materials; training can be accomplished through “testimonials” of experienced salespersons.
3. Integration into Direct Selling Company’s Business— Independent contractor services are not essential to the company’s business and are not incorporated into the product or services sold by the company. This can be problematic for direct selling companies to establish but, fortunately, it is a factor of less importance.
4. Services Personally Performed— Independent contractors should be able to subcontract all or a portion of the services performed.
5. Hiring, Supervising and Paying Assistants— Independent contractors can hire and supervise their own employees, but should not supervise, or be supervised by, the direct selling company’s employees.
6. Continuing Relationship— Independent contractors generally work on one project and move on, accepting additional projects when and if he or she is available. This factor is less important when examining salespersons.
7. Hours of Work— Independent contractors set their hours of work, working as necessary to accomplish the end result.
8. Time Requirement— Independent contractors usually have the right to work simultaneously for the direct selling company and others, as long as the end result is achieved.
9. Job Location— Independent contractors should be able to choose where to perform some, if not all, of the services.
10. Order of Sequence of Work— Independent contractors can control the manner and method of performing the services.
11. Reports Not Required— Independent contractors are only responsible for the end result, and are not required to submit interim reports.
12. Method of Payment— A flat-rate payment for the project is most consistent with independent contractor status, since the independent contractor is responsible for producing a completed project. This factor should not be applicable to salespersons.
13. Payment of Expenses— Independent contractors are expected to assume the burden of business expenses.
14. Tools and Equipment— Independent contractors should have the tools and equipment necessary to perform the services independently.
15. Significant Investment in Business— Independent contractors make an investment in tools, business equipment, publications, and supplies appropriate for his or her business. Salespersons should not receive sales materials (e.g., brochures) “free of charge.”
16. Realization of Profit or Loss— Independent contractors accept both the benefits and risks of a business transaction.
17. Working for Multiple Companies— Independent contractors can and do work for multiple firms simultaneously.
18. Services Available to the Public— Independent contractors offer their services to the general public.
19. Right to Discharge— A company can terminate an independent contractor’s relationship only according to the terms of the agreement. If the company’s termination is outside the scope of the agreement, the company will be liable for breach of contract.
20. Right to Quit— Independent contractors have an obligation to complete the work under contract.

States that apply the “abc” test will examine three factors, and all three parts of the “abc” test must be satisfied in order for the salesperson to be classified as an independent contractor.

1. Whether the salespersons are free from control over performance.
2. Whether salespersons perform services outside the regular course or place of the employer’s business— The “b” prong of the test has often proved difficult for direct selling companies to satisfy because many judicial decisions have held that since the direct selling company is in the business of selling and marketing products, the company’s salespersons perform services “in the regular course” of the direct selling company’s business. In other words, the direct selling company is dependent on the salespersons to sell its product so the salespersons perform services directly related to the company’s business.
3. Salespersons are customarily engaged in an independent business— The “c” prong of the “abc” test has also proved problematic for many direct selling companies. Some states will require that the salesperson remit the sales tax to the state in order for the salesperson to be engaged in an independent business. States will often look to see if the salesperson advertises his or her business in the yellow pages or on the Web in the salesperson’s name. The failure to advertise the business in the salesperson’s name can be evidence that the salesperson is not in business for himself or herself.

Conclusion
Direct selling companies must not take the direct seller and independent contractor status of their salespersons for granted. It is essential that companies understand that the direct seller exemption applies only in the context of payroll withholding taxes on the federal level and in the 32 states that have adopted direct seller statutes. In the remaining 18 states without direct seller statutes, companies must meet the more difficult common law or “abc” independent contractor tests if they are to prevail in an unemployment claim and/or state payroll tax audit. The direct seller test has no applicability outside the context of payroll withholding taxes or unemployment cases. Direct selling companies must meet the independent contractor tests when defending a salesperson’s claim for workers’ compensation benefits, wages, or complaints based on unlawful discrimination.

Lewis P. Janowsky is a partner in the Newport Beach, California-based law firm of Rynn & Janowsky, LLP. He currently serves on the Lawyers and Government Affairs Councils of the Direct Selling Association. Janowsky represents direct selling companies nationwide and has frequently participated as a panelist and speaker on various topics related to the direct selling industry.

The contents of this article should not be construed as legal advice or legal opinion; you are urged to consult your own attorney or Rynn & Janowsky, LLP concerning your particular situation and any specific questions you may have.

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