a. Laws and Guiding Principles
As discussed in Section I of this chapter, classification of independent contractors and employees is subject to an intricate framework of statutory and common-law approaches. A fundamental principle, however, is that courts must undertake a comprehensive examination of all relevant facts. No single factor is dispositive. Instead, careful balancing of all relevant factors is required to reach a determination based on the specific situation at hand.
That said, there are common themes that run through each of the various tests. Although an independent contractor agreement should be detailed and carefully documented, the written agreement between the parties never controls the outcome. Certainly, the parties’ intent matters. However, it is the actual implementation and the realities of the parties’ performance that determines how courts will characterize the relationship. For purposes of the common-law and Right to Control tests, the focal point of the analysis will be the company’s ability to control and direct the manner and sequence of the worker’s performance. Under the Economic Realities test, the analysis turns on the degree of the worker’s dependence on the company. At bottom, the fundamental question under any test is whether the facts demonstrate that the worker is truly in business for him- or herself. If so, an independent contractor relationship exists.
b. The Legal Consequences of a Re-Characterisation
When independent contractors are reclassified as employees, employers may be subject to payment of back income tax withholdings and Social Security and Medicare tax contri-butions, as well as for penalties for misclassification. Employers also risk potential claims by employees for unpaid hourly and overtime compensation, and past workers’ compen-sation and employee benefits liabilities. In addition, government agencies may conduct audits and investigations and impose additional obligations, combined with penalties and interest for noncompliance. Moreover, only employees, and not independent con-tractors, have the right to form unions. Reclassification thus entails the risk of greater unionizing activities and potential collective bargaining obligations if such activities are successful.
In some situations, reclassification of independent contractors as employees may increase the number of employees and render an employer subject to other laws that were previously inapplicable, because the employer did not meet the threshold. For example, the FMLA covers only employers with at least 50 employees, while most fed-eral employment discrimination laws cover only those employers who have at least 15 or 20 employees, depending on the statute. Employers with 100 or more employees must additionally file annual EEO-1 reports with the United States Equal Employment Opportunity Commission. Other reporting requirements similarly come into play once a particular employee size threshold is crossed. Employers thus must take careful account of the implications once coverage under a particular statute is triggered.
c. Judicial Remedies Available to Persons Seeking ‘Employee’ Status
If a worker believes he or she has been incorrectly classified as an independent contractor, the worker can request a determination of worker status for purposes of federal employment taxes and income tax withholdings from the IRS. In the event of a determination that the worker was misclassified, the business is sent a letter notifying it of its obligation to pay employment tax and to adjust any previously filed employment tax returns accordingly. Workers may also file complaints for unpaid wages with the U.S. Department of Labor, which enforces the FLSA. An individual complaint will result in anadministrative investigation, but may also trigger a broader audit of independent contractor classification practices for similarly-situated workers. When the agency finds that misclassification has occurred, enforcement actions may result seeking relief not only on behalf of the complaining individual, but also for other misclassified workers throughout the organization.
Apart from seeking relief through administrative agency determinations and enforce-ment actions, workers seeking employee status may also file civil lawsuits. At the state level, an increasing number of state legislatures are enacting misclassification statutes, many of which grant workers the right to file a private suit for misclassification, with varying remedies. Some laws are limited to particular industries, such as constructions. Others have broad applicability. For example, Massachusetts’ misclassification statute applies broadly to a wide range of industries and places the burden on the employer to prove each element of a more stringent version of the ABC Test discussed in prior sections.40 In addition to the penalties imposed by other laws, the Massachusetts statute authorizes the Attorney General to impose substantial civil and criminal penalties, and in certain circumstances, to debar violators from public works contracts.
Regardless of whether a state law affords the right to file an action for misclassification, workers may also bring lawsuits under many employment laws, claiming they were improperly classified and treated as independent contractors. For example, the FLSA permits individuals to file “collective actions” – actions filed by a plaintiff as the representative of a class of others similarly situated who elect to participate – in order to seek unpaid wages and overtime compensation based on their alleged independent-contractor misclassification. Under ERISA, persons may file both individual and class-action lawsuits to contest eligibility determinations denying them benefits as a result of having been designated as independent contractors. Civil lawsuits for discrimination, retaliation or interference with benefits can also be filed under various non-discrimination statutes such as Title VII, ADEA and ADA, under the FMLA and other various state and federal whistleblower statutes, as well as under various common-law theories protecting employees, based on the assertion that the contractor should have been classified as an employee protected by the statute.
Class and collective actions asserting misclassification under the FLSA, ERISA, and related laws represent a significant source of potential liability for employers. In some cases, especially where the alleged misclassification has affected broad job categories with numerous incumbents, the potential class size, and with it the potential liability exposure – not to mention the costs of defense – can be truly enormous. One recent case, for example, combined over 42 class action lawsuits filed in 28 states on behalf of thousands of delivery drivers for FedEx Ground, who alleged they had been misclassified as independent contractors and sought reimbursement of business expenses as well as payment of back wages and overtime.41 At the end of 2010, a federal district judge ruled in favor of FedEx Ground under the laws of 20 of the 28 states. That ruling remains on appeal. In the meantime, individual state class actions against FedEx Ground continue to progress, often with divergent and inconsistent results, depending on the applicable state law.
d. Legal or Administrative Penalties or Damages for the Employers in the Event of Re-Characterisation
The remedies and penalties flowing from independent contractor misclassification in the United States vary depending on the particular statute implicated in a given legal proceeding. A synopsis of penalties and damages based on federal law appears below. It is important to recognize, however, that the availability of collective and class action mechanisms under many statutes can expose employers to liability verdicts of potentially massive proportions.
The federal Internal Revenue Code (“IRS Code”) imposes significant potential liability on businesses that fail to withhold and pay employment taxes as a result of employee misclassification. In addition to payment of back taxes and accrued interest,42 if an employee is found to have been misclassified in an IRS audit, a company found to be in violation of federal tax law could be held liable for substantial penalties based on the company’s failure to withhold and collect federal income tax, FICA, and FUTA taxes (accruing monthly up to 25% of the net amount due); for failure to file timely and accurate tax reports (also accruing monthly up to 25%); as well potentially for civil fraud.43 A knowing violation of the statute might also result in criminal prosecution.44
The good news for employers is that in some cases, assuming the misclassification was not willful, liability can be avoided under the safe harbor provision established by section 530 of the Revenue Act of 1978.45 This provision allows an employer to continue to treat a worker as an independent contractor even if the worker would have been treated as an employee under the Right to Control test, if three conditions are met: (i) the employer has filed all required returns reporting payments to the worker as an independent con-tractor; (ii) the employer has not treated the worker or any similarly situated worker as an employee; and (iii) the employer had a “reasonable basis” to have treated the worker as an independent contractor. A “reasonable basis” can include reliance on prior case law, a past IRS audit, industry practice, as well as other reasonable considerations. If all of these requirements are satisfied, the employer’s liability for payment of employment taxes, interest and penalties may be terminated even though the worker is properly classified as an employee.
Under the FLSA, employees (other than those exempt from the relevant provisions of the FLSA) must be paid no less than a specified minimum wage for each hour worked, as well as an additional premium of one-half the employee’s regular rate for each hour of overtime work. Independent contractor misclassifications can result in liability for unpaid wages and overtime wages, an equal amount as liquidated damages, attorneys’ fees and costs. Also, because the statute permits lawsuits to be brought as collective actions on behalf of similarly-situated others, an employer’s liability exposure can be quite significant if a large group of workers is found to have been improperly classified as independent contractors.
Employee Welfare and Retirement Benefits
Employers who misclassify employees as independent contractors and deem them ineligible for participation in the company’s employee benefit plans can incur signifi cant tax penalties for failing to offer or provide sufficient coverage or make necessary premium payments. In addition, such employers run the risk of individual and class action lawsuits on behalf of all misclassified employees seeking rights to benefits.46 Class action lawsuits may also be filed under the federal Family and Medical Leave Act, which provides employees, but not independent contractors, a right to unpaid leave for certain family and health reasons and protects against termination for having taken such leave.
Workers’ Compensation Insurance
Misclassification of employees as independent contractors for workers’ compensation purposes can result in an award of benefits, as well as assessments of civil penalties and potential criminal liability, depending on the particular state’s workers’ compensation statute.
State Misclassification Statutes
Many state misclassification laws impose civil penalties and restitution requirements, particularly if the employer is found to have knowingly misclassified workers. Such stat-utes may also grant workers a private right of action.47