Independent Contractor Misclassification Is a High-Risk Game

In today’s evolving business landscape, employers are turning to independent contractors to meet their workforce needs. The U.S. Bureau of Labor Statistics reported that 42 million independent contractors generated more than $1.28 trillion for the U.S. economy in 2018. And for many companies, the number of independent contractors is nearly equal to that of employees. 

When you also factor in how the COVID-19 pandemic created an increased demand for remote work, we have to address independent contractor misclassification, which The U.S. Department of Labor describes as “one of the most serious problems facing workers, employers and the entire economy.”

To learn more about independent contractor misclassification, keep reading as we explore the basic aspects, discuss the common pitfalls employers should avoid, and offer guidance on how to ensure your business stays in compliance with the relevant laws and regulations.

Classifying Independent Contractors 

The biggest problem in classifying workers is that there is no uniform definition of “employee” or “independent contractor” under all the Federal and State labor and tax laws.

Although companies save with independent contractors by not paying labor-related taxes and benefits, government agencies are deprived of these taxes and, therefore, cannot protect, properly compensate, or give benefits these workers would receive by federal and state law. As a result, efforts seek to put money back into the pockets of workers who were denied fair pay—and return revenues to government coffers—due to misclassification.

Companies face challenges to their worker classifications from many fronts. A popular misconception is that the greatest risk is an IRS audit. In fact, the most typical and costly challenge is a worker lawsuit. This is followed by a Department of Labor investigation. An IRS audit is the third most likely threat. Each is based on a different evaluation standard, and each carries separate penalties for misclassification.

Individual or Class Action Lawsuits

Litigation is frequently triggered by worker concerns about working conditions or compensation. It also allows workers to be proactive about correcting workplace violations, rather than waiting for the government to act on their behalf.

Claims may be brought in state court or federal court depending upon what statute the claims are asserted under. Awards may be significant, mainly where the underlying statute provides for some form of punitive damages.

Government Investigations and Audits:

While funds have been established at the Federal and State levels to conduct misclassification audits, investigations are more likely to be triggered by a worker action. At the top of this list are errors or irregularities in tax filings, unemployment filings, or workers’ compensation claims.

Penalties Are Severe

If it is determined that a company has misclassified workers, the most common lawsuit compensation is back-waging in the form of unpaid overtime and minimum wage. Under the Fair Labor Standard Act (FLSA), plaintiffs can seek liquidated damages and recover up to double what they are owed.

Misclassified workers may also be eligible for expense reimbursement, unemployment insurance, workers’ compensation benefits, company-sponsored health insurance, pension plans, paid time off, medical leave, meal and rest breaks, expense reimbursement, and other employee benefits. Once deemed an employee, the worker is eligible to sue based on employment laws prohibiting discrimination, harassment, whistleblower retaliation, and wrongful termination.

Employers must also reimburse the government for back taxes, FICA and SUTA contributions, workers’ compensation premiums, and unemployment insurance taxes. These are compounded by fines and penalties. For example, in Missouri, if an employer is found to knowingly commit independent contractor misclassification by calling his employees independent contractors, the employer could face penalties of $50 to $1,000 per day per misclassified worker and up to six months in jail per violation. Almost as important, employers must also address damage to their reputation.

Avoiding Independent Contractor Misclassification Claims

While numerous analytical frameworks exist for classifying workers, all tests primarily focus on the degree of control a company exerts over the service provider. Questions consider financial control, behavioral control, and the relationship between the parties. No single factor is determinative, and elements indicating power are not weighed equally by reviewing courts and government agencies. This case-by-case analysis gives the courts and agencies wide latitude to evaluate classification if they support their decision with at least some of the significant elements.

To avoid independent contractor misclassification claims, establish a comprehensive IC Compliance Assessment and Management program.

At nextSource, we offer complete IC Classification solutions that educate, assess, and protect independent contract workers and employers. We also educate clients through hiring manager training, independent contractor onboarding and orientation, and regular briefings on the impact of changing legislation—connect with us today to learn more!