Labor and Employment Law

Misclassification of Employees as Independent Contractors - What's That Mean?

Misclassification of Employees as Independent Contractors

This is a problem that has plagued America's workforce for many years. Companies have repeatedly, and purposefully, engaged in the practice of misclassifying people who should be deemed employees as "independent contractors."

Why do Companies Intentionally Misclassify Workers as Independent Contractor?

There are many very significant benefits to having independent contractors versus employees.

First, the most obvious benefits, at least to the general public, is that independent contractors are paid on a 1099 basis, as opposed to a W-2 basis. This means that companies do not have to pay withholding tax, make Social Security contributions or pay into Medicare.

Benefits that are less commonly known to the average worker include the fact that independent contractors are not entitled to workers' compensation or unemployment benefits. This means that companies can save significantly due to the fact that they are not obligated to make workers' compensation or unemployment insurance contributions.

Further, independent contractors are not entitled to protection under overtime laws such as the Fair Labor Standards Act, and companies cannot be sued by independent contractors under employment laws prohibiting discrimination, sexual harassment, retaliation, wrongful termination, etc.

Finally, at least with regard to the major benefits of having independent contractors versus employees, independent contractors can be bound by all necessary employer policies, such as work rules, non-compete agreements, etc.

In short, having independent contractors versus employees is a win-win situation for a company.

They save significantly on payroll expenses, workers compensation and unemployment contributions, while at the same time eliminating obligations to comply with state and federal employment laws. At the same time, companies are able to require their contractors to adhere to company policies, and can limit their right to compete against the company subsequent to the end of their relationship.

Based upon the foregoing, is there any doubt that all companies would employ strictly independent contractors in non-management positions if they thought that they could attract enough people into such positions? Given the current unemployment crisis, the numbers of people willing to accept employment as Independent contractors has grown significantly, and thus the trend of having a significant percentage of workers deemed independent contractors is on the rise.

What is the Downside to Having a Significant Number of Independent Contractors Working for a Company?

In general, and although there is some variance of the test dependuing upon circumstances, a true independent contractor is not subject to control by the employer, and is free to accept or decline any work assignments. Thus, employing a large number of independent contractors creates, at least in theory, a significant risk for employers that required assignments will not be completed in a suitable or timely fashion.

How do Companies Get Around the Risks of Utilizing Large Numbers of Independent Contractors?

Typically, they control the manner and means of the employee's work via close supervision, while at the same time requiring (or least implicitly) that the employee accept all work assignments as a condition of future employment. In doing so, of course, they have been practice treated their independent contractors as employees, and are thus misclassified them. However, and despite the prevalence of this practice, companies get away with this on a regular basis throughout America.

What Does it Mean to Misclassify Employees as Independent Contractors?

We have written on this quite a bit in the past. In general, the common occurrence is that companies: 1) hire people under written independent contractor agreements that, on their face, suggest that the employee is a "free agent" who will work on his/her own and is free to accept of reject any work assignments; 2) in practice, and despite the language in the written agreement, the "independent contractor" is treated just like regular employees, in many cases having working side-by-side with them in the workplace, subject to direction by the same supervisor.

Companies do this because, while they want the financial benefits of having a workforce comprised of independent contractors, they do not want to have people working for them that are not subject to the control, free to decline work, etc.

Can I Recover Lost Benefits if I Have Been Misclassified as an Independent Contractor Even Though I was in Fact an Employee?

Generally, no.

First, it is important point out that, in most cases, only governmental agencies such as the United States Department of Labor or the Internal Revenue Service can make a misclassification determination.  Click here to read more about how IRS makes such a determination. Sometimes, state agencies such as those implementing unemployment or wage regulations get involved in this issue as well.

So, what happens if the IRS determines that you should have been paid as an employee, and not an independent contractor? The average person would want to be reimbursed for the Social Security contributions, withholding payments etc. that were not made on his or her behalf. Further, employees would be interested in being paid the same benefits during their employment as their fellow employees, such as vacation pay, sick pay, right to purchase paid in 401(k) programs, etc.

However, in the overwhelming majority of cases, the federal laws that currently exist do not permit employees to file a private lawsuit to recover such damages (the only exceptions to this rule is where employees are members of a union and or where companies have created IRS qualified retirement benefits to which employees are automatically entitled- Microsoft got hit on the latter scenario about 15 years ago).

To make matters worse, the IRS has recently decided that employers who voluntarily come forward to acknowledge that they have wrongly classified workers as independent contractors will, in exchange for their "honesty", be rewarded by not having to pay any interest or penalties for overdue payroll contributions, along with tax relief benefits. Now, that will fix the problem!

Can I Recover Overtime if I am Misclassified as an Independent Contractor?

Yes. This comes about in one of two ways. In some circumstances, if the IRS is determined that you were misclassified, then you could file a lawsuit to recover any overtime that you earn but were not paid during your employment. Alternatively, and independent of whether IRS has made a determination or not, if you believe that you were an independent contractor who is owed overtime, you can file a lawsuit on your own and seek a determination from the court that you were in fact an employee, and therefore entitled to overtime.

Thus, while you do not have a right as an individual to file a claim against the company for lost wages, benefits, withholding contributions, etc., you do not have a right as a private individual to file a lawsuit in state or federal court seeking a determination from the court that you were in fact an employee eligible for overtime compensation.  Click here for an overview of federal overtime laws in the United States.

Indeed, it is not uncommon to see a group of independent contractors employed by one come to you gather together to file a lawsuit in federal court seeking payment of overtime on the grounds that they were in fact employees.

Can I Recover Sue for Discrimination or Sexual Harassment if I am Misclassified as an Independent Contractor?

Yes, for the same reasons and utilizing the same mechanisms as described in the above section relating to overtime.

Can I Get Unemployment Benefits if I am Misclassified as an Independent Contractor?

Yes, you can. You have to take this issue up by filing for unemployment benefits once your "independent contractor" arrangement ends. This is a common dispute in many states.

Can I Get Workers' Compensation Benefits if I am Misclassified as an Independent Contractor?

Yes, you can. If you have suffered an injury while working under an independent contractor arrangement, you can seek a determination from a workers' compensation referee or judge that you were in fact an employee, and therefore eligible for workers' compensation benefits. This is also a common dispute in many states.

Read more articles about employment law issues at Philadelphia Area Employment Lawyer, a blog by John A. Gallagher.

For more information about LexisNexis products and solutions connect with us through our corporate site.