Misclassification of Workers: An Attempt to Save Could Cost Your Business A Bundle

Pessin Katz Law, P.A.
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Many business owners, including those in the construction industry, have noticed that their classification of workers is being closely scrutinized by a variety of  federal and state regulatory agencies.  There is no indication that this trend will slow any time soon.  In fact, it was recently announced that the U.S. Department of Labor is awarding $10.2 million dollars to 19 states to fund crack down efforts on businesses that intentionally or unwittingly fail to make unemployment contributions for individuals misclassified as independent contractors.  Maryland is part of the group slated to receive part of the award and is also part of a group of only four states to receive “high-performance bonuses” totaling over $2 million.  These funds were granted, according to Labor Secretary Thomas Perez, “due to their high performance or most improved performance in detecting incidents of worker misclassification.” 

Whether a worker is classified as an “employee” as opposed to an “independent contractor” or an “exempt” employee as opposed to a “nonexempt” employee can have a significant impact on an employer’s bottom line. Generally, an employer must withhold income taxes and withhold and pay Social Security and Medicare taxes, as well as unemployment tax on wages paid to an employee, but does not need to withhold or pay any taxes on payments to independent contractors. An employer does not have to pay overtime to an exempt worker, but does have to pay overtime to a nonexempt worker. While classification of a worker as an independent contractor and an exempt worker can save an employer a significant amount of money, misclassification of a worker can cost the state and federal government a significant loss of revenue. At a time when every tax dollar counts, the IRS and other state and federal agencies are launching initiatives aimed at business owners to stop and correct misclassification. Along with back taxes that will be owed, the penalties can also be severe.

In addition to the state and federal agencies, workers who have been misclassified are also going after business owners. These workers, when misclassified, often suffer lost wages because employers do not have to pay overtime and benefits to independent contractors or exempt workers. Their claims, which are termed “wage theft” claims and are attractive to many attorneys because of potential awards of attorneys’ fees and treble damages, are popping up in significant numbers.

What should you do if you are a business owner? A good start includes looking at the factors that are used by relevant agencies to determine whether a worker is an employee or an independent contractor, or exempt or nonexempt.

Employee vs. Independent Contractor

The U.S. Department of Labor has indicated that the following factors should be considered when determining whether a worker is an employee or an independent contractor:

1) The extent to which the services rendered are an integral part of the principal’s business.

2) The permanency of the relationship.

3) The amount of the alleged contractor’s investment in facilities and equipment.

4) The nature and degree of control by the principal.

5) The alleged contractor’s opportunities for profit and loss.

6) The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

7) The degree of independent business organization and operation.

Conversely, there are certain factors which are immaterial in determining whether there is an employment relationship. Such facts as the place where work is performed, the time or mode of pay, the absence of a formal employment agreement, or whether an alleged independent contractor is licensed by State/local government are not considered to have a bearing on determinations as to whether there is an employment relationship.

The IRS has set forth the following rules to help employers distinguish between an independent contractor and an employee. The focus is on the degree of control by the employer and independence of the worker. Facts that provide evidence of the degree of control and independence fall into three categories:

1) Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

2) Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

3) Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

Exempt vs. Nonexempt

The Fair Labor Standards Act requires that most employees in the United States be paid at least the federal minimum wage for all hours worked and that they be paid overtime pay at time and one-half the regular rate of pay for all hours worked over 40 hours in a work week. However, the FLSA provides an exemption from both the minimum wage and overtime pay requirements for those individuals employed as bona fide executive, administrative, professional, outside sales, computer-related, and highly compensated employees, provided they meet certain tests relating to duties, responsibilities, and salary as set forth in regulations issued by the Secretary of Labor. In addition, there are a number of other exemptions for, among others, salesmen, partsmen, and mechanics at a dealership, certain farm workers and seasonal employees, and drivers, helpers, loaders, and mechanics employed by motor carriers. It is important to become familiar with the various industry-specific exemptions as well as the general exemptions.

Unfortunately, classification of a worker is not always a simple process.  Ambiguities will exist and certain laws may change an independent contractor into an employee.  In addition, there are some differences between federal and Maryland laws that may have the affect of the employee being exempt under federal law, but not under Maryland law.  Employers who are concerned that they may have workers who are misclassified should have a labor and employment attorney assess the classification of their workers before they are contacted by a federal or state agency or a plaintiff’s attorney. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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