New Jersey employers should expect to see a significant expansion of investigations into misclassification of employees as independent contractors. Such investigations have always presented risks and costs to employers, but recent portentous announcements by Gov. Phil Murphy’s administration indicate that the cost of misclassification could soon increase exponentially.

By way of background, employee misclassification occurs when an employer classifies workers as “independent contractors” rather than “employees.” Independent contractors are not entitled to the same rights as employees, such as wage and hour protections, paid sick leave and unemployment benefits. Independent contractors are also treated differently from employees for tax purposes. Misclassification can take several forms, from employers simply paying workers off the books to requiring employees to form their own LLC or franchise as a condition of obtaining a job.

New Jersey applies the “ABC test” when analyzing potential employee misclassification. To demonstrate the worker is an independent contractor, an employer must show that, in the performance of a service to the employer:

A. The individual has been and will continue to be free from control or direction;
B. The service is either outside the employer’s usual course of business of the employer or that such service is performed outside of all the employer’s places of business; and
C. The individual is customarily engaged in an independently established trade, occupation, profession or business.

Importantly, this test is conjunctive, meaning that the New Jersey Department of Labor will deem the worker an employee unless all three elements are met. In cases of misclassification, DOL may assess fines and penalties for unpaid unemployment insurance and other employment taxes going back as much as six years. Further, these investigations tend to span out, as DOL investigates all of the employers from whom an alleged independent contractor received income.

The Task Force Report

In May 2018, early into his tenure, Gov. Murphy signed an executive order establishing a Task Force on Employee Misclassification. The goal was to identify and reduce instances of employee misclassification, especially in certain low-wage industries where that practice has been found to be particularly problematic, such as janitorial services, home care, construction, trucking and delivery services.

On July 2, 2019, the Task Force released a 31-page Report detailing recommendations for immediate action at the administrative level as well as proposed legislative reforms. As a starting point, the Task Force cited the DOL's 2018 audit of just 1 percent of employer accounts which revealed that 12,315 New Jersey workers had been misclassified. It estimated a cost to the state of $14 million in unpaid/uncollected employment taxes resulting from $462 million in underreported wages. Such underreporting has the result of requiring compliant employers to pay a greater share of contributions to the Unemployment Trust Fund to accommodate the shortfall. The Task Force also pointed to the impact on child support collections that are generally accomplished through wage garnishment.

The Report outlines steps already taken to combat misclassification, including the NJ DOL’s signing a Memorandum of Understanding with the U.S. Department of Labor, which will result in increased coordination and information sharing. Likewise, the Task Force – comprised of representatives from the NJ DOL, Treasury, Law and Public Safety and other departments that perform licensing functions – has taken steps to cross-train its member agencies’ personnel on misclassification law. The intent is to increase enforcement actions by having investigators who may be looking into, for example, cosmetology certifications, to also look into potential misclassification issues. Because of the breadth of regulation and licensing of professionals in New Jersey, this tactic alone could sweep in many more employers than relying on DOL’s audits and investigations of specific misclassification complaints alone.

The Report also notes that the NJ DOL sent a letter to 20,000 accountants earlier this year to educate practitioners on the ABC test and remind them “in the strongest possible terms” that an employer’s statement that a worker was a “1099 employee” or performing “1099 work” has no bearing on whether the test is actually satisfied.

Legislative Action on the Horizon?

Finally, the Report also recommends legislative action. Proposals include:

• increasing maximum fines from $1,000 to $5,000 for first violations and $10,000 for subsequent violations
• assessing the cost of DOL investigations on employers found to have misclassified employees
• making business owners individually liable
• publicly shaming companies found to have misclassified employees

One of the most significant legislative recommendations is the sharing of tax information with DOL. Currently, when DOL requests information from the audit subject, this includes Schedule Cs and other tax information that would show the percentage of income an entity received from one source. The fewer sources, the harder it is to claim the entity is an independent business and not just an employee of the income source. Obtaining access to the tax information directly from the state’s taxing agency would make the DOL’s work significantly easier.

One recommended legislative action was already signed into law by Gov. Murphy on July 9. It gives the DOL Commissioner the power to issue stop-work orders on public contracts as necessary after only an initial determination that misclassification violations have been discovered. This expanded power could prove costly to employers, though it remains to be seen how often or in what circumstances the Commissioner will choose to exercise it.

Review and Reevaluate

In sum, the release of this report signals that the Murphy administration is gearing up to take action on misclassification. In anticipation of such efforts, employers should take steps immediately to review and reevaluate the status of any workers who are currently identified as independent contractors, and take care when considering entering into new independent contractor agreements. To that end, employers should contact experienced labor counsel to review and revise independent contractor agreements, and attempt to avoid or minimize the risk of costly mistakes associated with misclassification.

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