Currently, under the Highlights section of the U.S. Department of Labor ("DOL") website, there is a caption that reads "Misclassification of Employees as Independent Contractors." Clicking on that linked caption takes one to a page that says, in bold letters, "The DOL Misclassification Initiative." The web page expresses the DOL's stated reasons for the initiative in the following way:
The misclassification of employees as something other than employees, such as independent contractors, presents a serious problem for affected employees, employers, and to the entire economy. Misclassified employees are often denied access to critical benefits and protections — such as family and medical leave, overtime, minimum wage and unemployment insurance — to which they are entitled. Employee misclassification also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers' compensation funds.
(See www.dol.gov/whd/workers/misclassification/)
This may be depressing to read, but it is also no surprise. The agency really is targeting companies (large and small) and is taking a close look at whether workers classified as independent contractors should be classified as employees instead. The difference, of course, means collection and payment by employers of employee income taxes to State and Federal agencies, Social Security and Medicare assessments on employers and employees, as well as employer payments of unemployment compensation and workers' compensation premiums. It can also mean the difference between paying overtime and not being obligated to do so. Because the interests of so many agencies converge on the classification of workers as employees, the audit of a company can emanate from many different enforcement agencies — which include the U.S. DOL, IRS, State DOL, State Unemployment Tax Office, and State Office of Workers' Compensation — to name a few. The results of an unfavorable audit can be costly and will likely include thousands of dollars due in back taxes for each misclassified worker.
Just a few of the DOL Press Releases in 2011 involving misclassification include:
July 27, 2011 — Essington, Pa., company pays more than $256,000 in back wages to delivery drivers following U.S. Labor Department investigation. Parts Distribution Express of Essington has paid $256,340 in back wages to 158 delivery drivers who were denied proper overtime wages as a result of being improperly classified as independent contractors, following an investigation by the U.S. Department of Labor's Wage and Hour Division. (U.S. Department of Labor Wage and Hour Division Release Number: 11-1109-NEW (426))
November 2, 2011 — Allston, Mass., employer to pay $250,000 in back wages and damages to 42 workers following U.S. Labor Department investigation. Employees of real estate and property management company misclassified as independent contractors, not paid required overtime. (U.S. Department of Labor Wage and Hour Division Release Number: 11-290-BOS / BOS 2011-079)
June 29, 2011 — C and K Rentals in Cuero, Texas, to pay more than $433,000 in back wages to 124 employees following U.S. Labor Department investigation. An investigation by the Wage and Hour Division's McAllen District Office found that the company misclassified FLSA-covered employees as independent contractors, thereby denying them the minimum wage and overtime compensation guaranteed under federal law. (U.S. Department of Labor Wage and Hour Division Release Number: 11-758- DAL)
And it does not look like the pace of investigations is going to let up. In September 2011, Secretary of Labor Hilda L. Solis announced that the DOL signed a Memorandum of Understanding ("MOU") with the IRS under which those agencies will work together to share information with each other to "reduce the incidence of misclassification of employees." In addition, labor commissioners and agency leaders representing 11 states have signed similar MOUs with the Department's Wage and Hour Division.1 The Department states that it is actively pursuing MOUs with additional states, as well.
As a practical matter, what does this mean to you and your company? It means that an audit by the state unemployment compensation tax office that finds violations might well indicate that a DOL or IRS audit will soon follow (resulting, potentially, in more back taxes and more penalties).
But don't forget that, despite the increased scrutiny and, in some states, the increased penalties that new laws allow to be assessed for misclassifying workers2, the law permits companies to have independent contractors and companies should make use of this classification when it is appropriate.
There are several proactive steps an employer can take to protect itself against a misclassification finding. While each agency employs one of several different tests to determine whether a worker is an employee or independent contractor, these agencies all generally weigh similar factors in making that determination. These factors revolve around who is actually controlling the way in which the work is completed — the worker or the company — and may include whether there is a significant investment by the worker. Where the worker is controlling the "how, when, and where" the work is performed, it is more likely that the worker will be found to be an independent contractor. Agencies look at facts such as who sets the hours of work, whether the worker has his own office or business location, whether the worker is free to hire others to do the work, whether the worker must periodically report on the status of the work, whether there is training provided by the company as to how to perform the work, whether the company requires the worker to follow its policies and procedures, and whether the worker is issued a 1099. Therefore, reviewing how the relationship works in reality and, to the extent possible, conforming the relationship to these factors is a good first step.
It is also prudent to review the company's independent contractor and consulting agreements to make sure they do not contain red flags (such as non-compete agreements or provision for benefits participation) and do contain helpful provisions (such as permission for the independent contractor to subcontract the work and do the work when, where and how they see fit).
At the end of an inquiry, companies sometimes realize that workers that have been classified as independent contractors instead are closer to employees and the risk of an adverse finding in case of an audit is simply too great. In that case, a company may want to begin reclassifying independent contractors as employees — a task that itself can be fraught with risk, as reclassifying workers arouses suspicion.
It is beneficial for a company to get a lawyer involved to coach it through this process. In the end, it could save the company a lot of time and money.
So, if you are thinking about what you can do in the coming year to protect your company from the increase in government regulations and oversight affecting American workplaces, take a close look at your independent contractor relationships. It is a boring New Year's Resolution, but it is easier than going to the gym three times a week.
Footnotes
1. These states include Colorado, Connecticut, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, Missouri, Montana, Utah and Washington.
2. Among others, California and Connecticut have recently enacted severely punitive laws where employers have willfully misclassified workers as independent contractors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.