Larry Lorber
Partner
Proskauer, Rose
Mr. Lorber is an experienced law practitioner.

Confusion Over Employee Classification

With the growing mobility of workers, more workforce regulations, and increasing penalties for misclassifying workers as independent contractors, employers—especially small businesses—have to be even more careful when designating a worker as an employee or independent contractor.

In 1992, the U.S. Supreme Court ruled that the dominant test for determining the status of workers should focus primarily on who has the right to control the actions of the worker. As applied by the IRS and other federal agencies, this test focuses on the following factors:

• Does the employer specify the manner and means by which the work is to be performed?
• Is the worker paid in a regular and consistent manner?
• Does the worker bring his or her own tools, or does the employer supply them?
• Does the worker or the employer choose the hours of work?
• Is the work permanent, temporary, or intermittent?
• Is the work related to the normal business of the employer, or is it separate and distinct?

Potential employer liabilities for misclassifying employees fall under several headings:

Taxes. If workers are reclassified as employees, the employer may be liable for penalties in addition to income tax withholding, FICA, FUTA, and state tax liabilities. Currently, the statute of limitations for imposing additional tax penalties is three years.

Overtime. If the worker is reclassified as an employee, the standard overtime rules apply. If the worker was not paid overtime for hours worked in excess of 40 hours per week, the employer may be liable for two years, or perhaps three, of back pay and liquidated damages for willful violation plus attorneys’ fees. Some states have longer statutes of limitation.

Employee benefits. If an employer provides ERISA-covered benefits, it must follow disclosure, participation, and, in some instances, funding requirements. Misclassification of independent contractors can leave the employer with substantial liability for years of retroactive benefits.

Employers can also be liable under various antidiscrimination statutes, workers’ compensation laws, and the National Labor Relations Act. Several states are considering greatly increased penalties for misclassification.

To avoid misclassification of employees, focus on the actual job function and the work performed, not on the job description or contract term. Even if the worker voluntarily deems himself or herself an independent contractor, the courts and the taxing agencies will disregard that decision if the functions are found to be that of an employee.

In addition, engage in periodic audits of classification decisions and work practices to ensure that control of the work product, means of production, and general supervision are still consistent with the independent contractor status. Also, put in place strict limits on the duration of the independent contractor relationship.