The Danger of Independent Contractor Misclassification Grows

July 31, 2015

We have consistently warned our clients of the dangers of misclassifying employees as independent contractors. Employers who improperly classify workers as independent contractors rather than employees face the risk of penalties imposed by the IRS or the State for the failure to withhold payroll taxes, fines for failure to provide worker’s compensation insurance premiums, retroactive payment of unemployment taxes including penalties and interest, and payment of social security taxes. The imposition of back taxes alone could amount to 10% of a worker’s compensation going back three years. Recently, the Administrator of the United States Department of Labor’s Wage and Hour Division made it clear that under the Department of Labor’s interpretation of the Fair Labor Standards Act (FLSA), most workers will be deemed employees and not independent contractors.

While different courts and agencies use different tests to determine employee v. independent contractor status (common law agency principles; IRS 3-Factor test; presumption of employee status under Pennsylvania’s Unemployment Compensation law, etc.) FLSA and most federal laws dictate that the determination of worker status be determined via the Economic Realities test. In Administrator David Weil’s July 15, 2015 interpretation of the Economic Realities test, Mr. Weil emphasizes that this test will result in most workers being classified as employees and not as independent contractors.

Mr. Weil begins his analysis by noting that the FLSA’s definition of “employee” is the “to suffer or permit to work” standard which was designed to insure as broad a scope as possible for workers. With that background, Administrator Weil noted that all factors under the Economic Realities test must be considered in order to determine whether a worker is economically dependent on the employer or truly in business for him or herself. Under the Economic Realities test, the factors that a court will consider to determine whether a worker is dependent on the employer will include: (a) the extent to which the work performed is an integral part of the employer’s business; (b) the worker’s opportunity for profit or loss depending on his or her managerial skill; (c) the extent that the relative investments of the employer and the worker; (d) whether the work to be performed requires special skills and initiative; (e) the permanency of the relationship; and (f) the degree of control exercised or retained by the employer. Under this test, only workers with economic independence who are operating a business of their own will be deemed independent contractors, whereas workers who are economically dependent on the employer regardless of their skill level will be deemed employees covered under the FLSA and other federal laws. Mr. Weil concludes his remarks by writing that, “In sum, most workers are employees under the FLSA’s broad definitions.”

Workers deemed employees, even if under contract and paid as independent contractors, are entitled to worker’s compensation and unemployment compensation, matching FICA contributions, and overtime compensation under federal law. The Department of Labor has enacted a Misclassification Initiative with the IRS and many states to address this issue, so more than ever employers who risk misclassification of their workers do so at great peril. At the very least, employers who use independent contractors must take certain steps to protect themselves, including an appropriate written independent contractor agreement; requiring the contracting party to submit invoices for payment; assuring that the worker has created a business entity with which to contract; avoiding any measures that would give the appearance of employee status such as providing business cards, uniforms, etc.; assuring that the worker maintains separate business records; allowing the worker to contract with other businesses; and allowing the worker to exercise control over his or her own work. It may even be advisable to have such workers provide their services through a separate employment agency. If any employer has questions with regard to employee classification issues, contact Ethan O’Shea, Esquire, a member of HRMM&L’s Business Advisory Group.

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