Employment and Self-Employment: Differences in Determining Earnings

By Polhemus, Jennifer L. | Journal of Legal Economics, Winter 2002 | Go to article overview

Employment and Self-Employment: Differences in Determining Earnings


Polhemus, Jennifer L., Journal of Legal Economics


Introduction

As self-employment in the United States continues to rise (Manser and Picot 1999), forensic economists are seeing the results of that phenomenon in their work. Economists skilled at evaluating earnings and fringe benefits for wage and salary workers also need skills in understanding the earnings of self-employed plaintiffs. The level of understanding required goes beyond recognizing the differences between a Form W-2 and a Form 1099, and extends to understanding the basic differences in the structures of revenues and costs and in the tax treatments characterizing each arrangement. The following discussion seeks to sensitize forensic economists to some of the issues that can come into play when analyzing earnings of self-employed plaintiffs and comparing them to traditional employees. Readers should note that for this discussion, the self-employed plaintiff is a pure sole proprietor, meaning that the business' revenues and earnings are the result mainly of the plaintiff's own labors, rather than the result of extensive use of capital and/or the labor of other employees.1 The author believes that this is the type of self-employed plaintiff encountered most often in personal injury cases. In the cases described here, there is presumed to be a strong nexus between the plaintiff's own labors and the revenue produced. When this connection is less clear, due to significant capital and/or use of employees, a lost earnings analysis tends to resemble a lost profits analysis.2

Some occupations have been characterized historically by traditional employer-employee arrangements; examples are manufacturing firms, retail stores, restaurants, and schools. Other occupations are characterized typically by independent contractor arrangements (i.e., self-employment), such as landscapers, real estate agents, insurance agents, and specialty building contractors. Some of the differences between employee workers and self-employed workers are described in this paper, with a focus on the dimensions relevant in determining an earnings base when estimating economic losses. In order to provide practical information to forensic practitioners, the example of two truck drivers is used to illustrate the distinctions according to employment status. The example assumes that each driver sustained a partial disability of limited duration; therefore, there is no discussion of possible residual asset value. The example includes some items, such as payroll taxes, that will not be relevant in every damages analysis. They are included in order to present a full picture of the financial differences. How a forensic economist uses the information presented will depend on the assignment, the facts of the case, and the relevant law in the subject jurisdiction.

Reasons to Understand Self-Employment Earnings

The most obvious consumers of the information presented here are financial experts dealing with injury cases and other cases involving self-employed plaintiffs. Yet understanding the differences between traditional employee earnings and self-employment earnings may be important in employer-employee litigation as well. A former employee, now the plaintiff in a wrongful termination action, may have mitigated lost earnings by engaging in self-employment. Thus, the analysis of lost earnings would need to reflect the differences in income between the two jobs, necessitating an understanding of the appropriate adjustments. Also, an economist may be asked to address these differences in conjunction with employment disputes concerning whether a certain worker should (or should not) be classified as an employee. Various legal issues, including insurance coverage, benefit coverage, standing to sue, and permissible damages can be influenced by a worker's employment status. Economists who understand the financial implications stemming from the differences between employees and independent contractors will be better able to analyze damages under the various scenarios they encounter. …

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