According to recent news articles, something like 3.5 million workers in the US are misclassified as “independent contractors”.
HOW DOES MISCLASSIFICATION HAPPEN?
Some employers may see the use of independent contractors, commonly called “1099 employees”, as a way to save money and gain a competitive edge in their businesses. Employers do not pay social security taxes, federal or state unemployment taxes, or worker’s compensation premiums on independent contractors. They do not pay overtime, vacation, or holiday pay. They avoid the costs of benefits, such as medical, dental, vision, disability, and life insurance. They also avoid complying with the many laws that apply to the employer-employee relationship. All of these can be tempting reasons to misclassify employees as contractors.
Some employers simply do not understand the provisions of the Fair Labor Standards Act. This 1938 law was passed to define what is meant by “employee”, as well as to regulate the payment of minimum wages and overtime, and to differentiate between “Exempt” and “Non-Exempt” employees.
The FLSA’s definition of “employee” is one who is “suffered or permitted to work”. A worker who is economically dependent on an employer is suffered or permitted to work by the employer.
HOW COURTS DETERMINE WHO IS AN EMPLOYEE
In order to make the determination whether a worker is an employee or an independent contractor under the FLSA, courts today use what is known as the “economic realities” test, which focuses on whether the worker is economically dependent on the employer or in business for him or herself.
There are 3 main parts of the economic realities test:
- Behavioral Control
- Who determines the when, how, and where to do the work
- What tools to use and who owns them
- Financial Control
- Does the person work for others?
- Extent of worker’s investment
- Opportunity for Profit or Loss
- Type of Relationship
- Written contract
- Key aspect of the company : An “integral” part of the business
- Length of assignment
While none of these factors are sole determinants in and of themselves, courts have found the “Integral Part of the Business” and the “Behavioral Control” tests to be especially compelling. Where an employer tells the person what to do and how to do it, what hours to work, where to work, and the work that is to be done is part of the reason the business exists, the likelihood is that the person is an employee, not a contractor.
Contractors typically have their own business, such as an LLC or an S-Corp, have a federal tax ID separate from their social security number, work based on written contracts with clients, perform work on a project or as needed basis, work for several different clients, may make a profit or a loss on their work, cannot just “quit” anytime they want but must fulfill the provisions of the contract, owns his /her own equipment and tools, and is responsible for a given outcome. The contract may be long term or a single project, but the failure of the contractor to complete the agreed upon work can result in a lawsuit by the client against the contractor for breach of contract.
If, after reviewing the three parts of the economic realities test, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
LAWSUITS
The Oakland Raiders football team had for years classified their cheerleaders as independent contractors. But in a lawsuit settled in September 2014, the football team had to pay out $1.25 million in back pay and reclassify their cheerleaders as employees.
In January of 2016, A New Jersey court approved a $325,000 settlement between the New York Jets and their cheerleaders for having misclassified the cheerleaders as independent contractors.
The Cincinnati Bengals, Tampa Bay Buccaneers, and Buffalo Bills have also been sued. The Buccaneers reached a settlement of $825,000, and the Bengals have reached a tentative pact with their cheerleaders. The cheerleaders for the Buffalo Bills were recently given authorization to bring a class action lawsuit against the team.
There are many other examples:
In April 2015, DOL announced that it recovered $700,000 in back wages, damages, and penalties for over 1,000 misclassified construction industry workers in Utah and Arizona.
In September 2014, a Sacramento Superior Court in California ruled that The Sacramento Bee Newspaper misclassified over 5,100 newspaper carriers as independent contractors.
In May 2013, the DOL helped 196 employees at a Kentucky based cable installer recover over $1 million in retroactive overtime pay and other benefits.
In 2012 and 2013, after having hired 300 additional investigators, the Department of Labor collected more than $18.2 million in back wages on behalf of 19,000 employees who had been misclassified.
According to a recent wage and hour class action lawsuit, Scarlett’s Cabaret, a dance club chain with locations in Florida and Ohio, allegedly misclassified its dancers as independent contractors. The misclassification allegedly resulted in the dancers receiving lower pay and not getting paid the proper overtime compensation when they worked more than eight hours a day or forty hours a week.
Dancers are often misclassified as independent contractors, even though they are commonly told when and where to work, as well as what to wear while working, which places them firmly in the employee category under the FLSA.
Rather than continue to fight the legal battle, Scarlett’s has agreed to pay $6 million to settle the class action lawsuit. The settlement will cover approximately 4,700 current and former dancers who worked at the club.
CONSEQUENCES OF MISCLASSIFICATION
If an employer classifies an employee as an independent contractor without any reasonable basis for doing so, they may be held liable for unpaid back employment taxes for that worker. If the misclassified person worked overtime and/or was paid less than minimum wage, those costs may be levied on the employer as well. Many well –publicized cases have demonstrated the high costs of misclassification.
Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.
REASONABLE BELIEF FOR THE MISCLASSIFICATION
If there was a reasonable basis for not treating a worker as an employee, the employer may be relieved from having to pay employment taxes for that worker. To get this relief, the employer must file all required federal information returns on a basis consistent with the treatment of the worker. The employer, and any predecessor, must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. See Publication 1976, Section 530 Employment Tax Relief Requirements (PDF) for more information.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.