Federal and state government agencies have been increasing enforcement efforts lately to address misclassification of workers as contractors rather than employees. The U.S. Department of Labor added 250 new investigators to aid with compliance efforts, and the IRS has likewise been transparent about its intent to step up audits and enforcement efforts to combat misclassification. The state of Oregon also created an Interagency Compliance Network to proactively educate businesses and coordinate enforcement activities between key state agencies. Washington’s state agencies, too, have stepped up enforcement efforts while also offering resources to promote awareness. Courts, too, are being asked to opine on worker classification more than ever, and some decisions totally contradict what had been traditional business models in certain industries. This includes a 2014 decision by the Ninth Circuit Court of Appeals, which held that under Oregon law, a class of 363 full-time FedEx delivery truck drivers were employees and thus entitled to additional wages and overtime.
So why is misclassification such a big deal?
Well, for taxing authorities, classifying a worker as a contractor rather than an employee results in lost tax revenue. For others, it means the worker will not receive the benefit of employment-related legal protections and benefits that the worker may otherwise be entitled to. For the businesses that incorrectly classify employees as independent contractors, it can be a “make or break” scenario. That’s because getting it wrong can mean the business may be on the hook for:
- Payment of back wages and benefits that were neither anticipated nor budgeted for
- Employment-related taxes on all wages owed to the misclassified worker(s)
- Fines, interest, and/or other penalties, including attorney fees, if the mistake is uncovered by the regulatory agency, or in connection with a civil claim brought by the worker
- Additional workers' compensation insurance premiums and potential claims for workplace injuries
- Liability for employment-related claims by the misclassified worker, including anti-discrimination, anti-retaliation, wage and hour, workplace safety and health, and protected leave laws
These amounts can be staggering for even a single misclassified worker. Where there are multiple workers, the figures grow exponentially. This can even happen where an otherwise properly classified contractor employed its own workers to perform services, but didn’t follow the requisite formalities.
Isn’t this as simple as looking at whether the business issued a 1099 or a W-2 at the end of the year?
Unfortunately, no. Instead, there are a patchwork of fact-specific tests that need to be considered. There are no less than 3 multi-factored tests that could apply under federal law, and both Oregon and Washington have a host of different tests that may apply depending on the purpose for which the relationship is being examined, and most other states do too. If a worker performs work in other jurisdictions, the business must also consider the tests applicable in those states. What generally isn’t relevant to any of the tests is what the business or the worker intended, or often even what the paperwork says. Instead, the best practice is to consider the applicable tests before commencing the work so that the relationship can be properly structured to comply with the applicable legal standards.
Given the inherent risks of misclassification, the complexities and fact-specific nature of the proper determination of each of those issues, and the increased enforcement efforts at every level, it should be easy to see how a mistaken misclassification has the potential for a huge negative impact on a business.
For that and other reasons, we typically recommend that the proposed relationship be first evaluated with advice of qualified counsel, and structured so that all of the potentially applicable tests are met, and then memorialized in an appropriate written agreement. If the contractor will be engaging employees or additional workers to perform the anticipated services, it would be wise to make sure the contractor is properly licensed and insured for the work anticipated, both at the outset and throughout the engagement, to help guard against similar claims by the contractor’s employees/workers. By properly applying the appropriate standards in advance, however, businesses can best avoid the foreseeable risks.
We hope that this brief summary has been useful. Of course, it is merely intended to highlight some of the issues and point out some of the common risks and pitfalls related to misclassification, not to replace independent legal advice for any particular situation.
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