DOL is Increasing Oversight of Independent Contractor vs. Employee Classifications
The Department of Labor (DOL) recently announced that it would be stepping up oversight and enforcement of independent contractor versus employee classifications under the Fair Labor Standards Act (FLSA). The FLSA is the federal law that implements requirements to pay employees at least the minimum wage for all hours worked and overtime pay requirements for non-exempt employees; however, the protections afforded to employees under this law, as well as most employment laws, do not extend to independent contractor relationships. Misclassifying a worker as an independent contractor can cost a company substantial fines and penalties plus payment of any back wages, benefits owed, make-up contributions relating to payroll taxes and deductions, and state unemployment compensation and worker's compensation insurance.
Why Worker Classification Matters
Misclassifying an employee as an independent contractor can cost you and your business some serious cash, and penalties can be substantial. In addition to the back taxes owed, for example, interest on the unpaid taxes will additionally be assessed and start to accrue as of the date the taxes should have been paid had the worker been classified correctly as an employee. In some cases, you or someone within your organization could be personally liable if considered a “responsible person” within your organization.
Some tax penalties you might incur include:
$50 fines for every omitted W-2
1.5% of the wages paid to misclassified employees from which taxes were not withheld
40% of social security and Medicare that were not withheld from misclassified employees
100% of the FICA taxes that should have been paid for misclassified employees
While most businesses do not intentionally misclassify a worker as an independent contractor for any particular nefarious intent, unfortunately, some businesses do see this as an “opportunity” to avoid paying benefits offered to employees or to avoid an increase in employee headcount that would “trigger” additional legal obligations for the company based on headcount, such as ACA requirements to provide health insurance for employers with 50 or more full time or full time equivalent employees.
Misclassifying a worker as an independent contractor deprives that worker of the protections afforded to employees under federal and state employment laws, including laws that prohibit discrimination in employment that don’t apply to independent contractors. Such misclassifications also create financial disparities that last into retirement; for example, not having the opportunity to participate in a company’s 401k retirement plan. In this case, employees are not making contributions to their retirement fund that would otherwise be invested, and they lose the opportunity to benefit from compounding growth that cannot be made-up by contributing more money at a later date with less time invested to grow. For this reason, state and federal labor agencies have become more aggressive about auditing businesses for misclassified employees since the use of independent contractors has increased substantially in the labor market.
Businesses that utilize independent contractors should review their worker classifications to ensure each worker is correctly classified as an employee or independent contractor under the FLSA. Keep in mind that if you previously evaluated these classifications to comply with IRS requirements under the tax code, you may still need to audit your classifications to ensure compliance with the FLSA. It is entirely possible for a worker classification to meet the requirements under the tax code for purposes of taxation but be misclassified under the FLSA for purposes of wage and hour protections, and it is under this test that the DOL will evaluate worker classifications for compliance.
Federal Worker Classification Standards
Unfortunately, there is no bright-line rule that businesses can use to easily determine whether a worker should be classified as an employee or an independent contractor under federal law. However, generally, the level of control exerted by the business over the how, when, and where the work is performed plays a substantial role in whether that worker is properly categorized. independent. While businesses can control what work an independent contractor performs as well as the timeline and deadlines for the finished product, businesses cannot dictate how, where, or when the work must be performed.
Some factors to consider when determining whether a worker is an employee or an independent contractor include:
The nature of the services the worker performs and whether they are essential to the hiring entity’s business
The nature and duration of the relationship
The nature and degree of the business’s control over the worker
The worker’s investment in tools and equipment
The worker’s ability to make a profit or loss
State Law Classification Tests
Ohio courts evaluate worker classifications using the same factors as those considered under federal law above, whereas other states have implemented their own "tests" to evaluate these classifications. As more and more companies hire remote workers, it is important to understand that the laws of the state where the worker is located and performs the work are the laws that govern that employee vs. independent contractor classification.
If your business works with independent contractors and you have not audited your worker classifications recently, now is the time to partner with your attorney to ensure that your classifications comply with federal and state wage and hour laws.