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, questions concerning the proper classification of workers as employees and independent contractors, is front and center for businesses across the country.
In a previous article, we addressed the various ways in which courts and agencies evaluate the issue. As discussed below, 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 is denied access to critical benefits and protections to which they are entitled, including minimum wage, overtime compensation, family and medical leave, and unemployment and workers’ compensation insurance. As such, for employers, the cost of misclassification can be severe. Fines levied by the U.S. Department of Labor (DOL), Internal Revenue Service (IRS) and state agencies for worker misclassification can reach into the thousands or even millions of dollars depending on the infraction. 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 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 improperly classified independent contractors are denied otherwise entitled to meal and rest breaks. 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.
DOL, IRS, Social Security Administration, or state agency audits can be triggered 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 the DOL or IRS because they believe they are being misclassified.
Misclassified 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 Katila Howard.
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