By TODD H. LEBOWITZ, an employment law attorney at Baker Hostetler in Cleveland, Ohio, and part of Baker Hostetler's multidisciplinary task force on worker misclassification
The passage of healthcare reform seems to provide a new incentive for companies to take workers off their books, either by using independent contractors or by bringing in employees of a staffing agency. Fewer employees have always meant lower healthcare costs, but after health reform, fewer employees also mean less exposure to penalties that will be imposed when employees opt out of company-sponsored health coverage.
Classifying workers as nonemployees, however, creates a different set of risks for companies. Under federal and state laws, a worker's employment status is determined by how the work is controlled, not by what the worker is called. Companies that misclassify workers as nonemployees face a range of potential penalties and liability--under tax law, employee benefits law and employment law.
The IRS has announced plans to conduct 6,000 worker misclassification audits over the next three years. More than a dozen states have recently enacted or considered legislation to increase record keeping burdens and penalties for misclassification. Other federal legislation is pending.
The use of nonemployee workers is therefore more appealing--but also more dangerous--than ever. Now is an ideal time for employers to evaluate their nonemployee workforce and to take steps to minimize the risks associated with this practice.
BENEFITS EXIST, BUT PITFALLS ABOUND
Starting in 2014, employers who fail to provide adequate, affordable health insurance to employees may face penalties of up to $3000 per employee. There are no penalties, however, for failing to offer health insurance to independent contractors or to leased workers employed by a staffing agency.
By using nonemployee workers, companies also save money by avoiding Social Security, Medicare and unemployment taxes (FICA and FUTA) and by avoiding the cost of providing employee benefits. Other advantages of a lower salaried headcount may include reduced expenses on the Selling, General and Administrative (SG&A) side of the ledger and smaller workers' compensation premiums.
These advantages may come at a great cost. Companies who misclassify workers as nonemployees may face liability under a range of legal theories, including:
-- Failure to withhold employment taxes, plus penalties and interest
-- Failure to pay FICA and FUTA, plus penalties and interest
-- Failure to pay overtime or minimum wage
-- Failure to provide employee benefits
-- Failure to obtain proof of eligibility to work in the United States
-- Increased exposure under anti-discrimination and anti-harassment laws
The stakes are increasing. In addition to the upcoming IRS audits, the federal government is considering legislation that would impose additional burdens and penalties on companies who misclassify workers as non-employees. In April 2010, Senator Sherrod Brown and Representative Lynn Woolsey introduced the Employee Misclassification Prevention Act, which would require companies to keep track of all workers' hours, including those of non-employees, and would increase penalties for misclassifying common law employees as independent contractors.
Another pending bill, the Taxpayer Responsibility, Accountability and Consistency Act, would eviscerate the safe harbor provision in the tax code that currently offers relief to companies who have misclassified employees as independent contractors.
In 2009 and 2010, Colorado, Connecticut, Minnesota and Missouri passed tougher state laws cracking down on misclassification, and similar legislation has been passed in New York, awaiting only the governor's signature at the time of this writing. Misclassification bills have been introduced in several other states across the country over the past two years, including Delaware, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan and Ohio. Some of these bills remain pending.
The plaintiffs' employment bar is becoming increasingly active in the misclassification arena as well. FedEx currently faces 63 consolidated class actions involving more than 20,000 drivers who claim to have been misclassified as independent contractors. Damages from these types of class actions and collective actions can mount quickly because classification errors are often repeated across large groups of employees.
Typical allegations in these lawsuits may include unlawful denial of wages, overtime pay, workers compensation coverage, unemployment insurance, retirement plan contributions, participation in employee stock purchase plans and payment for rest periods.
Where misclassification has occurred, defendant companies may find themselves at a disadvantage when trying to limit damages, since companies are unlikely to have adequate timekeeping records for workers they have treated as non-employees.
Even where companies have properly classified workers as contractors or as employees of a staffing agency, companies still may be held jointly liable under several areas of the law. Depending on the circumstances, federal employment laws may impose joint liability on companies that fail to accommodate a worker's disability, interfere with a worker's right to take family or medical leave, fail to maintain a safe workplace, and fail to ensure that workers are paid overtime or minimum wage. The Americans with Disabilities Act, the Family and Medical Leave Act, and the Fair Labor Standards Act all impose obligations on both the true employer and the company that engage the worker to provide services.
GETTING IT RIGHT
According to courts and the IRS, workers are properly deemed employees or independent contractors based on who has the right to control the means and manner of performing the work. The more control a company exerts--or has the right to exert--over how a job is performed, the more likely the worker doing the job will be deemed an employee. Courts and the IRS will consider a range of factors relating to behavioral control, financial control and the relationship of the parties to make a determination.
Companies can limit their misclassification risks by taking three steps.
First, companies should include protective language in their contracts with staffing agencies and with independent contractors. Contracts with staffing agencies should address each company's responsibilities under a range of employment laws, including those covering discrimination, disability, medical leave and overtime; tax laws, including the obligations to withhold and to pay FICA and FUTA; and benefits laws. Contracts should also include language clarifying the parties' working relationship, including who has the right to control the means and manner in which the work is performed.
Second, companies should include protective language in their benefit plans, to protect against the possibility that workers who have been treated as independent contractors may later be deemed common law employees. Well-drafted exclusionary language can protect against liability for having failed to provide employee benefits to misclassified workers.
Third, companies should establish limits in how their supervisors interact with nonemployee workers. Supervisors need to restrict the amount of control they exert over the means and manner in which independent contractors perform their work. Distinctions should be maintained between employees and nonemployee personnel, such as separate work badges and separate email accounts. Supervisors should not be making disciplinary decisions or conducting performance reviews on workers who are not company employees.
These steps provide a good starting point, but the risks and recommended action plan for each company will be different, depending on the facts of each particular situation. Companies should seek advice from their employment, tax and benefits counsel to ensure that they are protected under each of these areas of the law.
July 1, 2010
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