Employer Alert: Independent Contractor v. Employee: New Costs of Misclassification
It is the first question to ask when hiring a worker: independent contractor or employee?
Many employers first try to go for the independent contractor classification because it’s substantially cheaper: no workers compensation or unemployment insurance, no social security or Medicare payments, no health insurance coverage or pension payments. The worker’s agreed upon fee is what it is — with no hidden costs to the employer, as the worker handles any applicable tax payments and benefits.
However, classification as an independent contractor is not a straightforward, black and white process. There are federal and individual state standards, all generally related to the employer’s behavioral and financial control over the worker, that form the basis for determining whether a specific worker is an independent contractor or an employee. These standards are very case-specific and generally require consultation with employment counsel or a well-educated human resources manager.
In the past, the IRS or an individual state’s department of labor would periodically audit an employer in order to evaluate whether any workers were incorrectly classified as independent contractors, rather than as employees. If a worker had been classified as an independent contractor, but was found to be an employee, the employer would be required to retroactively make all legally mandated payments that should have been, but were not made during the worker’s entire period of employment. This unanticipated expense was frustrating to employers, but generally not financially devastating.
However, over the past two years, there has been a strong movement among individual states to (i) create task forces whose sole mission is to investigate and report on employee misclassification, and (ii) enact and enforce harsh penalties for employers who are found to have misclassified employees, even unintentionally. The State of New York’s task force was reported to have recovered approximately $6 million from employers who misclassified employees in 2009, and Illinois imposed fines of not only thousands of dollars per violation, but up to $1,500 per day for an employer who misclassified an employee as an independent contractor.
Most recently, in February 2010, the IRS announced its intent to train 200 auditors and target at least 6,000 employers nationwide in an effort to recoup what it estimates to be billions of dollars in lost federal taxes from employers who have misclassified workers as independent contractors. In order to solidify its efforts, the IRS has taken steps to sign information-sharing agreements with the departments of labor in most states, so that information gleaned from state investigations will be shared with federal investigators.
In light of this recent trend to investigate and heavily penalize U.S. employers who misclassify their workers, employers should take the following steps:
1. Act cautiously when classifying workers as independent contractors.
2. Consult with employment counsel as to the independent contractor criteria for the specific state involved.
3. Structure employment relationships in a manner that satisfies as many of the federal independent contractor criteria and relevant state criteria as possible.
4. Document such relationships with consulting agreements that clearly follow federal and relevant state criteria.
In sum, although classifying a worker as an independent contractor may seem fiscally advantageous, such classification must be based on a clear understanding of federal and relevant state criteria — as misclassification may cause an employer to incur not only the cost of retroactive legally mandated payments, but severe financial penalties, as well. As such, employee misclassification can be an expensive mistake.
Click here for a detailed chart- Employee v. Independent Contractor: Cost to the Employer
Meira Ferziger is the head of the labor and employment practice at Schwell Wimpfheimer & Associates and has significant experience in drafting policies, agreements, employee handbooks and guidelines in compliance with federal and state law. Meira functions as an integral part of the day to day operation of corporate clients by counseling them through their employment-related practices and decisions, and also advises clients as to employment issues that arise from corporate transactions, such as restructurings or acquisitions. She can be reached at meira@swalegal.com or at 646 328 0794.
This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Meira Ferziger. The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.
Filed Under: Labor & Employment , Publications
