The United States Department of Labor estimates that 30% of employers are misclassifying employees as independent contractors, which results in billions of dollars in lost revenue every year. Citing a desire to minimize losses in contributions to unemployment insurance funds, protect workers’ rights and “level the playing field” for employers that abide by the law, the DOL has launched the Federal Misclassification Initiative, where they are partnering with the IRS and a number of state governments to share information. The memoranda of understanding contain an agreement to share information, in order to determine when workers are being misclassified. The cooperative efforts will likely lead to multi-pronged scrutiny and enforcement proceedings.
The initiative will ensure that a worker classified as an independent contractor does not have to bring a claim against his or her employer to allege misclassification. Instead, the DOL, IRS and/or state agency may initiate directed investigation which could lead to an audit of the employer’s payroll practices. The DOL expects this initiative will increase the percentage of DOL-directed investigations to approximately 35% of all its investigations. In particular, the DOL stated that they will be targeting certain industries, including delivery companies, construction companies, companies with installation workers, sales organizations, companies that provide on-site computer technicians and those companies that hire them, and cleaning franchises.
The difficulty comes in defining an independent contractor, because no unified definition exists. Despite the difficulty in defining independent contractor, the pitfalls are significant. Employers who misclassify their employees as independent contractors risk numerous potential claims including tax claims (state, federal, and FICA); wage (e.g., overtime), indemnification, and benefit claims, claims for civil penalties, including penalties for failing to withhold taxes or pay final wages, or failing to provide itemized wage statements; unanticipated tort claims to third parties and wrongful discharge claims; and criminal investigations.
There are a number of steps that employers can take to prevent misclassification. Most importantly, employers must show that they do not exercise direction or control over their independent contractors. Employers should negotiate the rate of payment, require a signed agreement stating the independent contractor status, and require the worker to provide transportation, tools and equipment. Employers should never require reporting, issue handbooks, provide evaluations or prohibit the worker from working for or with others.
If you believe that employees may be misclassified, or you have any questions regarding classification in general, you should contact legal counsel as soon as possible.