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Employers face greater scrutiny for employee misclassification

by Ryan B. Frazier

Employers sometimes classify employees incorrectly under the law. For example, employees may be treated as independent contractors, who are considered self-employed. Although misclassification may be intentional, it is most often done mistakenly under a belief that workers are properly classified. 

Employees are misclassified for many reasons. Employers may try to avoid the overtime and minimum wage requirements of the Fair Labor Standards Act (FLSA). Businesses may want to avoid paying for unemployment costs or workers’ compensation insurance, or they may attempt to avoid payroll taxes. Employers may desire to avoid vicarious liability for their workers’ actions. Regardless of the reason, the U.S. Department of Labor (DOL) has been cracking down on employee misclassification. This article discusses some of the DOL’s recent efforts to ensure that workers are properly classified.

DOL: Most independent contractors are employees
Employee misclassification has been a hot topic recently. High-profile lawsuits, such as Uber Technologies’ drivers’ class action lawsuit, have propelled the issue into the spotlight. Now the DOL has weighed in by issuing guidance on determining whether workers are properly classified. The DOL has concluded that most independent contractors are misclassified and should be classified as employees. The clear message from the DOL is “most workers are employees under the FLSA’s broad definitions.”

On July 15, the DOL issued Administrator’s Interpretation 2015-1 in an effort to reduce employee misclassification. The guidance focuses on the application of the multifactor “economic realities” test for determining whether a worker is an employee or an independent contractor. The new guidance does not purport to establish new standards. Instead, it focuses on the economic realities of the parties’ relationship and whether a worker is “economically dependent” on her employer. The economic realities test has six factors:

  1. Whether the work is integral to the employer’s business;
  2. How a worker’s managerial skills affect his opportunity for profit or loss;
  3. The employer’s and worker’s investments in facilities and equipment;
  4. Whether the work requires special skills or initiative;
  5. Whether the relationship is permanent; and
  6. The amount and nature of control the employer exercises over the worker.

The guidance indicates the relationship should be evaluated as a whole. The DOL cautioned that no factor should be determinative or overemphasized. Each factor should be considered in the analysis.

In the past, employers often used the “control test” to determine whether a worker was an employee or an independent contractor. However, the DOL noted that Congress rejected the control test with the enactment of the FLSA and explained that the control test was replaced by the economic realities test.

LLCs and franchises
Employers have come up with many ways to avoid classifying workers as employees. A recent trend has been to use limited liability companies (LLCs) and franchises to mask employees. Using those labels, employers make workers members of an LLC or owners of an independent business.

However, the DOL and other government agencies have started taking action to squelch that practice. The DOL has recently pursued employers it believed attempted to circumvent the law by treating workers as members of LLCs. In fact, on April 23, the DOL announced that after a five-year investigation, it (with the assistance of the U.S. Department of Justice and the state of Utah) secured consent judgments against Utah and Arizona businesses that required construction workers to become members of LLCs. The consent judgments resulted in approximately $600,000 in back wages and liquidated damages and $100,000 in civil penalties. The DOL explained that it shared information with the state through the Utah Worker Classification Coordinated Enforcement Council, which was created by the Utah Legislature to stop employee misclassification.

The message is clear: The DOL will scrutinize employers’ use of LLCs and franchises as tools to avoid paying wages, taxes, benefits, and other obligations associated with designating workers as employees. Consider the ramifications of using sham business entities to avoid classifying workers as employees.

Consequences of misclassification
Employers should endeavor to properly classify their workers. What may seem like an effective strategy for avoiding payroll taxes, employee benefits costs, unemployment insurance costs, workers’ comp insurance, and vicarious liability may become a nightmare. Often, employers do not fully appreciate the consequences of misclassification.

Misclassification can result in financial liability, legal claims, employee relations problems, and administrative headaches. Employees’ classification may be challenged by the IRS, state tax agencies, the Equal Employment Opportunity Commission (EEOC), state antidiscrimination agencies, the DOL’s Wage and Hour Division (WHD), workers’ comp agencies, U.S. Immigration and Customs Enforcement (ICE), unemployment compensation agencies, wage agencies, third parties asserting claims against the employer, contractors asserting claims against the employer, or misclassified employees.

Reclassification of employees may result in unpaid income, Social Security, and unemployment taxes, interest on unpaid taxes, and penalties. Reclassification may result in an employer owing past workers’ comp insurance premiums and unpaid overtime compensation, which may be accompanied by liquidated damages, interest, costs, and attorneys’ fees. There may be immigration consequences for failing to complete I-9 forms and not using E-Verify. Further, employees may be retroactively entitled to health insurance and other benefits, including accrued vacation or sick leave.

Need to learn more? Are you exempting employees from time and a half when you shouldn’t be? Do you use “independent contractors” that are actually your employees, under complex wage and hour laws? Join us today for the BLR webinar “Exempt, Non-exempt, or Contractor? How to Correctly Classify Employees and Avoid Costly Mistakes.” Learn what to watch out for to avoid expensive legal missteps under federal law, including state-specific regulations that could impact your compliance obligations. For more information or to sign up, go to http://store.hrhero.com/classify-120215

Bottom line
Employers should carefully and regularly analyze whether their workers are properly classified. With the DOL issuing new guidance, now is a good time to undertake this assessment. The classification of every worker should be scrutinized under the guidance. Employers should not be surprised if the guidance means they must reclassify their workers. It is anticipated that many workers currently classified as independent contractors will have to be treated as employees instead.

In addition, remember that many strategies to avoid classifying workers as employees are often disfavored. Improperly classifying employees as independent contractors, members of LLCs, or franchisees may result in significant liabilities and penalties. Liabilities and penalties may increase if misclassification is intentional. Employers should consult with legal counsel on how to properly classify workers under the new regulations and whether strategies they are using to avoid classifying workers as employees may result in unintended legal ramifications.

Ryan B. Frazier is an attorney with Kirton McConkie in Salt Lake City, Utah. He may be contacted at rfrazier@kmclaw.com .