YourABA July 2011 Masthead

Employee misclassification can lead to big penalties for employers

Employee misclassification is becoming an increasingly large problem for employers, workers and the government. By some estimates, contingent or temporary workers could reach 30-50 percent of the U.S. workforce. A federal study contends that an estimated 3.4 million employees are classified as independent contractors when they should be reported as employees. A 2009 study by the treasury inspector general estimated that misclassification costs the United States $54 billion in underpayment of employment taxes and $15 billion in unpaid FICA and unemployment taxes.

With pressure to reduce the federal deficit, the Obama administration has made retrieving tax revenues from employers who misclassify their workers a top priority, requesting $45.8 million and 129 full-time employees for the new multi-agency Misclassification Initiative.

Labor Secretary Hilda Solis testified before a House appropriations committee with the goal of leveling the playing field for employers who abide by the law and providing workers with their rightful pay and benefits. “Our efforts to recover lost wages not only help workers make ends meet in hard times, but can bolster the economy, since back wages amount to new resources to low-income workers who spend most of the money they have earned.”

Addressing the complexity of the issue as well as the pitfalls of using independent contractors, the Section of Labor and Employment Law recently presented the in-person program,“You Don’t Own Me…Or Do You?”

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To underscore the perils of misclassification for employers, panelists recapped several high-profile cases: Vizcaino v. Microsoft, which resulted in a settlement of $97 million; Estrada v. FedEx, which brought a verdict for drivers, $5 million compensation and $13 million in attorneys’ fees; and another one involving FedEx, where the IRS found the company misclassified employees, owed $319 million in back taxes and penalties for tax years 2004-2006, which was later rescinded after an appeal by company. However, the IRS did find that the drivers were employees of the company, which may result in tax liability for future years.

Program panelist Clayton Halunen of Halunen & Associates of Minneapolis, an employment and consumer litigator who is nationally known for his work in misclassification cases, cautioned, “Once the IRS gets involved, their audit procedure is very intense. FedEx was under investigation for years.”

Halunen added, “The single greatest potential liability to any company that misclassifies independent contractors is the state and federal tax obligations that may result.”

Panelist Nora Macey of Macey, Swanson & Allman in Indianapolis pointed out that it’s not just labor and employment lawyers who are dealing with misclassification issues. “The misclassification issue is not going to be solved in the labor and employment law realm. It’s going to be solved in the tax realm, because suddenly the IRS has figured out how much money it’s losing by routine misclassification.”

Under the National Labor Relations Act, “independent contractors” are excluded from the definition of “employees.” Unions have no right to organize or represent independent contractors and employers have no duty to bargain over their working conditions.

Employers in unionized environments should consider:

  • A union may claim temporary/contract workers as part of its bargaining unit;
  • A union may claim that use of temporary or contract workers violates the union contract;
  • The union and client employer may negotiate language to cover the use of temporary workers—limitations and representation;
  • Unhappy union workers are not typical unhappy workers: they have resources and support;
  • If the staffing relationship is long-term and profitable, the client and staffing employers can consent to a union’s joint representation of client and staffing employees.

Using leased workers may benefit a company uncertain about its future growth since training, human resources and payroll are often handled by the staffing firm. Leased workers may cost less than hiring regular employees, since most of them do not receive other employment benefits, such as health insurance, pension, paid sick leave, etc.

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Panelist Ann Fromholz, who was senior counsel in the Corporate, Employment & Procurement group of ConocoPhillips’ legal department, cautioned, “When you’re representing an employer, look at the staffing companies and make sure the workers they’re sending you are W-2 employees and not independent contractors of that company.” There may also be a risk that the staffing companies or agencies providing independent contractors may have misclassified their own workers.

Using temporary and leased workers can create a joint employment relationship, which means potential legal exposure for the engaging company—particularly when it comes to harassment, discrimination and retaliation claims. Fromholz’s advice to employers is to engage in the same care of the contractors as you do with your own employees. When you want to “fire” or remove a contract employee, call up the company and have the company remove its worker, she said.

When it comes to harassment, employers need to make sure their lease workers know what the policy is, but training on the topic should be done by the staffing company.

The best way to handle discrimination claims is a good indemnification agreement. Fromholz advises employers to make sure the staffing company has the resources to indemnify them.

There are also risks involving the Family Medical Leave Act. If a contractor is denied a request for leave that would otherwise be covered by the FMLA, and later proves that she was actually an “employee,” the employers may have interfered with FMLA rights. Approving FMLA leave should be handled by the staffing agency. If a temporary worker requests FMLA leave directly from an employer, the request should be communicated back to the staffing agency.

A measure pending before the U.S. Senate—the Payroll Fraud Prevention Act—is intended to prevent misclassification by implementing record-keeping requirements for employers. Fines of up to $5,000 and penalties would compel compliance.

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