In an effort to save on labor costs and reduce employee headcounts, businesses have looked to outside independent contractors to perform some of the services once executed by employees.
Some of the cost savings realized by using outsourced workers include not having to pay taxes, not complying with minimum wage and overtime requirements, and not having to provide insurance or other benefits.
This practice has raised concerns at the IRS and Department of Labor (DOL).
The IRS is interested in maximizing tax revenue, while the DOL wants to ensure compliance with employment laws such as the Fair Labor Standards Act (FLSA), which sets forth the minimum wage, overtime requirements and other employee protections.
This use of outsourced workers also catches the attention of class action plaintiff lawyers when companies classify large blocks of people as independent contractors instead of employees.
All of this has led to an explosion of FLSA claims in the past 10 years, with some years seeing the number of FLSA lawsuits increase more than 20 percent over the prior year.
Smart Business spoke with Steve Ciszewski, partner at Novack and Macey LLP, about the misclassification of workers and the risks it creates.
What are the signs that a company might have misclassified employees as independent contractors?
The signs of misclassification depend on the context in which the question arises.
When the question is posed for tax purposes, the IRS has adopted an extensive analysis to determine the right classification. There is a specific tax form — SS-8 — that is intended to measure behavioral control, financial control and the general relationship between the parties. The general concept is to determine whether the company or the worker controls the working environment.
For purposes of the FLSA, the DOL has developed what it calls an economic realities analysis, which consists of six factors that attempt to determine whether, as a matter of economic reality, the individual is more like an employee or more like an independent contractor.
Many courts interpreting the FLSA have adopted this economic realities analysis.
It’s important to note that each state may have its own interpretation of its state tax and employment laws.
What are the consequences if a business misclassifies an employee?
The company could face a large class action suit by the misclassified employees.
Depending on the number of people involved, there could be significant damage exposure consisting of the amounts that should have been paid as well as statutory damages equal to 100 percent of the amount that should have been paid and attorney fees.
In addition, the government will be looking to the employer for make-up payments and penalties on income taxes and contributions to Social Security, Medicare, the federal unemployment tax, etc.
How can businesses best protect themselves against the risks of misclassification?
Any decision to classify a worker as an independent contractor should be done carefully and only after a close analysis of the specific facts surrounding the relationship.
In some cases, this will be a very easy analysis that can be performed by in-house human resources staff. This type of review would be most appropriate when there are only a small number of people whose classifications are in question or when the relevant factors point heavily in one direction.
Other cases might require a detailed legal analysis from in-house or outside counsel.
This would be most appropriate when many people are in question or when it is a close call as to whether those involved are independent contractors or employees. ●
Insights Legal Affairs is brought to you by Novack and Macey LLP
