Step 9 - Grow Your Business By Hiring Employees or Sub-Reps

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Independent Contractors or Employees?

Introduction

Historically, independent manufacturers’s agents or manufacturers’s representatives have played a significant role in our economy. There are a number of reasons for the development of this practice and, while it is not a universal industry practice, it is certainly the practice in a significant segment of the economy.

Over the years, the Internal Revenue Service (IRS) has challenged the classification of independent contractors. The reasons for its challenges include concern for the alleged under-reporting of income; the alleged overstatement of business expenses by independent contractors, which would not have been incurred if the individual were an employee; and ensuring payment of taxes through withholding.

Every tax situation is different; therefore, the information included in this guide presents a general overview. It is not to be relied upon in lieu of a professional tax advisor, who should be consulted for advice on your specific circumstances. The manufacturers’s agent may be the independent contractor for a manufacturer and may also engage others as independent contractors. Therefore, the manufacturers’s representative will need to look at his/her relationships from both ends of the equation.

The reader should note that the IRS uses the term “sales agent” to identify several sales-related functions, including what we would consider to be a manufacturers’s agent or representative. Throughout the text, the individual that may be subject to reclassification is referred to as either salesperson or sales agent. We are keenly aware that terms mean different things to each individual. Therefore, we have chosen this nomenclature, for consistency, fully aware of these nuances. In the context of this guide, the terms “taxpayer” or “company” refer either to a manufacturer or “rep firm” that is engaging the individual as a sales agent.

The purpose of this guide is to present you with the opportunity to make an informed decision on whether to be, or to engage, an independent contractor; to evaluate whether you conduct your current relationships in a manner that might be upheld under scrutiny; and to prepare you in the event your relationships are challenged by government agencies.

What’s at Stake?

The determination of whether a salesperson is an employee or an independent contractor can have a wide range of ramifications. An employer is required to withhold income and Social Security taxes (FICA) from employees, as well as pay an employer’s share of Social Security. The employer is also liable for unemployment insurance tax (FUTA). Remember, the IRS is likely to make this assessment against the manufacturer, not the manufacturers’ agent. If the manufacturers’ agent has paid his or her taxes on the commission received, this will ultimately reduce the liability of the manufacturer, if the IRS prevails.

More important than the tax liability for the manufacturers’ agent, however, is the agent’s future status. While it may be the manufacturer who is “on the hook” for back taxes, if the IRS prevails, it will insist that in the future the manufacturer use only employees to perform the functions previously performed by the manufacturers’ agent.

In addition to tax responsibilities and liabilities, an employer is liable for workers’ compensation for an employee. Increasingly, Congress is holding the employer responsible for the benefits provided to an employee. For example, the so-called COBRA law (the Consolidated Omnibus Budget Reconciliation Act) requires an employer to continue health insurance coverage, under certain circumstances, for an employee when the employee has been terminated. Whether an individual is an employee or independent contractor will determine if the individual is covered by the Fair Labor Standards Act. In such a case, overtime and minimum wage rules may apply.

In addition, the status of the salesperson could determine the extent of the liability of the business for actions taken by the individual while performing work for the business.

This guide covers only the test for determining whether a salesperson is an employee or independent contractor for the purposes of Federal income tax, FICA and FUTA. There is, however, a common theme to the tests used for almost all purposes; therefore, how one fares under the tax test will provide some guidance for these other purposes.

It should be noted that, in addition to the liability for withholding or payment of taxes, an incorrect classification can result in the imposition of interest and penalties by the IRS. Suffice it to say, penalties and interest can quickly add to the potential liability of a taxpayer.

Audits

In most instances, the question of whether a salesperson is an employee or an independent contractor arises as the result of an IRS audit of the manufacturer engaging the individual, and, of course, no one volunteers to be the subject of an audit. Almost by definition, it places the taxpayer on the defensive. Questions like, “What have I done wrong?” and “What are they really looking for?” run through your mind.

Reviewing the company’s and the independent contractor’s policies and procedures on an annual basis is the type of preventive medicine that can make that audit a less than frightening experience. This is perhaps more true in an employment tax audit than in a “regular” auditing because the answers depend on a number of variables, as we shall see later.

If the tax man does call, what do you do? It is best to strike a cooperative tone. There is little to be gained by confrontation. The IRS has extensive enforcement authority; if it wants to see specific records, more often than not, it will eventually secure the authority to do so.

Second, do not volunteer more information than necessary. The auditor may be looking at a very narrow range of issues, and you certainly do not want to open up the proverbial can of worms.

Third, you should immediately contact your tax advisor, accountant or attorney. Ask if your advisor has specific experience and success in this area. If not, ask your advisor to recommend someone who does. Many advisors will suggest they meet with the IRS alone. Your advisor will protect your rights and keep the audit on a narrow track.

There is no way to predict if an audit is in your future. Likewise, the law does not specify either the time or place. Thanks to the Taxpayer Bill of Rights, the IRS must prescribe standards for selecting a time and place for taxpayer interviews. If the IRS is insistent on conducting a field audit at your office, it may be difficult to prevent it from taking place.

You do have the right, if you did not do so earlier, to suspend an interview at any time to consult with your tax advisor.

In the following sections, we will review how the IRS classifies an individual, the principles which apply, and how you can respond to a determination you believe to be incorrect.

Form 1099 and the Independent Contractor

A business must file a Form 1099-MISC for payments for services performed for a trade or business by people not treated as its employees, if the total payments in a year exceed $600. A copy is sent to the independent contractor and the IRS. A business is not required to issue Form 1099-MISC to corporations.

SS-8

Most manufacturers’ agents will not find themselves the subject of an audit with regard to their status as an independent contractor. More likely, the manufacturers’ agent will be “pulled in” to an audit of a manufacturer by the IRS in the form of a request to complete a questionnaire the IRS uses to collect information during an employment tax audit. The SS-8 form originally was a “rehash” of the infamous 20 questions, known as the common law test. The most recent version is based on the IRS’ internal training manual. Both the common law test and the training manual are discussed later in this guide. The IRS will ask both the manufacturer and the manufacturers’ agent to complete SS-8 forms. The IRS will use the information collected on the SS-8 form, as well as the information produced by the audit of the manufacturer, to make a determination of whether the manufacturers’ agent was an employee or independent contractor.

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After the Audit

Remember, the process usually begins with an audit of the company using independent contractors as salespersons. This may be the manufacturer or a manufacturers’ representative firm engaging “subagents.”

Throughout this text, references to the “taxpayer” or “company” refer to the manufacturer or the “rep firm” that is engaging the salesperson and is subject to the audit. Once an audit is conducted, the IRS agent will “write up” his or her findings. The taxpayer generally learns of the audit results when a notice of deficiency arrives in the mail, advising the taxpayer that taxes and penalties are owed.

The taxpayer has several courses of action, including internal IRS appeals and, ultimately, litigation, if the taxpayer chooses to pursue the matter. In any case, the taxpayer will have some opportunity to respond to the findings of the agent. There are several arguments to be made in an employment tax matter. One is to argue the common law test used by the IRS to determine whether an individual is an employee or independent contractor was improperly applied, and to use available administrative or judicial precedent to demonstrate why it was improperly applied. Another is to utilize the statutory “safe harbor,” Section 530, created by Congress in 1978.

In the audit of a business and the reclassification of independent contractors as employees, three tax responsibilities are usually at issue. The first is the employer’s responsibility to withhold income taxes from the wages paid an employee. The second is to pay the employer’s share and withhold the employee’s share of Federal Insurance Contributions Act (FICA) taxes. Finally, the employer is responsible for payments under the Federal Unemployment Tax Act (FUTA).

Typically, the audit will cover a three-year period. In addition to the deficiency, the IRS will assess a penalty for failure to deposit payroll taxes in a timely manner.

Even though an independent contractor may have properly paid taxes on income received from the company, the initial assessment by the IRS will generally reflect their assumption that those taxes were not withheld or paid. Therefore, the assessment will often appear to be a staggering amount. While by no means simple, there is a process to reduce that assessment by the amounts properly paid by the independent contractors, in the event the company is unable to establish a case on the merits the individual is indeed an independent contractor. It is a cumbersome initiative and is outside the purview of this guide. At this point, the important thing to remember is not to panic at the sight of the assessment.

Determining Whether an Individual is an Employee or Independent Contractor

Under the law, an individual performing service for the company will be classified in one of four categories: independent contractor, common law employee, statutory or legally defined employee, or statutory non-employee. For the manufacturers’ representative, the likely possibilities are independent contractor, common law employee, or statutory employee. Salespersons are generally not employees under common law rules if they meet all four of the following tests:

1. They depend almost entirely on their own initiative, efforts, skill and personality to retain old customers, develop new ones, and achieve a successful volume of sales.
2. They set their own working hours.
3. They pay their own expenses and are not reimbursed by the person or company they represent.
4. They are paid solely on a commission basis and their pay is derived from the results of their work. They are not guaranteed any minimum pay.

If a salesperson meets the above tests, the taxpayer does not have to withhold Federal income tax from his/her pay. However, even if a salesperson is not an employee under the usual common law rules, his/her pay may still be subject to Social Security (FICA) taxes and Federal unemployment (FUTA) taxes. To determine whether a salesperson is an employee for Social Security and Federal unemployment purposes, you must apply the statutory employee tests. A salesperson is an employee for Social Security and Federal unemployment purposes if he/she:

1. Works full-time for one person or company except, possibly, for sideline sales activities on behalf of some other person;
2. Sells on behalf of, and turns his/her orders over to, the person or company he/she works for;
3. Sells to wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments;
4. Sells merchandise for resale, or supplies for use in the customer’s business;
5. Agrees to do most of this work personally;
6. Has no substantial investment in the facilities that used to do the work, other than in facilities for transportation; and
7. Maintains a continuing relationship with the person or company he/she works for.

Common Law Test

Under the common law test, an individual generally is an employee if the person for whom the individual performs services has the right to control and direct that individual, both as to the result to be accomplished by the work and to the details and means by which that result is accomplished. An important factor under the test is the degree of control, or rights of control, the employer has over the manner in which the work is to be performed.

In determining if the necessary degree of control exists in order to find that an individual has common law employee status, the courts and the IRS ordinarily consider all of the facts of a particular situation, which are evaluated and weighed in light of the presence or absence of the various pertinent characteristics. The decision as to the weight to be accorded to any single factor depends upon both the activity under consideration and the purpose underlying the use of the factor as an element of the classification decision. Because of the particular attributes of a specific occupation, any single factor may be inapplicable.

The IRS starts out with this direction to its examiners:

“Worker status cannot be determined simply by looking at job titles. Facts must be developed to make a correct determination. When developing the facts, consider the following:

1. In making a determination, look at the entire relationship between a business and a worker. The relationship often has several facets; some indicating the business has control, while others indicate it does not.
2. Control is a matter of degree. In fact, even in the clearest case of an independent contractor, the worker is constrained in some way. Conversely, employees may have autonomy in some areas.

“It is important to first understand the work that is being performed and the business context in which it is being performed. The examiners need to identify and evaluate evidence. This is a critical point in case development.

“To make a correct determination regarding the status of the worker, examiners need to consider the evidence of both autonomy and the right to control.

“In determining whether a worker is an employee, first apply the common law rules.

“When an employer-employee relationship exists, it is of no consequence whether the employee is designated as a trustee, agent, independent contractor, or other title. Additionally, signing a contract does not always indicate the worker is self-employed. What does govern is the substance of a particular relationship, and consequently, employers cannot contract away their employment tax liabilities.

“Under the common law, a worker is an employee when the person for whom the services are performed has the right to control and direct the individual who performs the services. This control reaches not only the result to be accomplished, but also the details and means by which that result is to be accomplished. Note that control must be present, but need not actually be exercised. Also, note that courts have held that the degree of supervision necessary to demonstrate control is only ‘such supervision as the nature of the work requires.’ McGuire v. United States, 349 F. 2d 644, 646 (9th Cir. WA 1965).

“To determine whether the control test is satisfied in a particular case, the facts and circumstances must be examined. Questions about the relationship between the worker and the prospective employer are asked to ascertain control. Historically, this series of questions was called the twenty factor test. This is the number of objective pieces of information identified as relevant by analyzing the approaches that courts have developed in making employee status determinations.

“However, these are not the only factors that may be important, and in certain cases some of the traditional twenty factors may be disregarded as unimportant. Every piece of information in a case that helps the extent to which the firm does or does not retain the right to control the worker is important.

“There are four very important points to remember:

1. There is no magic number of relevant evidentiary factors.
2. Whatever the number of factors used, the factors merely point to facts to be used in evaluating the extent of the right to direct and control.
3. As in any examination, all relevant information needs to be explored before answering the legal question of whether the right to direct and control associated with an employment relationship exists.
4. The evidence you gather must be factual and well-documented. It must support your determination.
   “The pieces of information that are important to help determine employee status change over time because business relationships change over time. What might have been a crucial piece of evidence in 1985 on which to base a decision about whether a business retained the right to control a worker may not carry the same weight for making an employee status determination currently.

“If the relationship of employer-employee exists, the designation or description of the parties as anything other than that of employer-employee is immaterial. Contractual designation of a worker as an independent contractor cannot outweigh evidence regarding the actual relationship between worker and business.”

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The 20-Point Common Law Test

Traditionally, the IRS begins its analysis with the 20 common law factors that courts have identified over the years as they grappled with the fact-intensive cases. The 20 points are set forth below:

1. Instructions. An employee is required to comply with instructions about when, where and how to work. Even if no instructions are given, the control factor is present if the employer has the right to give instructions.
2. Training. An employee is trained to perform services in a particular manner. Independent contractors ordinarily use their own methods and receive no training from the purchasers of their services.
3. Integration. An employee’s services are integrated into the business operations because the services are important to the success or continuation of the business. That shows the employee is subject to direction and control.
4. Services rendered personally. An employee renders services personally. That shows the employer is interested in the methods, as well as the results.
5. Hiring assistants. An employee works for an employer that hires, supervises and pays assistants. An independent contractor hires, supervises, and pays assistants under a contract that requires him or her to provide materials and labor, and to be responsible only for the result.
6. Continuing relationship. An employee has a continuing relationship with an employer. This indicates an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring, although irregular, intervals.
7. Set hours of work. An employee has set hours of work established by an employer. An independent contractor is the master of his or her own time.
8. Full-time work. An employee normally works full-time for an employer. An independent contractor can work when and for whom he or she chooses.
9. Work done on premises. An employee works on the premises of an employer, or works on a route or at a location designated by an employer.
10. Order or sequence set. An employee must perform services in the sequence set by an employer. This shows the employee is subject to direction and control.
11. Reports. An employee submits reports to an employer. This shows the employee must account to the employer for his or her actions.
12. Payments. An employee is paid by the hour, week or month. An independent contractor is paid by the job or on a straight commission.
13. Expenses. An employee’s business and travel expenses are paid by an employer. This shows the employee is subject to regulation and control.
14. Tools and materials. An employee is furnished significant tools, material and other equipment by an employer.
15. Investment. An independent contractor has a significant investment in the facilities he or she uses in performing services for someone else.
16. Profit or loss. An independent contractor can make a profit or suffer a loss.
17. Works for more than one person or firm. An independent contractor gives his or her services to multiple, unrelated persons or firms at the same time.
18. Offers services to general public. An independent contractor makes his or her services available to the general public.
19. Right to fire. An employee can be fired by an employer. An independent contractor cannot be fired as long as he or she produces a result that meets the specifications of the contract.
20. Right to quit. An employee can quit his or her job at any time without incurring liability. An independent contractor usually agrees to complete a specific job and is responsible for its satisfactory completion, or is legally obligated to make good for failure to complete the job.

A New View of Classifications

In 1978, Congress, at the behest of the private sector, prohibited the IRS from issuing any rules or regulations regarding employment tax status.

As a result, the IRS and taxpayers have relied on 20 common law factors that have been in place for many years. They have not stood the test of time, and many no longer have a place in the modern economic environment.

The IRS found a way in the mid-1990s, without violating the statutory prohibition on employment status rules, to provide some insight to its field staff and to taxpayers as to what the IRS now believes are important criteria for making a determination of whether an individual is an independent contractor or employee.

The IRS issued a training manual for its field staff on how to conduct a classification audit. The manual established a new set of criteria which, as a practical matter, was expected to replace the 20-point common law test, but both remain relevant.

In the introduction to the manual, the IRS reminds its field staff that, “EITHER WORKER CLASSIFICATION — INDEPENDENT CONTRACTOR OR EMPLOYEE — CAN BE A VALID AND APPROPRIATE BUSINESS CHOICE.” While the manual cannot be cited as precedent, it does provide insights as to how the IRS will evaluate a particular relationship. As such, it takes on great significance and should be read carefully.

Much of the text that follows is taken verbatim from the text of the IRS manual. REMEMBER, THIS IS THE IRS INTERPRETATION OF WHAT IS IMPORTANT. IT DOES NOT MEAN THIS IS THE CORRECT INTERPRETATION OR THAT WE AGREE WITH THE INTERPRETATION. It is set forth merely so you can understand how the IRS will review your situation.

The following reflects primary categories of evidence and includes examples of key facts upon which the IRS has placed a priority.

Behavioral Control — Facts which illustrate whether there is a right to direct or control how the worker performs the specific task for which he or she is engaged:

• instructions
• training

Financial Control — Facts which illustrate whether there is a right to direct or control how the business aspects of the worker’s activities are conducted:

• significant investment
• unreimbursed expenses
• services available to the relevant market
• method of payment
• opportunity for profit or loss

Relationship of the Parties — Facts which illustrate how the parties perceive their relationship:

• intent of parties/written contracts
• employee benefits
• discharge/termination
• regular business activity

Behavioral Control

Instructions

Virtually every business will impose on individuals, whether independent contractors or employees, some form of instruction (for example, requiring that the job be performed within specified time frames). This fact alone is not sufficient evidence to determine the individual’s status, according to the IRS.

As with every relevant fact, the goal is to determine whether the business has retained the right to control the details of an individual’s performance or instead has given up its right to control those details. Accordingly, the weight of “instructions” in any case depends on the degree to which instructions apply to HOW THE JOB GETS DONE rather than to the END RESULT.

Types of Instructions

Instructions about how to do the work may cover a wide range of topics, for example:

• when to do the work
• where to do the work
• what tools or equipment to use
• what workers to hire to assist with the work
• where to purchase supplies or services
• what work must be performed by a specified individual (including ability to hire assistants)
• what routines or patterns must be used
• what order or sequence to follow

Prior Approval

The requirement that an individual obtain approval before taking certain actions is an example of instructions.

Degree of Instruction

The degree of instruction depends on the scope of instructions, the extent to which the business retains the right to control the individual’s compliance with the instructions, and the effect on the individual in the event of noncompliance. All these provide useful clues for identifying whether the business keeps control over the manner and means of work performance (leaning toward employee status), or only over a particular product or service (leaning toward independent contractor status).

The more detailed the instructions are that the individual is required to follow, the more control the business exercises over the individual, and the more likely the business retains the right to control the methods by which the individual performs the work. Absence of detail in instructions reflects less control.

Presence of Instructions or Rules Mandated by Governmental Agencies or Industry-Governing Bodies

Although the presence and extent of instructions is important in reaching a conclusion as to whether a business retains the right to direct and control the methods by which an individual performs a job, it is also important to consider the weight to be given those instructions if they are imposed by the business only in compliance with governmental or governing body regulations. If a business requires its individuals to comply with rules established by a third party (for example, municipal building codes related to construction), the fact that such rules are imposed by the business should be given little weight in determining the individual’s status. However, if the business develops more stringent guidelines for an individual in addition to those imposed by a third party, more weight should be given to these instructions in determining if the business has retained the right to control the individual.

Instructions by Customer

If the customer tells the business that engages the individual HOW work is to be done, the IRS advises its staff this type of evidence must be evaluated with great care.

If the business passes on the customer’s instructions about HOW to do work as its own, the business has, in essence, adopted the customer’s standards as its own. The IRS advises its staff not to disregard the instructions and standards merely because they originated with the customer.

Suggestions v. Instructions

A SUGGESTION does not constitute the right to direct and control. For example, a dispatcher may suggest avoiding Highway “X” because of traffic congestion. However, if compliance with the SUGGESTIONS is mandatory, then the SUGGESTIONS are, in fact, INSTRUCTIONS.

Nature of Work for Instructions

An employment relationship may also exist when the work can be done with a minimal amount of direction and control, such as work done by a stock person, store clerk or gas station attendant. The absence of NEED to control should not be confused with the absence of RIGHT to control. According to the IRS, the key fact to consider is whether the business retains the RIGHT to direct and control the individual, regardless of whether the business actually exercises that right.

Evaluation Systems

Like instructions, evaluation systems are used by virtually all businesses to monitor the quality of work performed by individuals, whether independent contractors or employees. Thus, in analyzing whether a business’ evaluation system provides evidence of the right to control work performance or the absence of such a right, the IRS tells its field staff to look for evidence of how the evaluation system may influence the individual’s behavior in performing the details of the job.

If an evaluation system measures compliance with performance standards concerning the DETAILS of HOW the work is to be performed, the system and its enforcement is evidence of control over the individual’s behavior. However, not all businesses have developed formal performance standards or evaluation systems. This is especially true of smaller businesses. The lack of a formal evaluation system is a neutral fact.

Training

Training is a classic means of explaining detailed methods and procedures to be used in performing a task. Periodic or ongoing training provided by a business about procedures to be followed and methods to be used indicates the business wants the services performed in a particular manner. This type of training is strong evidence of an employer-employee relationship.

However, not all training rises to this level. The following types of training, which might be provided to either independent contractors or employees, should be disregarded:

• orientation or information sessions about the business’ policies, product lines, or applicable statutes or government regulations
• programs that are voluntary and are attended by an individual without compensation

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Financial Control

Economic Aspects of the Relationship

Economic aspects of the relationship between the parties are frequently analyzed in determining the individual’s status. These illustrate whom has financial control of the activities undertaken. The items that usually will be explored are:

• significant investment
• unreimbursed expenses
• services available to the relevant market
• method of payment
• opportunity for profit or loss

All of these can be thought of as bearing on the issue of whether the recipient has the right to direct and control the means and details of the business aspects of how the individual performs services. The first four items are important in their own right, but also affect whether there is an opportunity for the realization of profit or loss.

Economic Dependence

Although economic aspects of the relationship between an individual and a business are significant in determining an individual’s status, it is equally important to understand that some features of the economic relationship are NOT relevant. According to the IRS, the question to be asked is whether the recipient has the right to direct and control business-related means and details of the individual’s performance. THE QUESTION IS NOT WHETHER THE INDIVIDUAL IS ECONOMICALLY DEPENDENT ON OR INDEPENDENT OF THE BUSINESS FOR WHICH SERVICES ARE PERFORMED. THIS ANALYSIS HAS BEEN REJECTED BY CONGRESS AND THE SUPREME COURT AS A BASIS FOR DETERMINING INDIVIDUAL CLASSIFICATION. Nationwide Mutual Insurance Co. v. Darden, 503 U.S. 318 (1992). AS A RESULT, THE INDIVIDUAL’S ECONOMIC STATUS IS INAPPROPRIATE FOR USE IN ANALYZING AN INDIVIDUAL’S STATUS.

Significant Investment

A significant investment is evidence that an independent contractor relationship may exist. The IRS notes, however, that a significant investment is NOT necessary for independent contractor status. Some types of work simply do not require large expenditures. Further, even if large expenditures (such as costly equipment) are required, an independent contractor may rent the equipment needed at fair rental value.

No Dollar Limitation on Investment

There are no precise dollar limits that must be met in order to have a significant investment. However, the investment must have substance. Further, as long as the individual pays fair market or fair rental value, the individual’s relationship to the seller or lessor is irrelevant. The size of the individual’s investment and the risk borne by the individual are not diminished merely because the seller or lessor receives the benefit of the individual’s services.

Business Expenses

The extent to which an individual chooses to incur expenses and bear their costs impacts the individual’s opportunity for profit or loss. This constitutes evidence that the individual has the right to direct and control the financial aspects of the business operations. Although not every independent contractor need make a significant investment, almost every independent contractor will incur an array of business expenses either in the form of direct expenditures or in the form of fees for pro rata portions of one or several expenses. These MAY include:

• rent and utilities
• tools and equipment
• training
• advertising
• payments to business managers and agents
• wages or salaries of assistants
• licensing/certification/professional dues
• insurance
• postage and delivery
• repairs and maintenance
• supplies
• travel
• leasing of equipment
• depreciation
• inventory/cost of goods sold

Reimbursed Expenses

Businesses often pay business or travel expenses for their employees. However, independent contractors’ expenses may also be reimbursed. Independent contractors may contract for direct reimbursement of certain expenses or seek to establish contract prices that will reimburse them for these expenses. The IRS advises its field staff to focus on UNREIMBURSED expenses, which better distinguish independent contractors and employees, inasmuch as independent contractors are more likely to have unreimbursed expenses.

Unreimbursed Expenses

If expenses are unreimbursed, then the opportunity for profit or loss exists. Fixed ongoing costs that are incurred, regardless of whether work is currently being performed, are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their businesses. Thus, relatively minor expenses incurred by an individual, or more significant expenses that are customarily borne by an employee in a particular line of business, such as an auto mechanic’s tools, would generally NOT indicate an independent contractor relationship.

Services Available

An independent contractor is generally free to seek out business opportunities. Indeed, the independent contractor’s economic prosperity depends on doing so successfully. As a result, independent contractors often advertise, maintain a visible business location, and are available to work for the relevant market.

Of course, these activities are not essential for independent contractor status. An independent contractor with special skills may be contacted by word of mouth without the need for advertising. An independent contractor who has negotiated a long-term contract may find advertising equally unnecessary and may be unavailable to work for others for the duration of the contract. Further, other independent contractors may find that a visible business location does not generate sufficient business to justify the expense. Therefore, the absence of these activities is a neutral fact.

Method of Payment

The method of payment may be helpful in determining whether the individual has the opportunity for profit or loss.

Salary or Hourly Wage

An individual who is compensated on an hourly, daily, weekly or similar basis is guaranteed a return for labor. This is generally evidence of an employer-employee relationship, even when the wage or salary is accompanied by a commission. However, in some lines of business, such as law, it is typical to pay independent contractors on an hourly basis.

Flat Fee

Performance of a task for a flat fee is generally evidence of an independent contractor relationship, especially if the individual incurs the expenses of performing the services. When payments are made (daily, weekly, or monthly) is not relevant.

Commissions

A commission-based individual may be either an independent contractor or employee. The individual’s status may depend on the individual’s ability to realize a profit or incur a loss as a result of services rendered.

Realization of Profit and Loss

The ability to realize a profit or incur a loss is probably the strongest evidence that an individual controls the business aspects of services rendered. The facts already considered — significant investment, unreimbursed expenses, making services available, and method of payment — are all relevant in this regard.

If the individual is making decisions that affect his or her bottom line, the individual likely has the ability to realize profit or loss. Examples include decisions regarding the types and quantities of inventory to acquire, the type and amount of monetary or capital investment, and whether to purchase or lease premises or equipment. Remember, employees can also make these decisions, but they do not usually affect the employee’s bottom line.

It is sometimes asserted that because an individual can receive more money by working longer hours or receive less money by working fewer, the individual has the ability to incur a profit or loss. This type of income variation, however, is also consistent with employee status and does not distinguish employees from independent contractors.

Not All Facts Required

Note that NOT ALL financial control facts need to be present in order for the individual to have the ability to realize profit or loss. For example, an individual who is paid on a straight commission basis, makes business decisions, and has unreimbursed business expenses would likely have the ability to realize profit or loss — even if the individual does not have a significant investment and does not market services.

Relationship of the Parties

Intent of Parties/Written Contract

Courts often look at the INTENT of the parties. This is most often embodied in their contractual relationship. Thus, a written agreement describing the individual as an independent contractor is viewed as evidence of the parties’ intent that an individual is an independent contractor.

A contractual designation, in and of itself, is not sufficient evidence for determining an individual’s status. The facts and circumstances under which an individual performs services are determinative of the individual’s status. This means the SUBSTANCE of the relationship, NOT THE LABEL, governs the individual’s status. The contract may, however, be relevant in ascertaining methods of compensation, expenses that will be incurred, and the rights and obligations of each party with respect to HOW work is to be performed.

In addition, if it is difficult, if not impossible, to decide whether an individual is an independent contractor or an employee, the INTENT of the parties, as reflected in the contractual designation, is an effective way to resolve the issue. The contractual designation of the individual is “very significant in close cases.” See, Illinois Tri-Seal Prods., Inc. v. United States, 353 F.2d 216, 218 (Ct. Cl. 1965).

Forms W-2

Filing a Form W-2 usually indicates the parties’ belief that the individual is an employee. However, individuals have succeeded in obtaining independent contractor status even when Forms W-2 were filed. See e.g., Butts v. Commissioner, T.C. Memo 1993-478, aff’d per curiam 49 F.3d 713 (11th Cir. 1995).

Incorporation

Questions sometimes arise concerning whether an individual who creates a corporation through which to perform services can be an employee of a business that engages the corporation. Provided the corporate formalities are properly followed and at least one non-tax business purpose exists, the corporate form is generally recognized for both state law and federal law, including federal tax, purposes. Disregarding the corporate entity is generally an extraordinary remedy applied by most courts only in cases of clear abuse. Thus, the individual will usually not be treated as an employee of the business, but as an employee of the corporation.

However, the fact that an individual receives payment for services from a business through the individual’s corporation does not automatically require a finding of independent contractor status with respect to those services. For example, a professional athlete who attempted to assign a salary received from the team to a wholly-owned professional corporation was nevertheless held by the Tax Court to be a common law employee of the team, rather than the professional corporation. Sargent v. Commissioner, 93 T.C. 572 (1989), rev’d 929 F.2d 1252 (8th Cir. 1991).

Employee Benefits

Providing an individual with employee benefits traditionally associated with employee status has been an important fact in several recent court decisions. If an individual receives employee benefits, such as paid vacation days, paid sick days, health insurance, life or disability insurance, or a pension, this constitutes some evidence of employee status. The evidence is strongest if the individual is provided with employee benefits under a tax-qualified retirement plan, IRC section 403(b) annuity, or cafeteria plan, for, by statute, these employee benefits can ONLY be provided to employees. Some decisions, however, have ascribed less weight to the fact that employee benefits were provided.

If an individual is excluded from a benefit plan because the individual is not considered an employee by the business, this is relevant (though not conclusive) in determining the individual’s status as an independent contractor. In contrast, if the individual is excluded on some other grounds (e.g., the individual’s work location or business unit), the exclusion is irrelevant in determining whether the individual is an independent contractor or an employee. This is because none of these employee benefits is required to be provided to employees. Many individuals whose status as bona fide employees is unquestioned receive no employee benefits. This pattern is possible even if some individuals in a business receive employee benefits, for there is no requirement that ALL individuals be covered.

Discharge/Termination

The circumstances under which a business or an individual can terminate their relationship have traditionally been considered useful evidence bearing on the status the parties intended the individual to have.

Under a traditional analysis, a business’ ability to terminate the work relationship at will, without penalty, provided a highly effective method to control the details of how work was performed and, therefore, tended to indicate employee status. Conversely, in the traditional independent contractor relationship, the business could terminate the relationship only if the individual failed to provide the intended product or service, thus indicating the parties’ intent that the business not have the right to control how the work was performed.

In practice, however, businesses rarely have complete flexibility in discharging an employee. The business may be liable for pay in lieu of notice, severance pay, “golden parachutes,” or other forms of compensation when it discharges an employee. In addition, the reasons for which a business can terminate an employee may be limited, whether by law, by contract, or by its own practices. As a result, inability to freely discharge an individual, by itself, no longer constitutes persuasive evidence that the individual is an independent contractor.

Looking at the issue from the other angle, an individual’s ability to terminate work at will was traditionally considered to illustrate that the individual merely provided labor and tended to indicate an employer-employee relationship. In contrast, if the individual terminated work, and the business could refuse payment or sue for nonperformance, this indicated the business’ interest in receipt of the product or service for which the parties had contracted and tended to indicate an independent contractor relationship.

In practice, however, independent contractors may enter into short-term contracts for which nonperformance remedies are inappropriate or may negotiate limits on their liability for nonperformance.

At the same time, businesses may successfully sue employees for substantial damages resulting from their failure to perform the services for which they were engaged. As a result, the presence or absence of limits on an individual’s ability to terminate the relationship themselves, no longer constitutes useful evidence in determining an individual’s status. On the other hand, a business’ ability to refuse payment for unsatisfactory work continues to be characteristic of an independent contractor relationship.

Because the significance of facts bearing on the right to discharge/terminate is so often unclear, and depends primarily on contract and labor law, the IRS advises its field staff this type of evidence should be used with great caution.

Permanency

Courts have considered the existence of a permanent relationship between the individual and the business as relevant evidence in determining if there is an employer-employee relationship.

Indefinite Relationship

If a business engages an individual with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence of their intent to create an employment relationship.

Long-Term Relationship

A relationship that is created with the expectation that it will be indefinite should not be confused with a long-term relationship. A long-term relationship may exist between a business and either an independent contractor or an employee.

The relationship between the business and an independent contractor may be long-term for several reasons:

• the contract may be a long-term contract
• contracts may be renewed regularly due to superior service, competitive costs, or lack of alternative service providers

A business may also have a relationship with an employee that is long-term, but not indefinite. This could occur if temporary employment contracts are renewed or if a long-term, but not indefinite, employment contract is entered into. As a result, according to the IRS, a relationship that is long-term, but not indefinite, is a neutral fact that should be disregarded.

Temporary Relationship

According to the IRS, a temporary relationship is also a neutral fact that should be disregarded. An independent contractor will typically have a temporary relationship with a business, but so will employees engaged on a seasonal project, or “as needed” basis.

Regular Business Activity

The courts have looked at the services performed by the individual, and the extent to which those services are performed, as a key aspect of the regular business of the company.

In considering this evidentiary fact, according to the IRS, the mere fact that a service is desirable, necessary or even essential to a business does not mean the service provider is an employee. An appliance store needs individuals to install electricity and plumbing in the store building. However, this work can be done equally well by independent contractors or employees.

In contrast, the work of an attorney or paralegal is part of the regular business of a law firm. If a law firm hires an attorney or paralegal, it is likely the firm will present their work as its own. As a result, there is an increased probability that the law firm will direct or control their activities.

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Facts of Lesser Importance

The following are facts that the IRS now believes provide less useful evidence of whether an individual is an independent contractor or an employee. In past decades, these facts were probably more important. However, recent court decisions give them little independent weight. To the extent these facts continue to have relevance, they are generally already reflected in the types of evidence described previously.

• Part-Time or Full-Time Work
• Place of Work
• One Location
• Different Locations
• Hours of Work

Revenue Rulings

Occasionally, when the IRS believes there is adequate interest in a particular subject, it will issue what is known as a “revenue ruling.” A revenue ruling establishes an administration precedent which agents cite in determining the appropriate status of an individual.

With respect to sales agents or manufacturers’ representatives, the IRS issued two revenue rulings back-to-back. In the first, Revenue Ruling 70-586, the sales agent was found to be an employee. In the second, Revenue Ruling 70-587, the sales agent was found to be an independent contractor. These are not the only two revenue rulings of interest. Several other rulings touch on various aspects of the sales representation relationship, but for the most part, these two rulings are the starting point for the IRS analysis.

In virtually any case involving sales, regardless of the nomenclature used, the IRS is almost certain to cite these two revenue rulings. A taxpayer confronted with a reclassification audit, by comparing the taxpayer’s circumstances to the fact patterns established in these two revenue rulings, can establish a framework for structuring the relationship between the taxpayer and the sales agent.

Revenue Ruling 70-586

“The question presented is whether sales agents engaged by a manufacturing company are employees of the company for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (Chapters 21, 23 and 24, respectively, Subtitle C, Internal Revenue Code of 1954).

“A manufacturing company entered into contracts with sales agents wherein each agent agrees to carry out and develop the business of selling the products of the company in the territory assigned to him. Under the terms of the contract, an agent must adhere strictly to the prices fixed by the company and be governed by the rules and regulations in existence when the contract went into effect, plus any additions or amendments made thereto, or any other instructions that the company may issue from time to time. All sales made by an agent are subject to the acceptance and approval of the company.

“If an agent maintains an office, he is required to place the name of the company on the office door, on the directory board of the building in which the office is located, and in the telephone directory. He is also required to maintain warehouse space suitable to, and approved by, the company for the purpose of storing such merchandise as may be consigned to him. An inventory report of the consigned merchandise must be furnished to the company each month, as well as such other reports as the company may require. An agent agrees to make no deliveries of merchandise except in accordance with company instructions.

“An agent may not disclose any information considered confidential by the company and he may not engage in the sale or distribution of competitive products during the life of the contract or for two months after its termination. The contract may be terminated by either party upon 30 days notice, except in the case of any breach of terms, the company may terminate the contract immediately. For his services, an agent receives a specified percentage of the retail price of the merchandise sold by him.

“Sections 31.3121(d)-1(c), 31.3306 (i)-1, and 31.3401(c)-1 of the Employment Tax Regulations provide, in part, that generally the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done.

In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so.

“In the instant case, the manufacturing company has the right to direct and control the sales agents to the degree necessary to establish the relationship of employer and employee within the meaning of the Employment Tax Regulations. Accordingly, under the facts presented, it is held that the sales agents are employees of the manufacturing company for purposes of the Federal Insurance Contribution Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages.”

Revenue Ruling 70-587

“The question presented is whether sales agents engaged in the sale and distribution of products manufactured by a manufacturing company are employees of the company for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954).

“The manufacturing company, through its district managers, engages and grants to sales agents the exclusive right to sell the goods of the company in their respective communities. As a condition to their appointment as agents, the company requires that the applicants possess a designated amount of capital with which to purchase the equipment and supplies the company feels is necessary to conduct operations. The company and the agent enter into contracts wherein the agent agrees to purchase from the company at wholesale prices merchandise for resale at list retail prices in his specified territory.

“The difference between the wholesale price and the selling price is the agent’s profit. The merchandise sold is shipped directly to the sales agent and the company has no contract with the customers. The company requires the agent to pay for the merchandise either on a cash or 30-day credit basis depending upon the circumstances. The agent is not required to work specified hours, nor is he required to make any reports to the company. He pays for his own transportation, meals, advertising, telephone, etc. and receives no allowance from the company as reimbursement for such expense. If an agent maintains an office he must pay his own rent, salaries of employees, and all other expenses. He is not controlled or directed by the company in the solicitation of business and may, at his own convenience, call on such customers as he chooses within his assigned territory. However, he does agree to fulfill a reasonable quota of sales, and obligates himself not to become interested directly or indirectly in any competitive enterprise. He also agrees to deal honestly with, and make no false statements concerning, competitors or their products. In case of termination of the contract, the agent agrees to return promptly to the company all textbooks, price lists, and other information belonging to the company. The contract may be terminated by either party upon 60 days written notice prior to the expiration of any yearly period.

“Individuals are employees for Federal employment tax purposes if they have the status of employees under the usual common law rules applicable in determining the employer-employee relationship. Guides for determining that status are found in three substantially similar sections of the Employment Tax Regulations, namely, Sections 31.3121(d)-1(c), 31.3306(i)-1, and 31.3401(c)-1.

“For example, it is pointed out in Paragraph (2) of Section 3121(d)1(c) of the regulations that an employer-employee relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done, but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so.

“In the instant case, the manufacturing company neither exercises, nor does it have the right to exercise, control over the agents as to how they shall conduct themselves in the performance of their services. No instructions in this regard are issued, nor are reports of any character required of the agents. They may operate under their own names without interference from the company and are not reimbursed for any expenses incurred. Accordingly, it is held that for Federal employment tax purposes, the sales agents are not employees of the manufacturing company.

“See Revenue Ruling 70-586, which holds that sales agents engaged in performing services for a manufacturing company are employees of that company for Federal employment tax purposes. In that case, however, the agents were required to follow such instructions as might be issued by the company from time to time, to promptly submit various reports and inventories, to make deliveries to stock as directed by the company, or, in other words, to follow the details and methods prescribed by the company for the sale of its goods.”

The IRS has also issued a revenue ruling on the subject of “subagents,” Revenue Ruling 74-98.

Revenue Ruling 74-98

“Advice has been requested whether an individual performing services for a manufacturers’ representative, under the circumstances described below, is an employee of the manufacturers’ representative for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (Chapters 21, 23, and 24, respectively, Subtitle C, Internal Revenue Code of 1954).

“The manufacturers’ representative, who is an independent contractor for Federal employment tax purposes, engaged a worker under an oral agreement to perform sales services as a “subagent” in a specific territory. Under the agreement, the worker performs his sales services from 8:30 a.m. to 5:00 p.m., Monday through Friday, with all sales made in the name of the manufacturers’ representative or the firms he represents.

“The prices, terms and conditions of sale are established by the firms. The worker is paid a commission by the manufacturers’ representative based on a percentage of sales and he is allowed a weekly draw. No pensions, bonuses or other benefits are offered. However, in the event of temporary sickness, the weekly draw would continue to be paid.

“The worker is furnished and required to follow up on leads to prospective customers. He reports daily, by telephone, to the manufacturers’ representative and submits a weekly written report on his sales activities. The manufacturers’ representative periodically works with the worker in his territory, and reviews his sales efforts. The worker is not required to meet a minimum quota of sales. While the manufacturers’ representative furnishes samples, brochures and calling cards, the worker pays all other selling expenses he incurs.

“The worker’s services may be terminated at any time by either party. The worker signed a statement that he is an independent contractor as to his sales activities. An individual is an employee for Federal employment tax purposes if he has the status of an employee under the usual common law rules applicable in determining the employer-employee relationship. Guides for determining that status are found in the Employment Tax Regulations Sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1.

“The regulations provide that generally the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done, but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient that he has the right to do so. The right to discharge is also an important factor indicating the person possessing that right is an employer.

“The facts in the instant case show the manufacturers’ representative exercises, or has the right to exercise, over the worker the degree of direction and control necessary to establish an employer-employee relationship under the usual common law rules. Under the circumstances, the fact the worker has signed a statement that he is an independent contractor is immaterial. A contractual provision is not conclusive of the relationship between the parties if it contradicts all the other facts and circumstances in the case bearing upon a determination of the true relationship between the various parties for employment tax purposes. See Bartels v. Birmingham, 332 U.S. 126 (1947), 1947-2 (C.B. 174).

“Accordingly, it is held that the “subagent” is the employee of the manufacturers’ representative for purposes of the taxes imposed by the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages.”

Private Letter Rulings

The outcomes of many reclassification audits are not recorded and, therefore, it is difficult to offer guidance as to what factors the IRS finds most critical to the proper classification of sales agents. From time to time, the IRS’ national office gets involved in individual taxpayer cases and issues; that are known as “private letter rulings (PLRs).”

Unlike a revenue ruling, a PLR applies only to the case at hand; it cannot be used by other taxpayers or by the IRS in other cases. Nevertheless, a review of PLRs does reveal some of the analysis used by the IRS in reclassification cases. It should come as no surprise that the overwhelming majority result in the reclassification of the independent contractor as an employee.

While there are literally dozens of PLRs on the subject of the proper classification of sales agents, we present two as examples of the IRS’ application of the law to actual circumstances.

PLR 8648025 was issued August 28, 1986. The facts of the case, as recounted by the IRS, were as follows:

“The information furnished indicates that W performed services for C from August 10, 1979 until June 10, 1986 as a sales and manufacturers’ representative. W was assigned a specific territory in which he had exclusive rights to solicit and obtain orders from customers for C’s products.

“Under the terms of the contract entered into between W and C, the agreement was terminable by either party during the first year upon 30 days written notice and in any subsequent year upon 90 days written notice. Under the terms of the contract, W was prohibited from representing other persons, firms or corporations that had a conflicting product with C. Nevertheless, C knew that W did also represent other manufacturers with various other product lines.

“W was required to attend annual sales meetings to familiarize himself with C’s product line and for annual updates on new products. C paid for W’s accommodations and meals during the sales meetings, but W paid for his own transportation to attend the meetings. W was required to submit quarterly reports to C on each customer or else his commissions were withheld.

“W’s work was monitored by occasional visits by C’s factory sales manager and by telephone calls to customers. W maintained a listing in the telephone directory as a manufacturers’ representative for C’s products. W maintained his own shop and held himself out as a sales representative with numerous product lines. C furnished W with leads for prospective customers and W was required to pursue and report on the leads. W was required to adhere to the prices, terms and conditions of sale established by C. Orders placed by W were submitted to and subject to C’s approval. C reserved the right to reject any order solicited by W.

“W was required to send reports to C that C’s display racks in stores were properly installed. W was also required to clean up the racks, estimate sales per store, and send C a list of the existing stores and customer’s records. C furnished W with the necessary promotional products, prices and information on the promotional products. C supplied W with the necessary advertising and selling literature, brochures, drawings, engineering specifications and other data on C’s products. C also provided W with the requisite customer lists, order forms and contracts that W was required to use in dealing with C. W was provided with specific figures by C concerning annual sales goals, discounts, shipping costs, displays, the necessary customer credit reference procedures, and delivery time. Upon request, C would provide W with business cards with C’s name, W’s name and W’s title on them.”

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After undertaking an extensive review of Revenue Rulings 70-586 and 70-587, the IRS concluded:

“Extended consideration has been given to the information submitted regarding W’s status. The fact that W was required to attend annual sales meetings, send reports to C, adhere to the prices, terms, and conditions of sale established by C, and the fact that W’s work was monitored by C indicates W had a status substantially similar to the sales agents described in Revenue Ruling 70-586. Therefore, we conclude that W was C’s employee for purposes of the FICA, the FUTA, and income tax withholding.”

The second PLR, PLR 86336037, issued June 4, 1986 is an example of the IRS application of the law to the classification of “subagents.” The IRS’ version of the facts was as follows:

“The information presented to us shows that your firm is a manufacturers’ representative in the automobile aftermarket. You have five salespersons who are engaged in selling products from the various manufacturers represented by the firm.

“The salesperson was engaged by the firm pursuant to a written agreement entitled ‘Agency Contract’ to sell automotive parts and supplies to customers in an assigned territory on a commission basis. Commissions are paid through a quarterly settlement procedure. Salespersons receive a bi-weekly draw against future commissions; however, there is no guaranteed minimum salary. In addition to commissions, bonuses are sometimes paid to those meeting sales quotas.

“The firm provides certain samples and materials, such as sales literature, price sheets, order forms, stationery, business cards and related sales supplies. The firm also provides a computerized Territory Weekly Sales Analysis for use by the salespersons. Salespersons are responsible for payment of their own travel expenses, including gasoline, insurance and repairs to their own vehicles, as well as meals, lodging and entertainment expenses. The firm does not normally reimburse for travel and lodging, except in the case of travel and lodging for trade shows and sales meetings scheduled by the firm. Salespersons are expected to attend all sales meetings. The firm does provide sales leads to the salesperson and, pursuant to the agreement, the salesperson is required to follow-up on manufacturers’ leads.

“Although the salespersons may set their own schedules, they are required to submit an advance weekly itinerary form to the firm which shows the date of activity, the account and city, the ‘promo lines’ and the ‘servicing lines.’ The agreement provides the ‘Principal must approve, in writing, any new customers procured by the Agent [salesperson].’

“Training is provided by the firm on matters such as writing orders, credit reports and follow-up reports. Salespersons are also occasionally required to take Manufacturers’ Factory Sales Representatives along with them on visits to their accounts. Service helpers are hired and assigned by the firm to assist salespersons in their respective territories; however, the firm may reduce commissions by 5% to defray the serviceman’s expense.

“The Agency Contract also mandates that the ‘Agent shall devote full time and energy to Principal’s business and shall not represent any other manufacturer…’ The responses provided by salespersons also indicated that working for the firm was their full-time exclusive occupation, or that at least the firm had priority on their time. The Agency Contract states: ‘The Agent shall be an independent contractor’ and that the Principal will not withhold from the salesperson’s earnings ‘any income taxes or FICA.’

“Either party to the Agency Contract may terminate the relationship at will by providing notice to the other party. Finally, the Agency Contract provides that the ‘Principal may establish rules and regulations in accordance with Principal’s contracts with manufacturers and Agent shall comport therewith.’”

The IRS reviewed the facts of Revenue Rulings 70-586, 70-587, and 74-98. The IRS then concluded:

“We believe that the facts of your case are analogous to both Revenue Rulings 70-586 and 74-98. In both the instant case and Revenue Ruling 70-586, the salespersons are required by the company to submit certain periodic reports of inventory or sales activities. In both cases, the salesperson agrees to follow rules and regulations established by the company. In both cases, the salesperson agrees to a non-competition clause. In the present case, the salesperson further agrees to devote his full time and energy to the business of the firm.

“The circumstances of the instant case and Revenue Ruling 74-98 both involve a three-tier relationship involving manufacturers, the manufacturers’ representative, and the subagent salesperson. In both Revenue Ruling 74-98 and the present case, salespersons are required to submit weekly reports and to keep in regular contact with the manufacturers’ representative. In both cases, the manufacturers’ representative periodically reviews the sales efforts and either provides training to the salesperson or works with that person in the territory. In both cases, there exists a contract provision describing the salesperson as an independent contractor. As stated in Revenue Ruling 74-98 and Treas. Reg. 31.3401(c)-1(e), the existence of such a provision is not conclusive as to the relationship between the parties.

“In some respects, the control exercised by your firm in the present case is more extensive than was the case in either Rev. Rul. 70-586 or 74-98. For example, the instant case involves mandatory sales meetings and an office staff provided by the firm with service helpers who are hired by the firm to assist the sales force. Your firm also retains the right to alter or amend the worker’s sales territory on 30 days written notice. Your firm must approve, in writing, any new customers who are procured by the salesperson. Your firm also pays for travel and lodging expenses for salespersons to attend national trade shows and the regular sales meetings.

“Although the working hours of your sales staff are less rigid than was the case in Rev. Rul. 74-98, your firm does require that your salespersons devote their full time and energy to your business; that they are barred from representing other manufacturers; and that they must follow up on manufacturers’ leads. Your contract also specifies that this agreement between the salesperson and the firm is terminable at will by either party with notice to the other party.

“Based upon the above, we have concluded that your firm exercises or has the right to exercise over your salespersons the degree of direction and control necessary to establish an employer-employee relationship under the common law rules. Consequently, using the guides found in Regs. 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1, we conclude that the salesperson performed sales services for you as an employee.”

We believe one could reasonably, conclude from reading the various revenue rulings that a sales agency which is incorporated, has multiple employees and multiple principals and which works on straight commission, paying all its own expenses, is likely to pass the test of independent contractor status. On the other hand, a sole proprietorship with one line and no employees, deriving 100 percent of its income from the one principal who also reimburses the agent/employee for some expenses, is almost sure to fail the test. Everything between these two extremes will depend on the facts of the case.

In the Courts

Just as the IRS has issued many private letter rulings on various aspects of the sales relationship, so have the courts rendered decisions. It is not unusual for both the taxpayer and the IRS to cite as precedent a dozen or more cases. As each case is so different, it is difficult to say which cases are most relevant. Both the facts as well as the venue for the litigation will dictate which cases are relevant.

One case, Lowen Corporation v. U.S., 72 AFTR 2d (P-H) 6350, decided on June 14, 1993, illustrates the frustration of the courts. Lowen’s decal division designs and manufactures custom decals, which are sold predominantly to large trucking fleets and to original equipment manufacturers. Lowen’s sign division predominantly manufactures real estate signs. Independent contractors were utilized to market and sell the products and services of both divisions. The IRS challenged the use of independent contractors and the company prevailed in court.

On the subject of precedent, the court observed:

“The parties have cited a number of cases in support of their positions that the salespersons are independent contractors and employees, respectively. While these cases are helpful, they serve to reinforce the conclusion that each case of this type must be decided on its own facts, with appropriate consideration of the common law concepts governing the distinction between independent contractors and employees.

“The court has read the other cases cited by the parties and additional cases found by its own efforts. Little purpose would be served in comparing and contrasting these cases. It is obvious that in this area of the law, something can be found in virtually every case to support each side’s position. Indeed, one can find cases involving the same type of business with comparable facts where two courts reached differing conclusions regarding the status of workers. This is as it should be because every case is highly fact specific. In each reported decision there are some facts which support the employer-employee relationship and some facts which support an independent contractor relationship. Considerable deference must be given to the trial judge who heard the witnesses, applied the factors and reached a conclusion based on the totality of the evidence.”

As to the facts, manufacturers’ sales agents can take heart from the court’s observations about the essential element of a proper classification. We wish more courts would take heed of this observation:

“In this case, the court is persuaded by the totality of the evidence that the relationship between Lowen and its salespersons was result-driven and that the result was determined not by the control exercised by Lowen but rather by the skill and initiative of the salespersons. The control exercised by Lowen insured the quality and consistency of its products, not how its products were sold. The burden of actually selling Lowen products fell squarely on the shoulders of the salespersons. While the salespersons undoubtedly were helped by being able to offer a quality-controlled product backed by a reputable company, the salespersons were responsible for finding customers and convincing them to buy Lowen products. Their success depended largely upon their individual abilities to sell and the evidence is clear that Lowen hired most of its salespersons based upon either proof that the salespersons had already possessed sales skills or, at least, had the ability to develop such skills…Lowen did not train its salespersons on how to sell; it trained them about Lowen services and products and largely left each salesperson to decide what businesses in his or her territory could use Lowen products and what approach or ‘sales pitch’ to use with respect to each customer.”

Statutory Safe Harbor

If the IRS takes the view that, on the basis of their interpretation of the common law factors, an individual is an employee, there is still the possibility employment taxes will not be owed. There is a statutory provision which overrides the common law determination. If a taxpayer has a reasonable basis for not treating an individual as an employee, the taxpayer may be relieved from having to pay employment taxes for that individual. To get the relief, the company must file all required Federal tax returns, including information returns, on a basis consistent with the treatment of the individual. The relief is granted by virtue of a statutory safe harbor known as Section 530. This safe harbor is not available if the salesperson is a statutory employee as explained earlier.

In the mid-1970s, the IRS began to aggressively reclassify independent contractors as employees. As a result of this activity, industry pressed Congress for resolution of the problem. Unfortunately, neither the IRS nor the industry could persuade Congress of the merits of its case. Instead, Congress passed a temporary, one-year moratorium in 1978 while it studied the issue. In 1979 and 1980, Congress extended the moratorium relief, known in Washington parlance as a “safe harbor,” indefinitely. The term safe harbor means if the taxpayer meets the criteria spelled out in the statute, the taxpayer can rely on the Section for protection. The safe harbor referred to is Section 530 of the Revenue Act of 1978. It does not repeal the common law but, in effect, suspends it, if the facts are within the parameters of the safe harbor.

In 1996, Congress made the first significant changes to Section 530 since its original enactment. Over the years, taxpayers and the IRS fought over many of the terms as used in Section 530. As a result, it was not widely used. By its actions in 1996, Congress has attempted to at least make Section 530 more “user friendly” as it grapples with the bigger issue of defining an independent contractor.

Section 530 Relief

Section 530 is a relief provision that the IRS tells its examiners should be considered as the first step in any case involving worker classification. Relief is available to businesses that are under examination or involved in administrative or judicial proceedings with respect to assessments based on employment status reclassification. The legislative history states that section 530 is to be “construed liberally in favor of taxpayers.”

It is not necessary for the business to claim section 530 relief for it to be applicable. In order to correctly determine tax liability, the IRS must explore the applicability of section 530 even if the business does not raise the issue. The section provides that a worker does not have to be an employee of the business in order for relief to apply. Additionally, the business need not concede or agree to the determination that the workers are employees in order for section 530 relief to be available.

Establishing Section 530 Relief

The business must meet two consistency requirements before the relief provisions of section 530 apply. For any period after December 31, 1978, the relief applies only if:

1. All Forms 1099-MISC required to be filed by the business with respect to the worker(s), for that period, are timely filed and are filed on a basis consistent with the business’s treatment of the worker as an independent contractor; and
2. The treatment of the worker as an independent contractor is consistent with the treatment by the business (or predecessor) of all workers holding substantially similar positions for any period beginning after December 31, 1977.

In addition to the consistency requirements, the business must have relied on some reasonable basis, including the safe havens of a prior audit, a judicial precedent, or an industry practice.

Employers seeking section 530 relief must:

1. Establish a prima facie case that it was reasonable not to treat an individual as an employee; and
2. Cooperate fully with reasonable requests from the examiner.

The IRS tells its examiners to work with the business to determine what information is needed to conclude whether the business has met the requirements for section 530 relief.

If the business cooperates with the investigation, the service will bear the burden of proving the business’s treatment of the worker is inaccurate.

If the business is entitled to such relief, the issue of worker classification will be discontinued. These workers will continue to receive Form 1099-MISC. However, the fact that the business is entitled to section 530 relief does not imply that the workers are employees.

Consistency Requirement— Reporting Consistency

The first requirement a business must meet to obtain relief under section 530 is timely filing of all required Forms 1099-MISC with respect to that worker for the period, on a basis consistent with the treatment of the worker by the business as not being an employee. This provision applies only “for that period.” (Rev. Proc. 85-1) That is, if a business in a subsequent year files all required returns on a basis consistent with the treatment of the worker as not being an employee, then the business may qualify for section 530 relief for the subsequent period.

If a business is not “required to file,” relief will not be denied on the basis that the return was not filed. Rev. Rul 81­224, 1981-2 C.B. 197, addresses specific questions about timely filing of Forms 1099-MISC. It provides that:

1. Businesses that do not file timely Forms 1099-MISC consistent with their treatment of the worker as an independent contractor, may not obtain relief under the provisions of section 530 for that worker in that year.
2. Businesses that mistakenly, in good faith, file the wrong type of Form 1099-MISC do not lose section 530 eligibility.

Consistency Requirement— Substantive Consistency

The treatment of the worker as an independent contractor must be consistent with the treatment by the business (or predecessor) of all workers holding substantially similar positions for any period beginning after December 31, 1977. Classes of workers would also be treated the same if the levels of control were equal, even if the types of work were different.

The determination of whether workers hold substantially similar positions requires consideration of the relationship between the taxpayers and those individuals. This includes, but is not limited to, the degree of supervision and control. Differences in managerial responsibilities and differences in reporting requirements may be taken into account, along with differences in job duties. Presumably, the contractual relationship and the provision of employee benefits are also entitled to some weight.

The determination of what is substantially similar work rests on analysis of the facts. The day-to-day services that workers perform and the method by which they perform those services are relevant in determining whether workers, treated as independent contractors, hold substantially similar positions to workers treated as employees. Rev. Proc. 85­18 provides examples of treatment consistent or inconsistent with payments to an independent contractor.

Comparison of job functions is an important factor. Workers with significantly different, though overlapping, job functions are not substantially similar.

Section 530 — Reasonable Basis

In addition to the consistency requirements, the business must have relied on some reasonable basis. It is the intent of Congress that “reasonable basis” should be construed liberally in favor of the business. This does not mean that the conditions for obtaining section 530 relief will be discounted or ignored by the IRS. Failure to satisfy one or more of the conditions for eligibility for section 530 relief is not cured by the requirement of liberal construction of the reasonable basis requirement

Reasonable reliance on any one of the following three “safe havens” is sufficient:

1. Published rulings or judicial precedent
2. Prior Internal Revenue Service examination of taxpayer
3. Long-standing recognized industry practice

A business that fails to meet any of the three “safe havens” may nevertheless be entitled to relief if the business can demonstrate, in some other manner, any reasonable basis for not treating the worker as an employee.

Safe Haven — Judicial Precedent or Published Rulings

The business must show that it reasonably relied upon a particular judicial precedent or published ruling. The facts in the case must be similar to the situation of the business at hand. The facts need not be identical and the precedent relied upon need not deal with exactly the same industry as the industry of the business being examined.

The judicial precedent or published ruling relied upon must have been in existence at the time the business began treating workers as independent contractors. One case is sufficient to establish a precedent that creates a safe haven. This is true, even if case law can be found to support either side of the independent contractor/employee issue.

State court decisions and rulings of agencies other than the IRS do not constitute judicial precedent. Under some circumstances, however, state court decisions and federal agency rulings may be the basis for findings that the business reasonably relied on some other reasonable basis.

Safe Haven — Prior Audit

For examinations that begin after December 31, 1996, the IRS audit must have included an examination for employment tax purposes of the status of the class of workers at issue or a substantially similar class of workers. For examinations that begin before January 1, 1997, the IRS audit does not have to have been an audit for employment tax purposes as long as the audit entailed no assessment attributable to the business’ treatment, for employment tax purposes, of workers holding positions substantially similar to the position held by the workers whose treatment is at issue.

A business does not meet this test if, in the conduct of a prior examination, an assessment attributable to the business’ treatment of the worker was offset by other claims asserted by the business. Nor can the business rely on a prior audit if the current working relationship between the business and the workers is significantly different from their working relationship at the time of the audit.

The audit must have included an examination of the business’ books and records.

1. Inquiry or correspondence from a Campus is not treated as a past examination.
2. Applications for status determination, such as an application for recognition for exemption from income tax as an exempt organization or an application for a determination letter for an employee benefit plan made on Forms 5300 or 5309, do not constitute an examination.
3. An examination of an employee benefit plan or consideration of Form 5500 (Annual Return/Report of Employee Benefit Plan) generally does not constitute an examination because the plan is not the business that employs the workers. However, an examination of the business’ pension plan that leads to an examination of the business’ books (i.e., such as payroll records to determine whether coverage requirements have been met) may create a safe haven for the business.

The prior examination safe haven is limited to past examinations conducted on the business itself. Therefore, a business is not entitled to relief based upon a prior examination of any of its employees. Nor would a subsidiary corporation usually be entitled to relief based upon a prior examination of its separately filing parent corporation. Even if a consolidated return was filed in the year the parent was audited, the subsidiary would only be entitled to relief if the subsidiary was examined in connection with the parent.

If a business which was previously examined begins conducting a new line of business, that business is not entitled to relief based upon the examination of the original line of business. However, if there has only been a change of form and the successor entity is in the same line of business, the taxpayer could qualify for section 530 relief based on other reasonable basis.

Section 530 limits the prior audit safe haven to audits that included an examination of the status of the class of workers at issue or of a substantially similar class of workers.

Safe Haven — Industry Practice

To claim a safe haven under industry practice, the business must show that it is following a long-standing recognized practice of a significant segment of its industry. An industry generally consists of businesses located in the same geographic or metropolitan area which provide the same product or service and compete for the same customers.

Twenty-five percent of the taxpayer’s industry (determined without taking the taxpayer into account) is deemed to constitute a significant segment of the industry. The legislative history notes that a lower percentage may be a significant segment, depending on the facts and circumstances.

Practices that began after 1978 may be long-standing and provide that practices that have existed for more than 10 years are long-standing. The legislative history notes that the 10-year rule is merely a safe haven. A shorter period may be long-standing, depending on the facts and circumstances.

Whether the business relied on industry practice can generally be established by several types of evidence. The IRS will examine business records, such as corporate minutes or unanimous consents in lieu of director’s meetings, to determine whether any written record exists that shows the reason for treatment of workers as independent contractors. The IRS will interview the workers themselves to determine what reasons were given to them by the business when establishing their status as independent contractors.

Other Reasonable Basis

A business that fails to meet any of the three “safe havens” may still be entitled to relief if it can demonstrate that it relied on some other reasonable basis for not treating a worker as an employee. The legislative history indicates that “reasonable basis” should be construed liberally in favor of the taxpayer.

Reliance on an attorney or accountant may constitute a reasonable basis. The business need not independently investigate the credentials of the attorney or accountant to determine whether such advisor has any specialized experience in the employment tax area. However, the business should establish, at a minimum, that it reasonably believed the attorney or accountant to be familiar with business tax issues and that the advice was based on sufficient relevant facts furnished by the business to the adviser. If other evidence shows that the adviser clearly was not qualified, the mere holding of a law or accounting license would not make the reliance on the advice of the attorney or accountant reasonable.

Prior state administrative action (e.g., workers’ compensation decisions) and other federal determinations (e.g., determinations under the Federal Labor Standards Act Wage and Hour Division) may or may not constitute a reasonable basis. This will depend on whether they use the same common law rules that apply for federal employment tax purposes. If the state or federal agency uses the same common law standard and interprets it similarly, however, its determination should constitute a reasonable basis. If the state or federal agency uses a different statutory standard or interprets the common law standard differently, its determinations should not constitute other reasonable basis.

Although a private letter ruling or technical advice memorandum issued to the business’ predecessor does not satisfy the requirements of the judicial precedent safe haven, the business may qualify for relief if there has merely been a change in the form of the business. In addition, the successor must be in the same line of business. Also, under the same requirements, the successor may qualify for “other reasonable basis” if the predecessor of the business satisfied the requirements of the prior audit safe haven.

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Preparing for the Future

The best way to prevent a problem is to ensure the relationship between the company and the independent contractors is a professional and well-documented one.

Remember, an independent contractor is just that, independent. The standards applying to any dealings with any business should apply. For that reason, we recommend an internal self-audit. Review the relationship. Why do you do things a certain way?

To summarize, these are some of the likely “hot” buttons that might be of concern to the IRS. The reality of “doing business” may not make compliance practical with all elements, but manufacturers and manufacturers’ agents should at least be aware of what to watch out for.

1. Salespersons should not be required to attend sales meetings for training or other purposes. This is true whether or not they pay their own expenses. An invitation to attend a meeting voluntarily can be extended, but an indication they are expected to attend, even if not required, will create problems.
2. Limiting salespersons to a particular territory or to particular customers would indicate the company is exercising control. Leads may be provided, but a salesperson should not be required to follow-up on them.
3. Salespersons should not be required to submit sales reports, nor should salespersons be required to work a minimum amount of time.
4. District managers who are paid an override on salespersons’ commissions suggest control.
5. Weekly, bi-weekly or monthly payment of commissions should be avoided unless such payment practice is consistent with the payment schedule of other vendors.
6. The preferable option is to pay commissions when the order comes in. Advances or draws should not be given unless they are actually charged against commissions and a minimum income should not be guaranteed. Travel or other expenses should not be paid.
7. Requirements to sell at list price should be avoided; an independent contractor should be able to adjust price by amount of commission.
8. Quotas should not be required, but voluntary participation contests based on quotas may be acceptable.
9. Salespersons should not be furnished any clerical or secretarial help, or be provided office space without fair market value charge for such services or space.
10. Salespersons should not be required to perform services such as collecting accounts, handling complaints, or investigating credit.
11. An independent contractor should never be threatened for failure or unwillingness to be available for work. Obviously, a company can choose those who have performed well and reliably in the past.
12. Be careful with terminology. Employees are paid on the basis of a payroll agreement; the payment for the independent contractor is based upon the contract. Remember, employees can be terminated but, in the case of independent contractors, the “contractual agreement” is ended.
13. Salespersons should be free to sell whatever they want and wherever they want. Selling multiple product lines is a very helpful factor.

There are as many variations on contracts as there are lawyers to write them. In and of itself, an agreement will not make or break a determination.

Finally, be consistent. Establish rules and follow them.

Link to Form SS-8

www.irs.gov/pub/irs-pdf/fss8.pdf

Hiring Salespeople for Your Manufacturers’ Representative Firm

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The similarities of reps working with principals and reps working with sub‑reps were evident over the course of a MANAchat. High on the list of those similarities were how and where do reps find sub-reps, and once found how do you work with them effectively and pay them fairly?

The problems that reps face in finding sub-reps were evident early on in the conversation when the question was raised “Why would a rep firm want/need to engage with a sub-rep?’

In answer the group of reps participating in the chat emphasized that often a manufacturer will place demands on their rep firm that require the firm to seek extra help or coverage that they can’t normally provide with existing staff. In addition, demands from the territory might require additional feet on the street which the agency — many times a single-person operation — can’t provide personnel-wise. When these events occur, it may be time to seek help in the presence of a sub-rep.

The situation was probably best described by one rep who explained, “We operate in California, and it’s expensive to work and live here. We’ve reached out to more than 12 rep firms to work on a sub-rep basis and only two got back to us. Whatever you propose to a sub-rep has to be worth their while or they’re not going to get back to you at all.”

Then the question was posed of how and where to find sub-reps. “The biggest challenge I’ve faced when it comes to finding them,” according to one rep, “is to locate reps who are really invested in the business. I’ve been working with sub-reps for more than five years and have had mixed results. Over that period of time, I’ve only had three that have really panned out.”

Admittedly the term “mixed results” fits many of the reps’ experiences working with sub-reps, but when the relationship does work out it can prove to be very beneficial to both parties. As an example, a rep firm recently profiled by Agency Sales described his successful beginning as a rep as owing itself to the successful relationships he had sub-repping for three other rep firms. Once the sub-rep got on his feet, he was able to gain direct lines for himself and left the sub-repping relationships on good terms.

Finding Sub-Reps

When it comes to locating potentially good sub-reps, one rep on the chat explained, “I work primarily with medical devices, and I’ve made it a habit to regularly attend their industry’s annual meeting. It all comes down to networking. Meetings like this are always populated with valuable potential sub-reps.”

Another rep noted that when he was seeking to hire some sub-reps “I contacted a woman who previously was in purchasing for a large manufacturer. She had dealt with more than 20 rep firms over her career. She was familiar with who reps were and what they did. She was a natural fit for me. She did a great job when it came to chasing them down.”

In addition to good old-fashioned networking, another rep touted the use of LinkedIn when it came to locating potential sub-reps. “We had a company contact us to sub-rep for them primarily because when they found us on LinkedIn, they learned that we repped several synergistic lines. I’ve worked with them for several years and it’s worked out very well.”

The last rep quoted raised an important subject that was of interest to all the other reps on the chat. According to one rep, “It’s important that when you consider working with a sub-rep that his lines are synergistic with your lines. Just as a principal values your line of synergistic products, so should you take that into account when considering whether to work with an agency on a sub-rep basis. You want to make sure that the lines he’s repping for you have an ample opportunity to be considered by his customers.”

If a rep is lucky enough to link up with other agencies on a sub-rep basis, they are then faced with a number of questions they have to answer:

• How are sub-reps paid?

When the subject of compensating sub-reps was raised, a variety of suggestions were offered. “There are many ways to skin the cat,” offered one rep. “In general, commission splits that were mentioned ranged from 25%–75%, 30%–70% and 40%–60%, with the larger portion going to the rep. However, it was offered that “If I’m the one who has to pick up the phone to verify the customer, mail them a brochure, and then direct the opportunity to the sub-rep, I’m going to receive a larger part of the commission.”

Another important part of the conversation was that you want to make sure the sub-rep has some business to work with — “No one wants to work for free.”

• Competing lines?

One rep who used to work as a sub-rep but is on his own now offered the following view of competing lines: “It’s inevitable that the subject of the sub‑rep carrying competing lines is going to come up. I have my own base lines and they (the sub-rep) have their own lines. There’s always going to be some new product that is going to be added. As soon as the sub-rep adds a new product that may be a great opportunity for him, you can have a problem. That’s a subject that has to be discussed up front with any sub-rep you’re dealing with. We’ve been able to solve that with constant and good communication up front.”

• How are they compensated for travel and expenses?

“My sub-rep pays for his own travel and expenses.” Another rep noted that when he worked as a sub-rep, “I never took on anything that involved airfare. I also never submitted expenses. I covered those myself.”

• How much time will they spend on their sub-rep lines?

“Once again, this is just like our relationship with our principals. If I’m giving someone (a sub-rep) a lead and they do the grunt work and they have another product they can sell, that means more contact time with the customer for me. What I’m looking for in a sub-rep is someone who is a constant contact with potential customers. That’s good for me as long as I keep an eye on it. It all comes down to hiring the right people.”

• Are contracts necessary?

“Just as you must have a written contract with your principals, so too should you have one with your sub-reps. The sub-rep is not a direct employee of yours, just as you are not a direct employee of your principal. Keep that in mind. Remember what you’re striving for here with your sub-rep is a strategic partnership. You’re working together on strategic planning and completing sales.”

Then there’s the subject of “What if you hire a sub-rep and they don’t do the work?” You have to have a termination clause written into your agreement so you can cancel the relationship. If the sub-rep is getting a good-sized check from you, then that means something is going on. If you’re paying him little or nothing, goals obviously are not being met. It’s really no different than the agreement we have with our principals.

Hiring and Partnering With Sub-Reps

By Jack Foster

September 2023

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Just as manufacturers should weigh the financial benefits of hiring an outsourced sales staff vs. independent manufacturers’ reps, so too should reps weigh whether hiring a direct employee vs. working with a sub-rep is the best way to expand or cover a territory. That was just part of the subject matter covered during a MANAcast by John McNellis.

McNellis, a former MANA Board member, heads McReps, Inc., Oconomowoc, Wisconsin, a national multi-person agency that works with a mix of both direct and sub-reps. The agency has represented specialized component manufacturers for more than 48 years. It focuses on custom-engineered parts from special materials to original equipment manufacturers (OEMs).

At the outset of his presentation McNellis made the point that just as manufacturers, reps have a choice when it comes to creating their own sales force. They can hire employees, or they can outsource the sales function to sub-reps. There is, however, quite a difference between those alternatives.

According to McNellis, “The first thing to think about when considering which path to follow is to conduct a cost analysis. That’s the very same thing a manufacturer does when the manufacturer decides upon having the fixed cost of a direct employee vs. the variable cost of an independent rep. If you hire a sub-rep, you have the obvious advantage of being able to expand and support your territory without controlling the reps. The obvious disadvantage is that you have less control. Just as you, they are independent. As a result, there may be a variation in their feedback, time allocation and reporting. At the same time, those sub-reps will have other lines and you have to consider how much effort will be devoted to your lines.”

Soft Costs

Another important part of the cost analysis, he maintained, is considering what he termed “soft costs.” According to McNellis, “When working with sub-reps there is the issue of management and communication time, not to mention time devoted to handling issues for that rep. All of these efforts may take resources from your own ability to sell to your customers.”

He added that perhaps the best territory to consider for the use of a sub-rep is a territory where the rep firm already has some existing business and predictable decent growth potential for the future. “If you select a territory with no growth potential, that will probably stunt the rep’s efforts and result in a poor outcome.”

After conducting a cost analysis, the firm is faced with the task of considering what it is to look for in the ideal sub-rep and how to find candidates.

Sub-Rep Attributes

Using a guideline of “hiring slow and firing fast,” McNellis urged agencies to make a list just as if you were hiring a direct employee. On that list should be the qualities you would want the sub-rep to possess. “You’d want them to be persistent, good communicators — both verbally and in writing. You’d also want them to be good collaborators and dedicated to the craft. Then you’d want them to possess the technical knowledge that fits into your category of lines. In selecting a sub-rep, you must be prepared to spend time upfront during the search and recruitment process. That will pay dividends later on.”

When it comes to finding prospective sub-reps, McNellis noted that his agency networks with other rep firms in their efforts to find common interests. “We also make sure to search Agency Sales magazine for the last 12 months to locate rep firms that have recently joined MANA.” He added that we “also go to our customers and ask them who are some of the best sales reps who are currently calling on them with synergistic products.”

Once a potential sub-rep is located, he continued that it’s important to set up a formal written agreement, similar to what you have with a principal. You need to have a sub-rep agreement that includes additional clauses explaining that the sub-rep must adhere to the agency’s agreement with the principal and a non-compete clause. You also want to include information that pertains to executive quarterly summaries for your principals, and CRM requirements. “We also include a clause that the sub-rep should return all electronic files upon termination. Sometimes that’s easier said than done, but at least if you do it, you have a leg to stand on if there is a disagreement.”

Agreeing on Expectations

Next is establishing expectations. “Once you have determined with the sub-rep what the potential is for them in the territory and ensured both sides that it’s a win-win proposition, all other items pertaining to expectations are discussed. Among those expectations are communication and the need for the sub-rep to provide ongoing feedback from the territory on a regular basis. That feedback should include customers’ contact details, leads and problem follow-up. You also want to ensure that the sub-rep will attend all pertinent sales meetings and teleconferences. Remember they represent your agency; they are an extension of your agency and must have a visible presence in the territory.”

Training and Education

Not to forget the important aspect of training and education for the sub-rep, McNellis explained, “We have a five-step process that actually covers both our direct and sub-reps:

• “We provide them with the principal’s website information and literature.
• “We conduct joint sales calls with them at both existing and potential customers. During those calls, the sub-rep is observing. During these calls, you make sure that you ask all the important questions for the sub-rep to gain an understanding of your agency’s style. This also gives them a feel for the type of customer that you are selling to.
• “Once that’s done, we bring them into our office and conduct additional technical training. We will train them on the basics and then go more in-depth with our principal’s materials and products.
• “Then we allow the sub-rep to go out on their own to call on small existing customers. This allows them to gain a familiarity with the territory.
• “Fourth, we then pay for the expenses for the sub-rep to travel to our principal’s factory for additional training. We travel with them to ensure that the principal is happy with the selection that we’ve made.
• “Finally, we follow up with any additional training that is needed — more is always needed.”

Following McNellis’ presentation, there were a few questions pertaining to the use of sub-reps from attendees of the MANAcast. Among those questions were:

• How do you approach or notify your existing principals to let them know that you now have a sub-rep working with your agency? According to McNellis, “The obvious hope is that you have a good working relationship with your principal. We’ve been working with sub-reps for 25 years and we never had a problem. What we generally do is let the principal know six to nine months in advance of what our plans are. They’ve all bought in to our process.”
• What is the commission split with your sub-reps? McNellis explained, “We split 65 percent-35 percent, with 65 percent going to the sub-rep. They have done the majority of the work and our sub-reps have found that is acceptable.”
• What are the sub-rep’s communication requirements with the agency? “We ask our sub-reps to use our CRM system and we’ve found that to be a good and easy tool for them. In addition, phone or computer communication is more than acceptable.”

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Where and How to Find Rep Salespeople

By Jack Foster

June 2021

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“When I start thinking about adding someone to my agency, I know I’m in for a rough ride. Just about everyone working in my industry right now is in the 50- to 70-year-old range. It’s more difficult now than ever before to find someone younger who might be interested in carving out a career as a rep.”

“I was so desperate the last time I had to hire someone that I developed a flyer describing the position and ran around town dropping it off in the hopes someone would be interested. I don’t think it’s a surprise to me or anyone else, that didn’t work out too well.”

Those are just two scenarios described to Agency Sales in interviews over the last couple of months on the subject of where — and how — to find independent rep salespeople.

That subject has been raised often enough that MANA hosted a MANAchat devoted to the subject of finding prospective employees earlier this year. With 29 association members participating, a week-long, wide-ranging discussion took place that covered, among other things:

• The difficulty in locating prospective employees.
• Where and how to find them.
• What to look for in those prospects.
• How to compensate sales personnel.

The first subject tackled in the discussion was challenges that rep agency owners face when they reach the point that they feel they should add to staff. Initially one rep offered, “One of the first problems you face is that we’ve found that today it’s difficult to locate someone who actually knows what it takes to be a rep. Not everyone has the motivation to make their own decisions and fend for themselves.”

Hunter vs. Farmer

That comment led right into a discussion of the “hunter/farmer” concept and a consideration of what the agency needs most. According to one rep, “Whom you hire basically depends upon those things that as owners you need for your agency. Here’s what I want — salespeople who are ‘hunters’ and want to file an IRS 1099 as opposed to a W2. Sure, there are a lot of people out there who have real potential, but they have an addiction to the regular paycheck — let’s call them ‘farmers.’ I’m up against that whenever I’m looking to add someone.”

He continued, “We’ve actually hired some of those ‘farmers’ over the years. Let’s describe them as individuals who are comfortable selling for just one manufacturer. What it comes down to is that they haven’t been able to make that leap to ‘hunter,’ that is, going out looking for new business for additional manufacturers. They were simply used to business being given to them and they fulfilled their obligations by just farming, or maintaining, the business. When we look for people, we want those hunters who are comfortable searching for new business.”

A second rep offered, “Looking at the real world, there are any number of people out there who are happy not working all that hard. On top of that, we’re a commission-only agency and that backs off a lot of people. My message to prospects is that being a rep is one job in your life where if you work smart, and you work hard, your potential is unlimited. The more you sell, the more you make. In your search for employees, you have to find people who want to make a lot of money. As a result, they’ll want to work, and they’ll have that sense of accomplishment that comes with putting forth extra effort.”

And finally, another chat participant stated, “While we’re not opposed to hiring anyone regardless of age or gender, the fact is, when you look at statistics, we’re working primarily in a male-based business, and the majority of those males are in their 50s or older. That somewhat limits your possibilities.”

Exploring the Where and How

Admitting that there are any number of problems to consider when beginning the search for new employees, chat participants next took up the subject of where and how to find prospects. High on their list of logical places were networking with fellow reps, referrals from manufacturers and customers, print ads, business associates, friends, recruiters, and various online portals. The subject of making use of social media — primarily a tool such as LinkedIn — was raised with chat participants voicing mixed results with that approach. For example, one rep noted that “When I got a recommendation from a rep peer that I use LinkedIn, I looked immediately and actually got a couple of hits right away. However, in general, with how things played out, I don’t think it really worked for me.”

Another suggestion was offered by a rep who explained, “I had some success in recruiting at the college level. I contacted a local college engineering department and made an effort to hire sales-oriented individuals from the ground up. By that I mean get them fresh and train them without them having any bad habits to begin with.”

The benefits to this approach were described by one rep who explained, “Right now I’ve got two people out on the street working for the agency that don’t have any sales training experience. What I’ve decided upon doing is to bring them in ‘green’ to the industry, teach them the needed skills and then systemizing for them what we do. Once we’ve got that system in place, they don’t have to think about our processes. All they have to do is sell the products that we represent.”

In general, however, the tone of the chat participants was that “…it’s difficult to hire someone to work for your agency when the majority of people don’t know what it takes to be a rep.”

Interview Process

Assuming prospective candidates have been located, the chat participants were asked to relate their experiences during the interview process, that is, how were interviews conducted and what were agency owners looking for when they got the opportunity to directly communicate with prospects?

According to one rep participant, “Given all that we’ve been through during the past year, it’s not easy finding people. You can’t go out and personally meet and touch prospects like we used to be able to face-to-face. But, what we’ve settled on in our approach to this task is to turn over every rock to find individuals who possess integrity and have a good work ethic. Given the limitations of what we’ve been able to do during the pandemic, once we think we’ve found a prospect, my approach is to speak with them face-to-face via a virtual computer meeting. This approach has been great. There have been a great deal of good conversations and I felt I really got to know the individuals I was considering.”

Once those conversations transpired, chat participants described what they were looking for once they firmly got a prospect in their sights. Universally, agency owners are looking for people who possess a sales aptitude. Given that, however, a work ethic and integrity are of paramount importance.

Describing the process, one rep offered, “To begin with, we don’t put a great deal of credence in an individual’s resume. When we’ve found someone we want to speak with, I’ll conduct the initial interview. Following that, if we decide we want to proceed, we’ll have the individual come into our headquarters for additional conversations. This is all done at our expense. We have them meet with our inside people. Our feeling is that if there’s something odd, our people will pick up on it.”

The ability to communicate via the phone was important for another agency owner who explained, “When we’re interviewing someone, and the initial interview is conducted over the telephone, we’re seriously considering their phone skills. You want to understand how they’re able to communicate because, generally, that’s the customer’s first impression. Then, considering the restrictions that Covid has imposed on us, we want to know how they’ll behave on a Zoom, or other remote, call.

“The way we sell has been dramatically affected by the pandemic. A majority of our customers are now working from home and we want to know how creative an individual can be when they’re communicating remotely.”

The Compensation Question

No conversation of locating, attracting and signing new personnel can be complete without the consideration of compensation, and, the MANAchat was no exception. Among the strategies employed by agencies when it comes to compensating new personnel were:

• One-hundred percent commission with a draw.
• Combination of base salary and commission.
• Bonus structure in which all outside people share
• Salary, plus commission, plus an incentive plan where “We sit down with everyone at the beginning of the year and agree on the terms.”

Among all the MANA members who participated in the chat, there was agreement that whatever compensation program is agreed upon, agency owners have to be sure their salespeople have sufficient income to pay the bills, while at the same time being incented to develop and grow the business. According to one rep, “It’s a little bit like investing in capital equipment. You must be sure you’ll get a return on your investment in order to cover the up-front cost. How long you’re willing to make that investment depends upon how long it will take to get the new person up to speed so they can make their own way financially.”

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Checking References:
Just Confirming the Decision to Hire or Not?

By Jerry Ballard

May 2020

© Prostock-studio | stock.adobe.com

Over the last 45 years, I’ve hired and trained many outside and inside salespeople. I’ve made a lot more hiring mistakes than wins. This writing is to hopefully help you, the manager, make fewer mistakes than I did. Sales professionals can also learn to stay in touch with previous supervisors. Make checking references an integral part of the interviewing process, not just a formality. The tendency is to ask easy questions, hoping no red flags come up that would cause you to question the decision you have already made to hire the person. Don’t do this!

Who will give a usable reference? I’ve found the only reliable references are previous supervisors. They will know how well the candidate performed. Friends and former coworkers will tell what a nice person the candidate is and will only say what will help the person get the job. Character references were worth something 60 years ago, but not anymore.

If a candidate can’t give me at least one former supervisor to speak with, that ends the interviewing process. A lot of large companies require reference checking go through their human relations department. You can only find out dates of employment, position title, and sometimes pay. Finding out the candidate lied about his employment dates and title can weed out a few candidates, otherwise human relations can’t help you with what you really need to know.

I’ve learned to ask for two supervisor references before a final interview. I call them, hoping to uncover some good attributes and generate some clarifying questions for the final interview. Sometimes just asking for two supervisors will stop the interviewing process because you may never hear from the candidate again. (Meaning the candidate does not have good references.) Time and trouble saved!

When responding to requests for references of your own past employees, check the law of your state. You may find that your honest feedback on a former employee is protected as long as it wasn’t done to intentionally hurt the candidate, but was simply answering legal questions honestly. This essentially protected the reference giver from liability in giving reference information. Sometimes a previous supervisor will say, “I have to call human relations for a reference.” I tell the supervisor I will not hire someone without speaking to a previous supervisor and ask if I can call his personal cell after work hours to talk about the candidate. If he or she still refuses, this may or may not be a negative reference in itself. You have to sense the tone of the supervisor and decide if it is a red flag or not.

Questions to Ask About the Candidate

Ask the tough questions. This is important. Before we get into the tough (important) questions, what does it take to do a reference check? Reference checking requires both skill and intuition. Let’s talk about skill first. A vital skill is to ask all reference givers the same questions about the candidates. This means you have to have them written down, leaving space for answers.

The first thing you say is “Anything you tell me will be held in strict confidence, meaning no one else will know what is said except you and me.” If you hire the person, don’t tell him or her what was said, just say “It was a good reference.” Next, state the position the candidate is being considered for. This will tell the reference giver why you are asking certain questions so he or she will answer more completely.

Verify month and year of the start and end of employment and the job title held. Ask what the nature of the work was. Ask how well the person got along with coworkers and why the person left the company. Ask about how many sick and personal days were taken per year. For sure, ask how often the person was late for work and by how much. I’ve had to let two people go in the past year because they were consistently late by 15 to 30 minutes. (I didn’t ask the question in my reference check.) Ask: how were his or her results compared to others in a similar job?

Now for the difficult questions. Ask what two main strengths the person had, then what the two main weaknesses were. To help the reference giver feel more comfortable with answering, I tell him or her, “We all have our weaknesses, I know I do.”

Always ask if the person had any drinking, drug or gambling habits that interfered with his or her work. This question paid off one time when the reference said, “I prefer not to answer that question, but you can call a Salt Lake City police detective for the answer.”

Always ask if they would rehire the person if a suitable opening came up. This is a hard one to ask because, before asking, you may think they might re-hire when they find the candidate is available again. This is a chance you have to take. It can be a make or break question. If they say no, always ask why not? If there is a long pause before answering yes or no, this is where your intuition comes in. It is important to probe at this point, hoping to uncover the issue. Sometimes the issue is not one that affects doing the job you have open. Last, ask: Is there anything else you’d like to tell me that might help in understanding his or her capabilities?

Your intuition comes into play with reading the way the tough questions are answered. One time I called a small business owner/supervisor reference saying a candidate had given his name to call. The owner responded that he can only tell me dates of employment and job title. I then said to him, “I’ve called references, hired and trained a lot of salespeople, and one thing I’ve learned is that it is more important to read in between the lines of what is being said than what is actually said. Would I be correct to read between the lines of what you just said? “He responded emphatically and loudly, “Yes!” I thanked him. He obviously didn’t want to recommend the candidate.

The president of an equipment company called me one time to check a reference on a person who used to work for me. He told me he was calling about an individual who was interviewing for vice president of sales. When I heard the name, I thought to myself, “This person is not qualified to be vice president for any equipment company.” I responded that I would answer any question as long as it was very specific and not general. To me, that is a red flag statement in itself. He proceeded to ask me several “soft ball” questions, questions that really do not uncover the capabilities and weaknesses of the person. He hired the individual. I heard he let the person go after a few months. He might have saved his company time and money had he not already decided to hire the person.

In summary, the reference check is a vital part of hiring a person who can do the job. Make it count.

The Ongoing Search for the Right Sales Fit

By Jack Foster

February 2018

© Kurhan | stock.adobe.com

Agencies’ quest to locate and hire competent and hopefully successful outside salespeople remains a constant. If there was any need to have a reminder of the importance of that ongoing process read the interviews with agency heads that appear in this issue of Agency Sales. At the same time, it’s worthwhile to take a look back almost 10 years to an article that appeared in this publication (May 2009) entitled “In Search of the Right Salespeople.”

In that article, Mike Norton of AxiomOne, a company that provides diagnostic and evaluation tools to assist in the hiring process, detailed some of his thoughts on the importance of carefully approaching the hiring process.

At that time Norton professed great optimism in the future of the independent rep business model when he said, “I see great opportunities for reps. I believe manufacturers will turn to reps — as they already are in great numbers — because reps are such a flexible sales force. Those numbers turning to reps will only increase when the financial people who occupy so many of the manufacturers’ decision-making positions understand the message that reps:

• Work on commission.
• Don’t need the benefits and support the manufacturer commonly provides its direct sales force.
• Know the needs of their territories.
• Know who the customers are and have long-standing relationships with them.
• Tend to have deep roots in their territories.
• And, they work with 30-, 90-, or 120-day contracts.

“So for manufacturers, the question remains, ‘What better time than now to sign on with reps?’”

Mike Norton

Norton added that while these attributes provide the ideal opportunity for reps to shine, at the same time rep firm owners are faced with the challenge of growing their organizations by finding, hiring, training and retaining professional salespeople. The question remains, however, “How does the rep accomplish those tasks?”

He continued, “As many manufacturers continue to downsize, there’s an exponential challenge for reps to choose from among the many available people to make sure they get the right fit. To achieve that correct fit, what should the rep firm owner be looking for? I’m not going to volunteer that there are blanket capabilities they should be seeking. What they should be seeking, however, are individuals that they can measure or affix a benchmark to. In other words, they’ve got to be able to have someone in place so that they can say, ‘Here’s what I want you to be achieving in 90 days, 120 days, or a year.’ In the absence of that kind of benchmark or goal setting, they’re not going to be successful in finding what they need for their organizations.”

Norton emphasized that the obvious first step in the process he was referring to is recruiting. He cited one rep firm that “…formalized an approach that I’ve heard many other reps refer to, and that is simply staying alert to what he hears from others in the industry. Basically, when he learns of someone who’s good at their job, he asks that the person be sent his way — if they’re available.”

In order to be effective in this process, the rep needs to have a clear picture of the exact type of person he’s seeking to join his firm. Be able to ask and answer the following questions:

• What skills must they possess?
• What benchmarks are we looking to achieve?
• Where do we want to be in the future with this person?

“Once you’ve accomplished that, the rest just falls into place,” he maintained.

In addition to regularly touching base with fellow reps, Norton urged reps to make use of the networking organizations they belong to. He cautioned, however, on the practice of taking personnel from your rep peers. “That’s something I’d definitely stay away from; however, if you learn from one of your manufacturers or distributors that there’s someone very good available, there’s nothing wrong with acting on that information. If networking efforts don’t bring the desired results, don’t be afraid to search various job boards for individuals who might meet your position requirements.”

He went on to address questions that any sales manager has had to face and they are, “When it comes to selling, is it an art or a science? Is effective selling innate, or can the individual be trained to be effective?”

In answer, he maintained “I’m of the mindset that as you develop your job requirements, you keep in mind that if someone isn’t from a specific industry, but is a ‘killer salesperson,’ and possesses the drive and work ethic, they can be trained to be effective in your industry. I’ve seen some rep firms fall into a trap of sorts — they find someone from their industry, get all excited about them and the fact that they’ve made the right hire, and then as they approach various benchmarks, they realize they’ve made a serious hiring error.”

Once an agency locates a prospect, Norton maintained that rep firms have to go above and beyond the norm in order to attract the kinds of top-performing people needed. “In challenging times people tend to stick with the ‘devil they know.’ They’re not as willing to make a change as they would be during boom times when they’re much more willing to take a risk. As a result, to attract people the rep firm has to communicate to prospects that the firm is going to be around for the next 10 years. They can point to their stability in the territory as an indication of their roots in the community and then work to convince candidates that their organization has what it takes to keep the doors open. Finally, show candidates that there are plenty of opportunities to make money when going to work with a rep firm.”

If what Norton described constituted the “selling” job a firm owner needs to perform on a prospect, he cautioned against over selling in that area. “Be careful about selling yourself and your firm right out of the gate. Instead, save that till the very end when the prospect has already exhibited genuine interest in your organization.”

Once the recruitment process has been completed and the firm owner is faced with the question of who should be added to his sales team, Norton advised against comparing and contrasting the final candidates. “Don’t just sit there and look at whom you have and compare and contrast them with each other. If you follow that practice, what you’re ultimately going to do is go with the best of the worst. You’re going to choose the one who’s least offensive, the one with the fewest warts. Instead, refer to what I’ve already emphasized about the need to set measurements and benchmarks, and make your decisions based upon which of the candidates is best able to meet those mutually established goals. Let each candidate stand alone, and if the answer is ‘No’ on all of them, then move on.”

The consultant continued by maintaining that reps should also be cautious in the area of “personal chemistry” or “gut feeling” when it comes to making a final choice. “I always warn my clients about the danger of ‘falling in like’ with a candidate. Certainly we’re all aware of the fact that customers are more inclined to buy from someone they like, but that doesn’t mean you have a close personal relationship with the person you hire. If you objectively assess their talents and determine they can excel at their jobs, then they should be a ‘go.’”

Norton concluded his thoughts on the recruiting and signing of salespeople by noting that as rep firm owners consider how they’re going to grow and where they’re going to find the people to work for them, “They should have concrete plans to serve them in the future. A number of firms were started and sustained on the sheer drive, energy and talent of their founders. Those attributes may have worked well when the firm had three to five people, but it’s different as you continue to grow. You need a plan, a vision and mission to move forward. If you do and the new hire sees clearly where they can fit into that plan, you’ve unlocked the door to future growth and success.”

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Hiring With an Eye to the Future

By Jack Foster

February 2018

As Kurt Kroemer and his partners in CEP Sales Inc., Zionsville, Indiana, looked to the future, what they saw was a good deal of uncertainty. “Faced with the prospect of half the sales force anticipating retirement in the next couple of years, not even counting what plans I might have, we had to make some decisions. One of the decisions we could make was to simply do nothing and just let the agency peter out. Another path we might take would be to try to sell the agency to someone. The latter course obviously takes a great deal of planning and work. Ultimately, you might be able to get a year or two commissions out of the sale to sustain you, but neither decision seemed all that exciting.”

Kurt Kroemer

Rather than just standing pat, however, the four partners decided on a positive course of action. According to Kroemer, “We have spent three years developing the plan for the next generation for CEP Sales. We have begun implementing the plan and recently completed two hires.”

Admitting that “We’re fairly new at this,” Kroemer explains that the present ownership bought the agency — which was started in 1980 — from his father in 1995. Fast forward to the point where Kroemer and his partners are planning for the future and that plan had to materialize — and materialize it did. Ultimately, the decision was made to expand the agency’s territory and then hire new young salespeople that “we could develop into reps with the intent that they would stay and carry on after we’re gone.”

With a five-year plan in place, the goal was to hire two new people, pay them salaries while funding the buyout of the departing partners. “That’s why it was so critical to hire the right people to ensure that we could afford to pay them while compensating those who were leaving.”

Kroemer explains that the agency’s first successful hire came about as the result of the time-tested word of mouth. Following that “We tried to locate people through networking with our principals and our own customers. We asked that if they knew anyone to let us know. We worked on that basis for about two years and finally decided we weren’t getting the results we needed.

A Love for Sales

“One of our concerns was that we were looking for someone in Ohio where we never really had a presence. We were seeking someone to place in Columbus who loved sales and was energetic. We ran an ad for one month and wound up with a lot of reps responding that they wanted to merge with us. We ended that effort quickly. Next we did a trial run with Monster.com. We purchased an ad and put in the necessary filters for the territory and for the type of person we were looking for. The results were that we wound up with too many people responding — not the guys we wanted. Once again, after two or three months we decided that this just wasn’t working.”

Finally, last March, LinkedIn came in with a free trial offer that included a hiring application. According to Kroemer, users of the offer would stipulate the type of person they were looking for. For instance, you could specify the level of experience, industries that they work in. “Once you did that, LinkedIn would present you candidates who made it through your filters. You’re able to see where they’ve worked previously and what industries they specialize in. You get a feel immediately as to whether they’d be good fit or not. It really allowed you to zero in on the type of person you’re looking for.

“I went through about 500 of these LinkedIn resumes and wound up writing to about 75 of them alerting them to the fact I was looking to fill this positon in Columbus. Out of the 75, I got maybe 12 back and from that total I interviewed six. I drove to Columbus, set up appointments for every two hours and covered all of them.

CEP sales representatives, left to right: Bruno Cosentino, Josh Valentine, Case Roberts, Gary Coval, Kurt Kroemer, Darcey Elmore, Bill Kroemer and Wayne Kroemer.

MANA Research

“Even before we had anyone come in for an interview, I had them go to the MANA website and conduct some research to learn what a rep was. My feeling was that if they learned ahead of time what it took to be a rep, they could better determine whether it was for them or not. My feeling was that it made no sense to talk to them if they didn’t have a clue. As it was, the real key for me during the interview was whether the candidate could convince me that they could work independently managing their own territory. Out of those interviews, we hired one of the people and another one was slated to move to Chicago to handle that territory.”

As he looks back at his search/interview/hiring experience Kroemer notes, “I’m hardly an HR guy. When I meet an individual I’m not going to know all about their history. My job is to understand people — that’s what I do for a living. I have to have an understanding of what real people are when they’re in front of me. As a result, when I’m evaluating a candidate, I’m determining whether I like them or not.”

At the same time, he admits that perhaps more important than whether he likes someone or not is the fact that they can sell. “The person we wound up hiring had already had an immense amount of sales training. He was required to make calls each week and come back with quotes. That experience alone was more than I was looking for. Look, no one knows how to sell castings, but I can teach them how to do that. It’s the selling skills that are so important.”

Admitting that possession of sales skills is a real positive, Kroemer spoke for a moment about some of the negatives that could steer him away from a potential candidate. “It’s not always easy to pick up on negatives in the beginning, but certainly if someone has worked for four or five different companies in the first 10 years of their career, that shows me that they’re just moving around too much. On top of that, if they’re not selling to the industries that we’re involved with, then it’s not going to be a good fit.

“In addition, I pay close attention to the e-mails they might send to me. Did they sound professional and did they spend time in putting together a good e-mail? After the interview, did they follow up with me? Did they fail to make eye contact? Did they talk beyond their level of experience? These are all things I pay close attention to.”

Armed with his own experience, Kroemer says that if he’s got any advice to offer other reps faced with a future similar to CSP’s, have a plan in place and make sure the lines of communication remain open with principals. “One of the things I did was to speak with MANA’s President Charley Cohon to ask his thoughts about the future of reps in general. If anything, Charley let me know that reps and the value they bring will be here well into the future. They’re simply not going away.”

Armed with that encouragement, the agency decided to expand its territories into Michigan, Illinois, Georgia and Tennessee. “Then we moved ahead to hire these younger salespeople to work the territories themselves. In doing that, we naturally had to have a commitment from our larger principals, and they were absolutely thrilled with our plan. An important part of what we communicated to our principals was that we wanted these people in place to be in the territory for the next 30 years or more. That’s just something they have to know for their own future planning.”

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