Should Your Independent Contractors Be Employees?

 

If you are a small business and hire workers in your company, here is something that might concern you.  The U.S. Department of Labor (USDOL) and the Internal Revenue Service (IRS) are cracking down on companies that improperly treat employees as independent contractors.    

I know we’ve heard about the worker classification issue for a long time but now it appears they mean business.  The USDOL is signing agreements to share information with the IRS and nine states and guess who one of those states is – Missouri.   

Employee misclassification is an issue affecting companies across the United States.  The distinction between an employee and I/C can be difficult to determine.  One example is FedEx Ground, which claims its drivers are I/C’s because they own their trucks and sell their routes.  The attorney General of NY and several other states are investigating whether this is the correct classification.  Because of their classification FedEx drivers are unable to unionize and are not subject to wage and hour laws.

Understanding the difference between employees and I/C’s is the best way to prevent your company from finding itself in a legal situation.

If your company hires independent contractors, now is a good time to revisit the classification to make sure you have it right.  Many of you don’t.  The DOL ranks Missouri as the worst state in the nation in terms of misclassified workers.   

Three reasons you may have gotten by this long:

First, the USDOL encourages a 10 percent random audit selection with 90% of audits coming from high risk/targeted industries.  The Missouri Division of Employment Security (DES) instead used 100 percent random audit over that timeframe.  As a result, industries that historically have shown higher instances of misclassification have not received increased audit coverage.  Furthermore, the DES does not perform follow-up audits of employers that misclassify workers.

Second, the statutory definition of an "employee" in Missouri is more subjective than the majority of other states, resulting in less efficient reviews and more confusion among employers.  Furthermore, the MODOL does not adequately utilize Form 1099 data from the IRS to identify misclassified workers even though the IRS has stated it’s the most powerful tool for identifying misclassified workers and searching for hidden wage.

Third, historically the DES has not penalized employers for intentionally misclassifying workers. State law allows the division to penalize an employer 25% of the amount the state has been defrauded in the event of "fraud or evasion on the part of any employer is discovered by the division."

Why does Missouri and the IRS care so much how my workers are classified?

Lots of reasons but money is always at the top of the list. Lawmakers and government agencies on both the federal and state level see the "correction" of misclassified workers as a way to raise revenue by recouping lost tax revenues and collecting fees and penalties associated with misclassification.    

Coupled with this is a concern that workers are being deprived of the protections of various employment laws.  Workers classified as independent contractors do not receive unemployment insurance benefits if laid off or workers compensation if injured on the job, and they rarely receive health insurance or other fringe benefits.  They are not covered by the Fair Labor Standards Act – a law that protects employees for minimum wage and overtime pay.  Due to these and other reasons the IRS and states are cracking down.

Why should you care about improper worker classification?

Because wrong treatment can be a costly mistake.  If an I/C is found to actually be an employee, misclassification and mistakes in status can result in considerable liabilities to employers. 

Wages:  A misclassified employee may be entitled to back pay for overtime.  See Somers v. Converged Access, Inc. case. In this case, it didn’t matter that the I/C was paid more than the employees working in a similar position.  The court deemed the amount paid the I/C a salary and required the employer to pay overtime.

Taxes:  An employer may be liable for a percentage of back payroll and employee income taxes that were not withhold as required for an employee.  The employer is also responsible for the employer portion of the payroll tax and unemployment insurance. 

Tort liability: An employer could be held liability for the negligence of it’s I/C’s if they are reclassified as employees.  In the Huggins v. Fed Ex case, the courts sided against Fed Ex and for an injured man riding in a Fed Ex truck when it collided with another truck on Interstate 44.  Fed Ex treated their drivers as I/C’s but the court disagreed.  A St. Louis, MO jury awarded the plaintiff $1.05 million but found him 10% guilty for not wearing his seat belt.  His judgment was reduced to $945,000.  Fed Ex was found 40% guilty and they had to pay $420,000.

Benefits:  A misclassified employee may be entitled retroactively to workers’ disability compensation, unemployment benefits, reimbursement of medical expenses that would have been covered by the employer’s medical insurance plan and payment for holidays and unpaid leave days.  The Vizacaino v. Microsoft Corp. case involved workers classified as I/C’s who had tenures as long as many permanent employees but did not receive the same benefits.  The I/C’s objected to being shut out of a benefits program allowing permanent employees to buy Microsoft stock at a discount.  The court held that the workers were employees who could not be excluded from participation in the program, in part because they worked on site, shared the same supervisors, performed the same functions, and worked the same core hours as regular employees.

Insurance Premiums:  Insurance companies may seek retroactive premium payments for individuals who should have been included as employees and covered under an employer’s insurance plans (health, workers’ compensation, etc.).  See Injured Workers’ Ins. Fund v. Orient Exp. Delivery Service, Inc. case.

Penalties:  Federal penalties and fines because the employer failed to withhold employment taxes.   These penalties vary greatly depending on whether the IRS views your misclassification as intentional and whether Form 1099’s were filed for all I/C’s.

Jail time:  In 2010 New York passed the “Construction Industry Fair Play Act” which now makes it a criminal offense for an employer to willfully misclassify a construction worker as an I/C.  Punishment is 30 days in jail for the first offense and 60 days for each subsequent offense.

So who determines the worker classification status?

The law does.  It doesn’t matter what the worker or company wants, you have to follow the law.

The problem is that the law is changing so fast it’s hard to keep up.  In 2010 and throughout the first few months of 2011, a number of courts have issued important and interesting decisions in cases involving worker misclassification claims.  As a result, a multitude of tests have evolved for determining whether a worker is an employee or an I/C.   Do you know what tests apply to your state and company?

New legislation in various states have made it more difficult to classify a worker as an I/C.  For example, the enactment of the Construction Industry Fair Play Act passed in 2010 in New York makes it difficult to qualify a construction worker as an I/C.  Under this act, construction workers are assumed to be employees, rather than I/C’s.  They can still be classified as I/C’s if they qualify as having their own separate business in addition to meeting qualifications that show an obvious separation from the general contractor on the job.

So have you assessed your worker classification exposure lately?  I can help you do that.

Check back in a couple of days to read my next post to learn about steps you can take to minimize or avoid future worker reclassification.  J

And as always, you can call me if you have any questions.  My contact information is on my website.