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The Consequences of Misclassifying an Employee as an Independent Contractor

Due to increased scrutiny from state and federal government agencies and high profile cases involving companies such as Uber, UPS and FedEx Ground, businesses are becoming increasingly concerned over proper classification of workers.

In a previous article, we addressed the various ways in which courts and agencies evaluate this issue. Below, we discuss how misclassification can be harmful to workers and lead to significant liability for employers.

When an employer misclassifies a worker as an independent contractor, the worker has employment-based benefits and statutory protections, including minimum wage, overtime compensation, family and medical leave, and unemployment and workers’ compensation insurance. However, employers that misclassify a worker as an independent contractor would be responsible for such wages and benefits.  In addition, fines and penalties may be levied by governmental agencies, including the U.S. Department of Labor (DOL), Internal Revenue Service (IRS) and state agencies, so the cost of misclassification can be severe. In particular, misclassification can implicate and give rise to liability with respect to state and federal wage and hour laws, employment tax issues, employee benefits liability and workers’ compensation concerns.

Wage and Hour Laws & Benefits Issues

Employers who misclassify employees are at risk of being held liable for failure to pay overtime and minimum wage under the federal Fair Labor Standards Act (FLSA) and applicable state wage laws. Both criminal penalties and liability for back wages may be levied against employers and executives found in violation of FLSA laws. In addition, businesses may face liability if employees that are improperly classified as independent contractors are denied fringe benefits that they otherwise would have been entitled to. Businesses can also be assessed significant penalties for failure to issue wage statements to workers, and failure to pay wages when due.

Penalties—above and beyond the actual tax due—may be assessed against an employer for failing to withhold state and federal payroll taxes, including failure to make matching Social Security and Medicare tax payments. Penalties may be increased in cases where an employer’s actions are deemed intentional.

DOL, IRS, Social Security Administration and state agency audits may be triggered in a variety of ways, including when: (1) the 1099 worker files a claim for unemployment, workers’ compensation, or disability benefits; (2) a worker receives a W2 and a 1099 from the same employer in the same year; or (3) the worker files a complaint with a governmental agency.

Employees misclassified as independent contractors may be entitled to coverage under the company’s employee benefit plans, including pension and other retirement plans, health insurance, paid leave, and severance pay among others. Misclassification may constitute an operation violation under a particular benefit plan, and may affect non-discrimination testing under a health and welfare benefits plan. A misclassified worker denied life and/or disability benefits may be entitled to such benefits, and an employer may be required to provide such benefits on a self-insured basis.

Further, misclassification penalties may also arise under state workers’ compensation insurance laws and liability for unpaid workers’ compensation premiums, failure to provide coverage penalties, and potential exposure for uninsured losses.

Other Areas of Potential Liability

As if liability for misclassification under state and federal wage and hour, employment tax, employee benefits and workers’ compensation laws were not enough, businesses can also be forced to grapple with issues and claims related to harassment and discrimination suits, collective bargaining agreements, FMLA/paid leave benefits, immigration compliance, tort liability to third parties and class action lawsuits. Ultimately, businesses must be extremely careful in classifying their workers. Failing to do so properly has a significant impact on workers, employers and the economy more broadly.

If you need help understanding the rules related to the classification of workers, potential penalties, or have other questions concerning worker classification, please contact a member of Foster Swift's Labor and Employment practice group.

This blog has been updated with new content since its original publication on June 25, 2018.

Categories: Employee Benefits, Employment, Labor Relations, Lawsuit, Liability, Wage and Hour

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Mike Blum is an award-winning Michigan labor and employment lawyer in Detroit who has litigated some of the state’s most important cases. Part of Mike’s effectiveness as a litigator, in ADR and as a counselor to employers, comes from his 11 years with the National Labor Relations Board.

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