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CLIENT ALERT: Worker Misclassification

October 9, 2015

Continuing its focus on combating worker misclassification, the U.S. Department of Labor has awarded nearly $40 million in federal grants to 45 states and territories. The grants are designed to enhance unemployment insurance programs and the state’s efforts to reduce the misclassification of employees as independent contractors. Delaware received over $750,000 in grants, nearly half of which was specifically directed to combating worker misclassification.

Worker misclassification occurs when an employer improperly classifies an individual as an “independent contractor” rather than as an “employee.” Worker misclassification often results in individuals not receiving benefits that they would have received had they been properly classified as employees. Misclassification also affects the government. It is estimated that worker misclassification generates substantial losses to state unemployment insurance funds and also results in lost revenue to the Internal Revenue Service. Studies have estimated that misclassification will cost the IRS $7 billion in lost payroll tax revenue between 2010 and 2020.

Whether an individual is an “independent contractor” or an employee depends on several factors including: (1) the degree of control exercised by the employer over workers; (2) the workers' opportunity for profit or loss and their investment in their business; (3) the degree of skill and independent initiative required to perform the work; (4) the permanence or duration of the working relationship; and (5) the extent to which the work is an integral part of employer's business. No one of these factors is controlling; rather the DOL and courts will focus on the level of dependence the individual has on the business – the “economic realities” test. The greater the dependence, the more likely there will be a finding that the individual is an employee. 

Employers should be cautious when classifying individuals as “independent contractors,” as misclassifications could be a costly mistake. If workers are found to be misclassified, the newly deemed employees will be covered by the Fair Labor Standards Act. This means that the employees not only will be entitled to regular wages and potential overtime going forward, but also that the employer could be liable for unpaid wages and benefits. The misclassification also could have significant tax consequences if it is determined that the worker was or should have been receiving wages. If an employer failed to withhold income tax on such wages, the penalties could be severe.

Employers who believe a worker is properly classified as an independent contractor are advised to review the assignment carefully, with a close eye on the IRS standards for independent contractor classification. If the employer has particular concerns about the classification of workers, given the government’s focus on this misclassification, it is strongly advised that they seek the advice of counsel.