Worker Misclassification: The Profusion, The Cost, and The Remedy as appeared in the Spring 2009 issue of NYSBA L&E NewsletterJuly 1, 2009
Economic instability and market place fluctuations have contributed to a significant movement by workers classified as independent contractors to demand the labor and employment law benefits and protections guaranteed to persons classified as employees. Individual, collective and class actions by workers against putative employers have accelerated dramatically in recent years with an ever increasing cost to companies both in terms of lost time and legal expense incurred in defending such claims, as well as the concomitant adverse publicity and negative affect on stock prices. Similar lawsuits filed by white collar workers seeking reclassification as nonexempt employees entitled to overtime are proliferating across the legal landscape. The liability that arises from worker misclassification conjures up horror stories where businesses have paid large remedies to make the workers whole.
While it is not difficult, given our litigious society, to understand why employee misclassification is a hot topic, it is more difficult to remedy the problem. There is no universal definition of "independent contractor." Every government agency, federal and state government, and the courts often apply different definitions, rules and tests.
Work misclassification is not limited to any specific industry. The retail and hospitality industries have seen challenges by store managers and assistant store manages, concierge staff, lead persons and others to their being labeled exempt from overtime pay.
In 1996, Microsoft was faced with making whole hundreds of freelance programmers who acknowledged, when commencing work for the company, that they were independent contractors ineligible for benefits given to Microsoft employees. The benefits in question included an employee stock purchase plan that effectively gave the plaintiffs the right to purchase Microsoft stock at a fraction of its then market price. In its ruling, the Ninth Circuit focused on the actual duties, functions, and circumstances surrounding the freelancers' work and day to day management control, rather than on the language of the workers' contracts. Although it succeeded in dramatically reducing the district court's near billion dollar liability assessment, Microsoft ended up paying one hundred million dollars to litigate and settle the case. Vizcaino v. Microsoft, 97 F.3d 1187 (9th Cir. 1996); see also Robert W. Wood, Independent Contractor or Employee? The Multiple Issues Involved in Independent Contractor Status, NYSBA Journal, June 2008, at 31.
In another high profile case, the U.S. Department of Labor sued Time Warner for deliberately misclassifying as many as 1,000 persons to circumvent providing them with employee benefits. Herman v. Time Warner, 56 F.Supp.2d 411 (S.D. N.Y. 1999). In November 2000, Time Warner settled the case for five and a half million dollars.
The healthcare industry has seen an increase in misclassification cases as well. In Brock v. Superior Care, Inc., 840 F.2d 1054 (2d Cir. 1988), the Secretary of Labor brought an action against Superior Care, Inc., a provider of nurses to individuals, hospitals, and nursing homes, for willful violation of record-keeping and overtime pay provisions under the Fair Labor Standards Act. The Court of Appeals affirmed the District Court's decision that the nurses were employees, not independent contractors, and were entitled to nearly seven hundred thousand dollars in overtime pay, with interest.
In Weisel v. Singapore Joint Venture, Inc., 602 F.2d 1185 (5th Cir. 1979), the appellate court reversed the trial court and held that Weisel was entitled to unpaid minimum wages and overtime pay, liquidated damages and attorney fees resulting from the hotel's failure to classify him as an employee. The hotel argued that Weisel, a parking valet, whose compensation consisted of gratuities from hotel guests and others using the parking facility, was an independent contractor. The Court of Appeals found that Weisel depended on the hotel for his employment, was controlled by the hotel, and therefore should properly be classified as an employee.
Owner operated parcel delivery drivers classified as independent contractors have successfully sought reclassification as employees before the National Labor Relations Board, the U.S. Equal Employment Opportunity commission, state and local unemployment and workers' compensation boards, and in the Courts. Although such stories exist in every industry, the question as to how to eliminate company exposure remains.
II. The Definition of Independent Contractor
No universally accepted definition of an independent contractor exists; however, there are attributes that help differentiate between an independent contractor and an employee. According to the U.S. Department of Labor, independent contractors are self employed. They are not protected by employment, labor, or tax related laws. Characteristically, they are free from an employers' control and perform work outside the usual type of business of the employer. Preferably, the worker should be engaged in an independently established trade, occupation, profession, or business. Susan N. Houseman, A Report on Temporary Help, On-Call, Direct-Hire Temporary, Leased, Contract Company, and Independent Contractor Employment in the United States, August 1999 at 9.1 available at http://www.dol.gov/oasam/programs/history/herman/reports/futurework/conference/staffing/9.1_contractors.htm.
Different agencies utilize varying "tests" when determining whether workers are properly classified as employees or independent contractors. The U.S. DOL and the IRS, both federal agencies, use different tests when determining independent contractor status. A worker may be considered an employee according to one agency, but not the other. The DOL applies the "economic realities test" or a hybrid of the "economic realities test" and the "right to control test," while the IRS focuses solely on the "right to control," Houseman at 9.1. Conservative companies should follow the more stringent test when classifying workers.
A. The Economic Realities Test
The "economic realities test" focuses on how economically dependent an individual is on the business served. Under this test, workers who are highly dependent on the business served and who derive a substantial portion of income from it, may be employees rather than independent contractors. The following four factors are typically considered when applying the "economic realities test:"
1) the degree of skill required in the particular occupation;
2) whether the work is an integral part of the employer's business;
3) the intention of the parties; and
4) whether the company deducts/pays social security and other taxes and provides fringe benefits.
Charles J. Muhl, What is an employee? The answer depends on the Federal Law," Monthly Lab. Rev. Jan. 2002 at 7 available at http://findarticles.com/p/articles/mi_m1153/is_1_125/ai_85107273/pg_8.
In Donovan v. DialAmerica Marketing Inc., 757 F.2d 1376, 1389 (3rd Cir. 1985), the Third Circuit applied the "economic realities" test and found that home researchers whose job required them to locate subscribers' phone numbers and place calls when subscriptions neared expiration, were employees. The court determined that the home researchers did not make a great investment in their work; had little opportunity for profit or loss; used little skill in their work; and refrained from working for other employers.
B. The Hybrid Test
Some federal courts combine the "economic realities test" with "the right to control test," to apply the "hybrid test." This typically involves the following factors:
1) who exercised what degree of control over the manner in which the work is performed;
2) what is each party's opportunity for profit or loss;
3) has the worker made a significant investment in the materials or equipment;
4) does the work require a special skill;
5) what is the duration of the contract relationship; and
6) is the worker's service an integral part of the employer's business.
Muhl at 7.
C. The Common Law Test
In NationWide Mutual Insurance Co., v. Darden, 503 U.S. 318, 323 (1992), the U.S. Supreme Court ruled that when federal laws fail to define clearly an "employee," the relationship between the company and the worker should be evaluated according to the common law test, focusing primarily on who has the right of control.
New York State courts and administrative agencies such as the NYS DOL and the State Worker's Compensation Board apply traditional "common law" rules to determine whether an individual is an employee or independent contractor.
The IRS has also adopted the common law test. The 20 factors utilized by the IRS may be summarized generally as follows:
1) does the putative employer specify the manner and means of how the work should be done or accomplished;
2) is the method of payment regular and consistent;
3) does the worker bring his or her own tools to the job;
4) does the worker or the company choose/control the hours of work;
5) is the nature of the work temporary, permanent, continuous, or intermittent;
6) is the worker in a separate calling or occupation from the putative employer; and
7) is the work an integral part of the putative employer's business.
Reclassification as employees provides to workers, among others, the benefits and protections of state and federal nondiscrimination laws, employment rights laws, wage and hour laws, and membership in unions. Further, an employer is required to provide its employees, but not its contractors, with social security, workers' compensation, and unemployment insurance benefits.
Courts will consider the actual work duties, not the job descriptions in contracts. Frequently, although a contract may identify a worker as an "independent contractor," the courts have decided otherwise. It could be argued that workers who sign contracts labeling themselves as independent contractors should be estopped from later claiming that they are employees. However, courts generally refuse to hold workers to such declarations, absent other considerations. In Abillo v. Intermodal Container Serv., Inc., 266 Dkt. No. BC 17450 (Cal. Sup. Ct. Jan 14, 2000), for example, the court held that the actual working relationship was more instructive than the contract language. Similarly, a court found in Loomis Cabinet Co. v. OSHRC, 20 F.3d 938 (9th Cir. 1994), that the applicable economic reality test emphasized substance over the form of the relationship. Some courts have gone even further and rejected written contracts as "adhesion contracts." In S.G. Borello & Sons v. Dep't of Indus. Relations, 48 Cal. 3d 341, 349 (Cal. 1989), the court rejected as controlling — or even as a factor to be considered — the applicable contracts and held that cucumber farm laborers, who were contractually classified as "independent contractors" were really common-law employees covered under California's Workers' Compensation Act.
III. Joint Employer Liability
There are no foolproof ways to avoid misclassification liabilities. Some companies have tried to limit their exposure by utilizing temporary agencies or employee leasing devises; by contracting out or outsourcing a segment of the business; or by contracting with outside payroll businesses. Each option creates its own set of liability and risks. Reviewing agencies and courts generally reject such devices and, at best, may find that the outside entity and the putative employer are "joint employers." See, e.g., Amarnare v. Merrill, Lynch, Pierce, Fenner & Smith, 611 F.Supp. 344, 346 (S.D. N.Y. 1984)(temporary staffing agency and customer held liable jointly under Title VII when evidence showed that customer controlled the hours worked, the work place, and work assignments of worker); M.B. Sturgis, 331 NLRB No. 173 (Aug. 25, 2000) (both temporary employees and regular employees could be placed in the same bargaining unit, without the approval of the customer or temporary agency; NLRB v. Western Temporary Services Inc., 821 F.2d 1258, 1267 (7th Cir. 1987) (applying "community of interest" test, staffing firm and customer who both exercised substantial control over employees and were involved in determining essential terms and conditions of employment held jointly liable under NLRA); Capitol EMI Music, Inc., 311 NLRB No. 103, 1993 NLRB LEXIS 577, 9 (1993) (staffing agency may be liable for unfair labor practices if: 1) it knew or should have known that the customer acted against the worker for unlawful reasons; and 2) it acquiesced in the unlawful action by failing to protest or exercise a contractual right to resist).
IV. Liabilities to Consider
When workers are reclassified as employees, the employer will face a host of unanticipated liabilities including taxes, employee benefits, and overtime pay. Further, as employees, the workers will be protected against statutory discrimination, entitled to organize and demand union representation, and bind the employer for their own workplace wrongs under the doctrine of respondeat superior.
When workers are successfully reclassified as employees, the employer may become liable for penalties in addition to income tax withholding, FICA (social security), and FUTA (federal unemployment) taxes that were never withheld or paid. The statute of limitations for imposing the additional tax penalties is three years from the time the employment tax returns specific to the misclassification periods were filed. See I.R.C. §6501(a); see also Day v. C.I.R., No. 7118-98, 2000 WL 1839398, at *1 (U.S. Tax Ct. Dec. 13, 2000)(finding that for employment tax purposes, truck drivers were employees; therefore, the employer could be assessed FICA, FUTA, and income tax withholdings). However, §530 of the Revenue Act of 1978, allows for reduction, under some circumstances, of assessments of taxes and penalties against employers who, in good faith, misclassified employees as independent contractors. See Boles Trucking, Inc., v. United States, 77 F.3d 236, 239, (8th Cir. 1996).
Typically, independent contractors set their own hours of work and the putative employer keeps no records of their hours. When the worker is reclassified as an employee, the employer may face retroactive liability for record keeping violations and also for unpaid minimum wages and time and one half for hours worked over forty in each work week. Under the federal Fair Labor Standards Act ("FLSA"), 29 U.S.C. §206-07, employees may seek back pay, normally going back two years. However, if the employees can show a willful violation, they may seek back pay going back three years. Moreover, for willful violations the employer will be liable for liquidated (double) damages and attorneys' fees, 29 U.S.C. §§260, 794a. Further, some states have longer limitation periods: New York's is six years. NY Labor Law §663 (McKinney 2002).
In addition to independent contractor/employee misclassifications, employers must ensure that their acknowledged employees are properly classified as "exempt" or "non-exempt". Executive, administrative, and professional employees (and some others) may be exempt from overtime pay if their salary equals or surpasses $23,600 a year, and they meet a multi-factor "duties test." Employees who earn $100,000 or more a year are exempt if they meet a less stringent "duties test." See generally 29 U.S.C. §213(a)(1); see also, e.g., Serrano v. Interlingual of Am. Inc., No. H-07-1639, 2008 WL 2944570, at *2 (S.D. Tex. Jul. 23, 2008)(employees occupying executive, administrative, or professional positions are exempt from the overtime requirements of the FLSA under the Act's "white-collar" exemptions).
Courts focus more on actual job duties than written descriptions; therefore, employers should audit positions to ensure that they are properly categorized. See Higgins v. United States, No. 95-285C, 2005 WL 6112625, at *15 (Fed. Cl. Aug. 16, 2005)(an FLSA ruling cannot be based on the job description alone, but must be based on the duties the employee actually performs). There is also a "safe harbor" provision under the FLSA that may help insulate from violation under some circumstances, an employer, who in good faith, inadvertently treats an employee as non-exempt for a short period of time. 29 U.S.C. §260. "Safe harbor" protection is available when an employer clearly communicates employees status through handbooks and employer policies; provides a complaint mechanism for employees to use when questioning their status; and reimburses employees for any improper deductions, Rodriguez v. Farm Stores Grocery, Inc., 518 F.3d 1259, 1272 (11th Cir. 2008). In Joiner v. City of Macon, 814 F.2d 1537, 1539 (11th Cir. 1987), the Court determined that a class of city mass transit employees were entitled to liquidated damages when evidence showed the city knew or had good reason to know that the U.S. Department of Labor's policy change removed mass transit employees from FLSA exemption. However, the same court held in Dybach v. State of Fl. Dep't of Corrections, 942 F.2d 1562, 1556-57 (11th Cir. 1991) that "safe harbor" protection may be available to an employer who meets both objective and subjective determinations showing a good faith intention to comply with the Act.
C. Workers' Compensation
Proper classification is essential in workers' compensation and disability cases. Under the workers' compensation statutes of most states, including New York, employees who are injured in job related incidents (even due to their own fault or negligence) are entitled to have all of their medical and hospital bills paid for by their employer, and are entitled to be paid a weekly amount (approximately the same as unemployment insurance) for time lost from work. They may also be entitled to a lump sum payment for an injury determined to result in a permanent, albeit partial disability. N.Y. Workers' Compensation Law §25. Further, if the State were to investigate and find that the worker has been misclassified as exempt and is actually an employee, the employer could be responsible for retroactive and unpaid workers' compensation premiums. In State ex rel. Roberds, Inc., v. Conrad, 714 N.E.2d 390, 392 (Ohio 1999), the Ohio Workers' Compensation Bureau was able to recover over a million dollars in unpaid workers' compensation premiums retroactive to two years before the reclassification of carpet sales employees who had been improperly classified as independent contractors.
On the other hand, under the workers' compensation exclusivity clause, an employee, injured on the job would be prevented from suing the employer for pain and suffering, emotional distress, and other consequential damages.
D. Antidiscrimination Statutes
A plethora of federal, state and local antidiscrimination laws have eroded the long standing doctrine of "employment-at-will" in the United States. These statutes, executive decrees, and ordinances protect employees against discrimination in hiring, discipline, firing, job assignments, promotions, and other day to day activities in the workplace — but do not afford protection to independent contractors.
1. Title VII of the Civil Rights Act
Title VII of the 1964 Civil Rights Act, 42 U.S.C. §2000e, for example, protects employees from retaliation or discrimination on the grounds of race, sex, national origin, or religion. Independent contractors are not afforded the same relief. The United States Supreme Court has established a multi factor test to determine whether a laborer is actually an independent contractor or an employee. Community for Creative Non-Violence v. Reid, 490 U.S. 730, 751-752 (1989). The factors may be summarized as follows:
1) whether the hiring party has the right to control the manner and means by which the product is accomplished;
2) whether a certain skill is required and who supplies the instrumentalities and tools;
3) where the work location is and the duration of the work relationship;
4) whether the hiring party has the right to assign additional projects;
5) what is the method of payment for the hired party;
6) whether the hired party is responsible for hiring and paying assistants;
7) whether the hired party's work is part of the regular business of the hiring party; and
8) whether the hired party is entitled to employee benefits and tax deductions.
The Second Circuit has held that, when applying the Reid test, the greatest weight should be placed on the first factor, "the extent to which the hiring party controls the manner and means by which the worker completed his or her assigned tasks." Eisenberg v. Advanced Relocation, 237 F.3d 111, 116 (2d Cir. 2000). This decision reiterates the fact that a company cannot define a work relationship based solely on the paper/documentary or financial arrangement with its workers.
2. Americans with Disabilities Act
Title 1 of the ADA prohibits private employers, state and local governments, employment agencies, and labor unions from discriminating against qualified individuals with disabilities in any part of the employment process, 42 U.S.C. §12101. When determining whether a worker is an independent contractor or an employee for ADA coverage, the courts apply the "common law agency test." This takes into consideration the employee/employer relationship; the employer's ability to control the job; and the employment opportunities of the individual. Swanson v. Univ. of Cincinnati, 268 F.3d 307, 319 (6th Cir. 2001). In Wojewski v. Rapid City Reg'l Hosp., 450 F.3d 388 (8th Cir. 2006), an independent contractor physician was unable to pursue an ADA claim, since the ADA covers only employees.
3. Age Discrimination in Employment Act
The ADEA, enacted in 1967, prohibits employment discrimination against employees who are 40 years of age or older, 29 U.S.C. §621-634. Similar to the ADA, in order to have standing to bring an ADEA claim, the worker must be an employee, and not an independent contractor. In Shah v. Deaconess Hosp., 355 F.3d 496 (6th Cir. 2004), the Court held that a surgeon with surgical privileges was not an employee of the hospital and therefore was not entitled to bring a suit under the ADEA or under Title VII. See also Kuehnle v. Random House, Inc., No. 3:07cv095-B-A, 2008 WL 907467, at *1 (N.D. Miss. Mar. 31, 2008)(plaintiff sales representative denied recovery under the ADEA since he was admittedly an independent contractor).
E. National Labor Relations Act
The NLRA protects the rights of most employees in the private sector to organize and join labor unions, engage in collective bargaining, and participate in strikes and other concerted protected activities without fear of job retaliation, 29 U.S.C. §158 et seq. NLRA protections do not extend to independent contractors, 29 U.S.C. §152(3). In determining whether a worker is an independent contractor or an employee, the National Labor Relations Board ("NLRB") and the courts focus on the extent of control the putative employer may exercise over the worker. See Friendly Cab Co., Inc., 341 N.L.R.B. 722, 725 (2004)(based on high degree of control Friendly exercised over drivers, the drivers held employees entitled to union representation).
F. Occupational Safety and Health Act
Enacted in 1970, OSHA regulates work related injuries, illnesses, and deaths by requiring that certain standards for workplace safety and health are met. All employers, regardless of the number of its employees, have a general duty to maintain a safe workplace and to comply with the Act's safety and health standards, 29 U.S.C. §654(5). OSHA protection applies to employees, and not to independent contractors. See Hall v. Dieffenwierth, No. 2-07-058-cv, 2008 WL 2404462, at *2 (D.C. Tex. June 12, 2008)(refusing to enforce OSHA duties against the employer when the injured worker was found to be an independent contractor and not an employee). Some courts, however, have extended OSHA coverage to employees of an independent contractor (although not to the contractor) working on the employer's job site. In one such case, the Sixth Circuit concluded that, "once an employer is deemed responsible for complying with OSHA regulations, it is obligated to protect every employee who works at its workplace," Teal v. E.I. DuPont de Nemours and Co., 728 F.2d 799, 805 (6th Cir. 1984).
G. Employee Retirement Income Security Act
ERISA was signed in 1974 to guarantee minimum standards for pension and health benefits, 29 U.S.C. §1003. Although ERISA does not require employers to provide its employees with pension or health benefits, once in place ERISA regulates those benefits. In Todd v. Benal Concrete Const. Co., Inc., 710 F.2d 581, 584 (9th Cir. 1983), the court concluded that employer contributions may only be made on behalf of "true" employees. Independent contractors are not afforded ERISA benefits, regardless of how the contractual language describes them. In Broussard v. ConocoPhillips Co., No: 2-04-cv-1986, 2006 WL 220840, at *1 (W.D. La. Jan 24, 2006), the plaintiff who was not on the company's direct payroll unsuccessfully claimed entitlement to retroactive benefits from a company's Retirement and Savings Plans for the period between January 1, 1979 to March 12, 1990. The plaintiff had alleged that ConocoPhillips misclassified her as an independent contractor when, in actuality, she was a leased employee. Nevertheless as discussed above, if an employee is misclassified as an independent contractor, the employer may be liable for years of retroactive employee benefit plan. See Vizcaino v. Microsoft, 97 F.3d 1187 (9th Cir. 1996), see also Herman v. Time Warner, 56 F.Supp.2d 411 (S.D. N.Y. 1999).
V. Proposed Changes
As cases of misclassified workers continue to monopolize the courts and the media, the legislature and politicians have taken notice. Senators Barack Obama, Dick Durbin, Edward Kennedy and Patty Murray introduced S.2044 on September 12, 2007, to crack down on employee misclassification on a national level. Titled the Independent Contractor Proper Classification Act of 2007, the bill would revise procedures for worker classification, primarily focusing on §503 of the Revenue Act of 1978, concerning independent contractor treatment. See generally Robert W. Wood, Independent Contractor or Employee? The Multiple Issues Involved in Independent Contractor Status, NYSBA Journal, June 2008, at 29.
Currently under Revenue Act §503, employers are relieved of tax liabilities stemming from their failure to classify a worker as an employee if the employer meets three specific requirements: 1) reasonable basis; 2) substantive consistency; and 3) reporting consistency.
The proposed Obama bill would eliminate using industry practice as a "reasonable basis" defense and would prevent employers from receiving employment tax relief for any workers the IRS determines should have been classified as employees. Independent Contractor Proper Classification Act of 2007, S. 2044, 110th Congress (2007). Further, under the proposed bill, workers could petition for a determination of employment status and employers would be required, prior to classifying workers as independent contractors, to notify them of their rights to: 1) seek a status determination from the IRS; 2) clarify their federal tax obligations; 3) understand that labor and employment law protections would not apply to them.
The bill would allow the IRS to issue regulations and revenue rulings on employment status whenever workers were determined to be misclassified. The IRS would be authorized to perform an employment tax audit; inform the Department of Labor of its activities and findings; notify workers of the possibility of a self employment tax refund; and instruct the employer on how to minimize the violation. The Department of Labor would identify and track complaints, enforce actions involving misclassified workers, and investigate specific industries with frequent classification violations. The Department of Labor and the IRS would share information on worker misclassification and provide that information to relevant state agencies. See generally Robert W. Wood, Independent Contractor or Employee? The Multiple Issues Involved in Independent Contractor Status, NYSBA Journal, June 2008, at 30.
State governments have recognized the impact misclassification is taking on state economies. Last year New York Governor Spitzer, through Executive Order No. 17, established the NYS Taskforce to address worker misclassification. The Taskforce directs state agencies charged with investigating employee misclassification to coordinate their investigations and enforcement efforts and share relevant information, State of New York Executive Order No. 17, "Establishing the Joint Enforcement Task Force on Employee Misclassification," September 5, 2007. See http://www.ny.gov/governor/press/ExecutiveOrderNo.17.pdf.
The Taskforce is led by the NY Department of Labor and comprises representatives from the Workers' Compensation Board, the Workers' Compensation Inspector General's Office, the Department of Taxation and Finance, the Attorney General's Office, and the New York City Comptroller's Office. Working together, the Taskforce is responsible for developing strategies for systemic investigations into employee misclassification as well as for creating ways to facilitate the filing of worker and agency complaints and identification of potential violators. The Taskforce is challenged with working alongside business, labor, and community groups interested in reducing the perceived problem of employee misclassification, by establishing specific protocols. The Taskforce will issue a report each year on February 1st describing its accomplishments throughout the previous year. On February 1, 2008, the Taskforce called for legislation that would extend individual liability for workers' compensation misclassifications to corporate officers, shareholders, members of LLC's and LLP's, as well as to corporate successors and affiliated entities. See Richard J. Reibstein et al., The Risk of Using Independent Contractors, N.Y. L.J., May 15, 2008 available at http://www.law.com/jsp/nylj/PubArticleNY.jsp?id=1202421388098.
Further emphasizing growing concerns of misclassification, academics are focusing on the problem and on the increase in collective actions concerning worker misclassification, and are publishing suggestions on how to curtail misclassification. One such effort, the Cornell study, entitled "The Cost of Worker Misclassification in New York State," is based on an audit conducted by the NYS Department of Labor Unemployment Insurance Division, between 2002- 2005. The audits collected employment data from specific industries statewide. The study estimated that 9.8% (39,587 of 400,732) of New York State employers misclassify approximately 750,000 workers as independent contractors. Donahue, L. H., Lamare, J. R., & Kotler, F. B. (2007), Employee or independent contractor? Misclassification comes at a price (ILR Impact Brief #18), School of Industrial and Labor Relations, Cornell University (2007).
The authors of the study, argue that the broader implication of misclassification (beyond the adverse affect on the workers) is its cost to government and the taxpayers in substantial uncollected revenues that could have been applied towards government programs, services, and maintenance. The IRS estimates that worker misclassification costs the nation $2.72 billion annually in unpaid Social Security contributions and payments (employer and employee shares), unemployment insurance taxes, and income taxes. This loss in federal revenue translates to less money for communities, school districts, hospitals, law enforcement, and other services that must make up the difference. See U.S. Department of the Treasury, 2006 Internal Revenue Service, Publication 15-A, Employer's Supplemental Tax Guide, Ca. No. 21453T available at http://www.irs.gov.
The Cornell study made six suggestions for policymakers to consider in hopes of facilitating proper classification and protecting the rights of misclassified employees:
1) clarify guidelines;
2) presume employee status;
3) extend employee protections to independent contractors;
4) provide more resources for enforcement and promote information-sharing among agencies;
5) conduct high profile enforcement; and
6) extend current outreach and education efforts.
The Cornell study suggests mitigating the misclassification problem by giving both independent contractors and employees the same benefits. If state labor laws were extended to all workers regardless of classification as independent contractor or employee, the study asserts, there would no longer be an issue of misclassification. Kolter at 13.
The Cornell study fails, however, to take reality into consideration when outlining suggestions for misclassification disputes. Suggesting that all workers are presumed to be employees places an undue burden on employers and adversely affects the many admittedly independent contractors who provide services to putative employers. Although the Cornell study baselines important considerations, if reclassified as employees, independent contractors will no longer be entitled to deduct from gross contract compensation on their tax returns the costs of doing business and will lose the incentive to grow their business. Both independent contractors and employees are entitled to varying benefits specifically tailored to meet their job needs. Further, many employers will be forced out of business as the costs of litigation and back pay continue to rise.
Recently, the Massachusetts Attorney General's Office ("AGO") issued a guidance on how it will interpret and enforce that state's Independent Contractor Law. That law presumes that an individual is an employee. An employer must satisfy each part of a three part test to establish that the worker is an independent contractor. The test is as follows:
1) the individual must be free from the employer's control;
2) the individual must perform work outside the usual course of business of the employer; and
3) the individual must be engaged in an independently established trade, occupation, profession or business.
The Massachusetts AGO is now empowered to investigate potential violations of the law, including those that may be triggered by poor recordkeeping. According to the guidance, business entities, individual corporate officers, and managers may be liable for violations. The Massachusetts statutes authorize the AGO to impose substantial civil and criminal penalties, including heavy fines and imprisonment. An Advisory from the Attorney General's Fair Labor Division on M.G.L. Ch. 149, § 148b, 2008 available at http://www.mass.gov. Following suit, New Mexico presumes an employer/employee relationship for all workers in the construction industry, S.B. 657, 47TH Leg., 1st Sess. (N.M. 2005).
The IRS now provides tax forms for employee misclassification. Employees misclassified as independent contractors may use a new IRS tax form 8919 to figure and report uncollected social security and Medicare taxes due as part of their compensation. When reclassified employees file the new form, their social security and Medicare taxes will be credited to their social security record and the named employer may expect a government agency audit of payroll, its books, and records. This new form will continue to plague employers as independent contractors seek to gain employee benefits at their discretion. With the new tax form comes the greater likelihood of increased employee investigation, litigation, and costs.
VI. Suggestions to Mend Misclassification Errors
As employee misclassification, legislation, rule making, and litigation increases, employers should take the appropriate first steps to limit liability and protect their business, without raising "red flags." Employers should audit their contractor and employee job descriptions, actual job duties and functions, and the degree of day to day control exerted by management to determine who is an independent contractor, who is an employee, and whether the employees are "exempt" or "nonexempt" under applicable wage and hour tests. The actual duties the workers perform should be scrutinized, not the title or position or statement in any contracts. On an individualized basis, employers should review 1099 forms for independent contractors and determine whether workers are correctly identified as independent contractors or whether employee status is more appropriate.
If a misclassification is determined concerning independent contractors, the employer has two options: 1) reclassifying the workers as employees going forward, making proper tax and social security withholdings, and providing inclusion in relevant benefit plans; or 2) restructuring their contractor relationships to reduce or eliminate the degree of control the putative employer exercises over the day to day activities of the contractor and "restructuring" services by allowing independent contractors to set their own hours, perform services from home or other off site locations, supervise their own work, work for a prescribed period of time, confine work to a specific project, and to perform work for other companies. See e.g., Richard J. Reibstein et al., The Risk of Using Independent Contractors, N.Y. L.J., May 15, 2008.
The company will remain potentially liable for its past misclassifications, but will cut off and eliminate ongoing liability for future misclassification.
As to past misclassifications, and depending on the number of workers and amount of dollars involved, a putative employer may elect to communicate in a carefully scripted manner with these "possibly misclassified employees" and offer them some amount of compensation for past liability.
Depending on whether the Obama bill is passed, employers should focus on §503 of the Revenue Act of 1978, and incorporate "safe harbor" provisions into all independent contractor agreements. These provisions should spell out that independent contractors waive all rights to employee benefits and labor and employment law provisions. Furthermore, employment contracts should include a provision authorizing arbitration instead of judicial proceedings when a question concerning worker classification arises. Given the legal landscape, the judicial, government agency and political interest and trends, putative employers should be increasingly mindful of the worker misclassification issue.
The consequences of worker misclassification, both as to independent contractors and overtime exempt employees, are a burning hot topic of the moment. Individual, class and collective actions concerning worker status are proliferating. Companies are facing larger judgments, ramifications and costs, as one case sparks another. The costs can be staggering, from back pay with interest to stock options awarded at years' old lower prices. Misclassification cases are lucrative for plaintiffs' lawyers, particularly when they can assert class and collective claims and work on a contingent fee basis. Given this landscape, prudent "employers" may elect to meet the most stringent employee tests.