Diserio Martin O'Connor & Castiglioni LLP

Employee Misclassification; A Wake-Up Call for Employers

December 1, 2010

Traditionally, smaller to moderately-sized employers have treated at least some of their workers as independent contractors rather than W-2 employees.  Setting aside for the moment the issue of whether or not doing so in any particular circumstance is proper and legal, the practical reasons for an employer wanting to do so are obvious.  These reasons generally relate to convenience and cost. 

While a true independent contractor is paid in gross dollars and issued a Form 1099 at year end for tax purposes, an employer must withhold income taxes from an employee’s paycheck, pay state and federal unemployment taxes and social security taxes.  An employer must also pay for the added cost of covering an employee under its workers’ compensation and other insurance policies and provide to the employee employment-related benefits such as group medical coverage.

Additionally, whereas an independent contractor is generally paid a fixed sum of money, non-exempt employees are entitled to be paid time and a half for all hours worked in a week in excess of 40.  Lastly, employees are protected by a myriad of laws, both state and federal, relating to their rights in the workplace which are not necessarily available to independent contractors, such as Title VII of the Civil Rights Act of 1964, the Connecticut Fair Employment Practices Act, both federal and state Family Medical Leave Acts, the Americans With Disabilities Act, and so on.

While these potential financial and practical benefits might at first blush appear tempting, the reality is that the risks attendant to misclassification can far exceed any potential benefit, financial or otherwise.  Employers must tread very carefully when characterizing any service provider as an independent contractor to insure not only that the relationship will pass muster under scrutiny as one of independent contractor and principal, but also that it is properly documented in the event of an audit by a state or federal public agency.  

The federal government has announced that it will hire more than 275,000 workers for “mission-critical” jobs in the next three years, 30,000 of which involve compliance and enforcement positions.  The Internal Revenue Service has allocated a significant part of its fiscal year 2010 budget to enforcement activity, citing specifically employee misclassification as a target area.  It will engage in random audits of at least 6,000 U.S. employers for worker classification compliance issues in 2010.

Additionally, the Department of Labor is hiring inspectors, investigators and auditors and will spend roughly $244 Million Dollars to ramp up its enforcement efforts in the area of worker misclassification. 

Following the lead of the federal government, in May Connecticut’s Governor Rell signed legislation increasing State civil penalties for misclassification from $300 per violation to $300 per day per violation.

The bottom line is that the stakes for employers have been raised significantly by government agencies charged with enforcement of the law regarding worker classification.  Therefore, it behooves the prudent and responsible employer to consult with legal counsel to determine whether any independent contractor relationships it currently has may be properly characterized as such under the current state of the law and whether they have been properly and thoroughly documented consistent with applicable legal requirements.  It should be noted in this regard that the “ABC” test applied in Connecticut to determine whether a worker is properly characterized as an independent contractor is an extremely restrictive and narrow test which, in many instances, cannot be satisfied.  Moreover, while the applicable test in New York is somewhat more general in its approach, in implementation it has also been given rather restrictive effect.

This has become an area fraught with pitfalls and serious risk to the employer.  An employer can no longer simply characterize workers as independent contractors without a solid legal  basis for doing so hoping that they will never be caught in a random audit.  More often than not, the random audits are not so random as a phone call from a disgruntled ex-worker is all that is required to put the employer on the radar screen of the Department of Labor or some other enforcement agency.

Therefore, the most prudent course is for every employer to consult with legal counsel, review any positions that are treated as independent contractors, and come to an informed conclusion as to whether or not they should continue to treat those positions as such.  Moreover, a determination should be made as to whether, even if a position can continue to be treated as such, it must be better documented.  This is an area where an ounce of prevention is ultimately worth much more than a pound of cure.