I. Summary of Applicable Facts:
Career Institute of America, Inc. (CIA), was formed as a Delaware non-profit corporation one year ago by its current CEO who is the majority owner and controls the company’s business. CIA provides both online and classroom training to students. Although the majority of CIA’s income is earned from its online instruction, it has also benefitted from a U.S. Department of Labor retraining grant which is only available to non-profit organizations. However, the grant will not be renewed and future earnings will only be earned through tuition. The loss of the grant has lead the founder and CEO to question CIA’s non-profit status.
CIA’s courses are taught by instructors hired as independent contractors, not employees. The agreement currently used to hire these instructors, however, may not properly indicate their status as independent contractors. CIA needs to assure that its instructor’s contracts properly indicate their status as independent contractors.
A. What is the most appropriate form of business for CIA?
B. How can CIA’s instructor contracts properly reflect the status of its instructors?
A. Business Organization Law
Business owners who decide to incorporate in the state of Delaware may register their businesses as corporations, limited liability companies, professional service corporations, or non-profit associations. While a business owner may always organize a business as a sole proprietorship or partnership, these options are not discussed here because they do not provide limited liability protection for business owners. Limited liability protection is a key protection all business owners should have because it protects their personal assets from being used to pay business debts or obligations. In this way, should a business lack sufficient funds to pay a business loan, creditor debt, or lawsuit judgment, the assets of the owners cannot be used to pay the amounts due.
B. Independent Contractor Law
The key distinction between who is considered an employee and who is considered an independent contractor is whether the employer or the worker has control over the means, method, or process of completing the work (Kansas DOL; Sack; CA Dept. of Industrial Relations). An independent contractor determines how required work is to be done, whereas an employer tells an employee how to perform their job. In addition, employers are required to pay all payroll taxes for employees, provide employees with unemployment insurance and workers compensation benefits (Kansas DOL; Sack; CA Dept. of Industrial Relations). Independent contractors, however, are responsible for paying their own income and other employment taxes and for providing their own benefits (Kansas DOL; Sack; CA Dept. of Industrial Relations). Also, independent contractors normally work for more than one employer and complete skilled work or work requiring specialized training (Kansas DOL; Sack; Meier).
A. Business Organization
CIA, currently a non-profit, should terminate its status as a non-profit. A non-profit business or organization does not work to earn a profit. Because CIA seeks to earn revenues and provides its services on a fee basis, it does not seem to meet the initial requirement for a non-profit. CIA may choose to reorganize in Delaware as a corporation or a limited liability company (LLC). By forming either a corporation or an LLC CIA’s owner will benefit from limited liability protection. The registration process for a corporation is very similar to that of an LLC. Both require CIA to file either Articles of Incorporation (for a corporation) or Articles of Organization (for an LLC) and both should have their owners draft bylaws (for a corporation) or an operating agreement (for an LLC) in order to detail the duties, responsibilities, and powers of officers, owners (whether corporate shareholders or LLC members), and managers or board members. From the standpoint of the work required to form a corporation or LLC, as discussed here, therefore, they are equal in the amount of documentation and filings that must be completed. Also, either a corporation or an LLC can be created so that CIA’s owner retains a majority ownership in the business and retains majority control over the business.
However, although equal in the matters discussed above, an LLC appears to be the better option for CIA, even though it will need to change its name by removing the “Inc.” and adding an “LLC” to its name (Delaware Code § 18-102). Corporations under Delaware law are required to have annual or regular board of directors or shareholder meetings and specific numbers of officers (Delaware Code, Title 8). Also, under the IRS Tax Code, a corporation, unless Sub S status is elected (and this selection places restrictions on type of owners and the number of owners), will doubly tax its owners (IRS). Because a corporation is taxed on the profits it earns and its owners, shareholders, are taxed on the income or profits they earn from the corporation, the government is paid more than once on the money earned by shareholders (IRS). An LLC, however, does not have the requirements placed on a corporation regarding meetings or numbers of officers (Stimmel). This provides owners more flexibility in how to manage business operations. Moreover, LLC owners can elect to have their LLC earnings or profits taxed only at their personal income tax level without the need to select Sub S status, a selection which involves restrictions on ownership to only persons and the need to complete annual K-1 filings, in addition to corporate income tax filings (Stimmel; Karlinsky and Burton). Considering all of this, an LLC is the best, simplest business form for CIA.
B. Independent Contractor Contracts
The CIA instructors’ contracts must indicate, on their face, that CIA does not control the means instructors select to complete their work for CIA. While CIA can require its instructors to meet certain standards and to teach certain material in its courses, CIA must properly indicate that the choice as to how such standards are met or material is taught is up to the instructor to determine (Kansas DOL; Sack). This will allow CIA to determine the result of the work, as the employer of an independent contractor can do, while demonstrating that the independent contractor exercises independent authority to determine how he or she meets their job requirements. To further help indicate the distinction between an employee and an independent contractor, CIA’s instructor contracts should include language specifying that the relationship is not that of employer and employee, indicate that the instructors are free to pursue employment with others while working for CIA, as long as they are fully able to meet their CIA job requirements, and specify that the instructors, not CIA, is responsible for the payment of all earnings taxes and the availability of any insurance or other benefits (Kansas DOL; Sack; Meier).