Misclassifying Employees Extends Beyond Making Employees Independent Contractors

Misclassifying Employees Extends Beyond Making Employees Independent Contractors

Experts Explain High Cost of Employment Fraud

By John Stahl, Esq.

Fraud in the form of purposefully misclassifying workers’ employment status is comparable to a nation of slowly dripping faucets. Individually, this malfeasance usually lacks a significant impact. Cumulatively, it costs workers’ compensation insurers and employers who properly classify those who provide their businesses services a great deal of money.

Statistics also showed that this fraud resulted in $175 M in lost employment taxes in New York State in 2007, $144 M in that revenue in Illinois in 2006, and a current estimate of roughly $2.5 B in federal Social Security income tax revenue. The state amounts are anticipated to increase in 2012.

A November 8 session entitled “Employee or Independent Contractor? The Impact of Misclassificationat the 21st Annual National Workers’ Compensation & Disability Conference discussed the forms of this fraud and efforts to combat it. Mark Noonan, of Integro Insurance Brokers, California, moderated the session. The panel consisted of defense attorney Stuart Colburn, Esq., from Downs Stanford, Austin, TX, applicant’s attorney Robert Rassp, Esq., Sherman Oaks, CA, and Larson’s Workers’ Compensation Law staff writer Thomas Robinson, J.D. from Durham, NC.

The session primarily focused on the practice of misclassifying an employee as an independent contractor. This distinction regarding employment status centered around whether someone whose efforts benefitted an employer’s business qualified for workers’ compensation coverage and other rights and privileges that employees received.

The experts’ discussion of the factors that determined whether someone was an employee is summarized below. The spoiler alert is that properly establishing employment status largely depends on the extent to which an employer controls how an individual completes the task or tasks for which he or she receives payment.

Other topics included:

  • The range of misclassification fraud
  • Motives for misclassification fraud
  • Enforcement of employment laws

Misclassification of Independent Contractors

The panel discussed some employers falsely reporting to tax authorities and workers’ compensation insurers that an employee was an independent contractor. The respective motives for that fraud were evading employment taxes and obtaining artificially low workers’ compensation rates.

The experts discussed helpful examples, but another simple one timely illustrates the concept of control well. This hypothetical also reflects the elements of what the panel identified as the ABC Test.

Someone whose contract with a bakery owner merely provided for that person to clear the snow and ice from the business property for X dollars a storm was an independent contractor.

At the other extreme, a snow-removal agreement for the same compensation that also either dictated the equipment and materials for the work or that provided for the bakery owner to provide those resources and that stated more specifically the tasks that the service provider would conduct and under what schedule would almost certainly require classifying the person as an employee.

The importance of the distinction for workers’ compensation purposes was that an employee who seriously injured his back while shoveling snow for the bakery owner would likely qualify for medical and lost income benefits. An independent contractor who sustained the exact same harm under the exact same circumstances definitely would not qualify for those benefits.

The panel also discussed the IRS Test that sought to determine the following aspects of an employment agreement:

  • Behavioral control
  • Financial control
  • Relationship

This  test relates to what legal scholars called the “giggle test.” In this case, the standard was whether an employer could keep a straight face while asserting to an IRS official that the relevant individual was an independent contractor.

Rassp stated regarding this aspect of determining a proper employment classification that “because they [the employer] had control over what he did, where he did it,” the worker at the center of a hypothetical workers’ compensation dispute was an employee.

Regarding the proper determination of employment status, Colburn commented that Texas allowed signing an agreement that provided that the person who provided the services under that contract was an independent contractor. He stated that that agreement would be considered, but would not be determinative, in the event that employment status was relevant in a legal dispute.

The fact that employers often have the upper hand in employment relationships was one reason that Texas did not grant independent contractor agreements more weight. Colburn addressed this in stating that “you [ the worker] will say anything to have a job, including saying I won’t sue you [the employer.] I won’t do this or that. You will sign away your life to get a job.”

Other Misclassifications

The session’s scope extended beyond misclassifying an employee as an independent contractor to misrepresenting the nature of an acknowledged employee’s work. Workers’ compensation fraud was a primary motive for that practice.

The types of that fraud included:

  • Treating two distinct types of work that a full-time employee performed as two separate part-time positions
  • Classifying an employee as holding a position that had less risk of harm than that person’s actual work. A provided example was classifying truck drivers as clerical workers.
  • Not updating a classification to reflect an employee’s increased duties and responsibilities as that person advanced within the company

Motives for Misclassification

A discussion of the numerous advantages that misclassifying workers provided employers showed that the motivation for that fraud extended well beyond artificially low workers’ compensation rates. This helped understand why an employer would risk that fraud being discovered.

The reason for these offenses included:

  • Limiting the number of people qualifying for fringe benefits, such as stock options and pensions
  • Reducing the number of people who qualified for overtime pay and related legally required compensation
  • Avoiding liability for health insurance, especially the new requirements under Obamacare
  • Misrepresenting someone’s true earnings to reduce liability for workers’ compensation wage-loss benefits
  • Roughly 17-percent savings in employment taxes
  • Evading workers’ compensation liability by asserting that an incident occurred beyond the “official” scope of the employee’s duties.

On a more positive note, Robinson provided an example in which a university’s bureaucracy was at the heart of a classification controversy. In referring to that instance, he commented that “not all of these situations where there is a misclassification of employee, not all of these are nefarious.”

California Enforcement Efforts

After the panel extensively explained the methods for misclassifying workers and the related costs, Rassp reported on efforts in California to curb that wrongdoing. He explained that the state formed what was known as the “underground economy recovery unit (Unit),” which consisted of representatives from several state agencies that included the Employment Development Department and the Division of Workers’ Compensation.

The discussion on the Unit explained that it targeted roofing companies and other industries with known histories of misclassifying employees to achieve the money-saving objectives described above. The unfair advantage that that practice granted those malfeasors over their competitors that properly classified their workers provided a primary motive for California’s crackdown.

Rassp stated specifically that the Unit “will arrest the owners of these companies, utilizing sections in the various codes that govern taxation … to try to equalize this.” Possible penalties in addition to, or in lieu of jail time, were court-ordered retroactive payments of taxes and insurance premiums.

Rassp concluded by stating that California only wanted that employers “comply with the law, to pay the premiums and pay payroll taxes and call these people [workers] what they are. Employees.”

Further Complication

The panel ended relatively dynamically in emphasizing points that arose several times during the discussion. One issue was that some employers genuinely did not realize that they had been misclassifying employees. Related concerns were that some situations presented strong competing arguments for classifying someone as an employee or a subcontractor and that the outcome might hinge of which widely accepted test for making that determination was utilized.

Bottom Line

An employer that uses true good faith and errs on the side of caution in classifying employees stands a good chance of having those classifications withstand scrutiny in workers’ compensation proceedings or another other dispute in which that classification is relevant.

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