Strategies for Minimizing Risks of Worker Misclassification

While the use of independent contractors (IC) can have substantial business advantages given the current economic and political climate, IC relationships have been facing and continue to face increased scrutiny. Both the Internal Revenue Service (IRS) and the Department of Labor (DOL) believe that up to 30 percent of employers are misclassifying their workers. The Government Accountability Office also estimates that misclassification costs the federal government $2.7 billion dollars a year in unpaid unemployment, FICA, FUTA, and other taxes. With the Obamacare mandate that companies with 50 or more “full-time equivalent workers” offer health plans to employees who work the required number of hours per week or else pay stiff penalties, significant temptation exists to reclassify employees as ICs. The risks associated with implementing an IC business model, however, can be significant, and can include:

A. Federal and state DOL wage and hour investigations, testing the IC classification, or seeking unpaid overtime compensation and/or other relief if employee status is found;

B. Private individual and collective/class lawsuits under the Fair Labor Standards Act and state wage and hour laws seeking a finding of employee status, the recovery of unpaid overtime, amounts deducted, liquidated damages, treble damages (under some state laws), and attorneys’ fees;

C. Corporate campaigns by unions seeking to organize IC workers, which are often coupled with multiple misclassification challenges and lawsuits, or unions attempting to intervene in litigation or settlements to exert pressure;

D. Investigations and assessments/fines by federal and state taxing authorities, including the IRS, state Department of Revenue, or other entities for unpaid payroll taxes and unemployment compensation contributions if employee status is found;

E. Class action or individual lawsuits under other employment laws, such as Title VII, ADEA, ADA, FMLA, ERISA, etc., alleging misclassification and entitlement to the benefits/protections typically afforded to employees; and

F. Class actions or individual lawsuits under other state law theories, such as unjust enrichment, fraud, rescission, or improper wage deductions.

PRIMARY TESTS FOR INDEPENDENT CONTRACTOR STATUS

The test used to determine IC status varies depending on the particular law involved, and there are different IC tests that are used. Most of these tests in the litigation context focus, in whole or in part, on the same general factors, including: (1) who controls the manner, method, and means of performance; (2) whether opportunities for profit or loss exist; (3) who provides the equipment and pays expenses; (4) the length of the relationship; (5) whether the services provided are an integral part of the business; and (6) the degree of skill required. Other factors often considered in this analysis include whether benefits are provided; the intent of the parties; and whether the individual is paid on a 1099 or W-2, is free to hire helpers or employees, is able to work elsewhere or have another business, and can or does operate as a separate legal entity.

In contrast, the test used in the unemployment context is much narrower. This test is typically referred to as the “ABC” test. To meet the test, the individual contractor must:

  1. control the manner, method, and means of performance;
  2. perform services outside of the usual course of the employer’s business or outside the employer’s place of business; and
  3. perform services in an independently established trade, business, or occupation. Several states, such as Connecticut, Massachusetts, and New Jersey, have adopted the ABC test for broader use, resulting in a much tougher standard to prevail on IC challenges there.

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