One of the most overlooked issues by employers is proper classification of their workers. Whether to designate workers as independent contractors or employees, is a question employers must consider and failure to do so or guessing incorrectly is a mistake that can have drastic consequences for employers under both state and federal law.
Employers who misclassify workers, typically do so for one of two reasons: (1) Lack of knowledge or (2) Short term benefits.
(1) Lack of Knowledge
Many employers misclassify their workers unintentionally due to a lack of knowledge and understanding regarding the difference between the two classifications. Often employers falsely assume that the existence of an independent contractor agreement by itself means that a worker is thereby properly classified as an independent contractor. To properly determine whether a worker should be classified as an employee or an independent contractor, a multitude of factors must be considered, none of which alone are determinative. The factors, and considerations vary under state and federal law.
To evaluate the proper designation for a worker under Illinois Law, it is necessary to refer to the Illinois Wage Payment and Collection Act, and decide whether the worker meets the definition of an employee. If not, then they are to be considered an independent contractor. This Act defines an employee to include any individual permitted to work by an employer in an occupation, but shall not include any individual:
(a) who has been and will continue to be free from control and direction over the performance of his work, both under his contract of service with his employer and in fact; and
(b) who performs work which is either outside the usual course of business or is performed outside all the places of business of the employer unless the employer is in the business of contracting with third parties for the placement of employees; and
(c) who is in an independently established trade, occupation, profession or business.
To evaluate the proper designation for a worker under Federal law, one should consider the factors as set forth by the Fair Labor Standards Act and the Internal Revenue Service .
Where the Fair Labor Standards Act is concerned, the U.S. Department of Labor tends to focus on:
(a) The extent to which the services rendered are an integral part of the principal’s (employer) business;
(b) The permanency of the relationship;
(c) The amount of the alleged contractor’s investment in facilities and equipment;
(d) The nature and degree of control by the principal;
(e) The alleged contractor’s opportunities for profit and loss;
(f) The amount of initiative, judgment, or foresight in open market competition with others required; for the success of the claimed independent contractor; and
(g) The degree of independent business organization and operation.
Additionally, the Internal Revenue Services uses Common Law Rules which also focuses on the degree of control and independence.
(a) Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
(b) Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
(c) Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
(2) Short Term Benefits
Another fundamental reason why many employers misclassify their workers, is to reap the short term benefits. First, when workers are classified as independent contractors as opposed to employees there is no income and employment tax withholding required by employers.
Second, the Fair Labor Standards Act does not cover independent contractors, and as a result employers are not subject to minimum wage and overtime requirements. Some employees are also exempt from FLSA requirements, but for those which are not, employers must be aware of important hourly wage and overtime requirements. Wage and overtime requirements can be quite complicated. Below are some basic points to be aware of.
The federal minimum wage is $7.25 per hour, although many states have implemented higher minimum wages. Illinois has a higher minimum wage requirement of $8.25 per hour. Certain exceptions to the minimum wage rule apply such as for youths under 20 years of age or employees who receive a certain amount in tips.
For employees covered by the FLSA, an employer is also required to pay overtime (i.e. one and one-half times an employee’s regular rate of pay) for hours worked in excess of 40 hours in a workweek. One’s regular rate of pay is not always as simple as just their hourly rate of pay because there are various types of other work related payments that employers are required to factor in when doing the computation. Moreover, averaging of hours over two or more weeks is not allowed.
Finally, by classifying workers as independent contracts, employers could reap other benefits such as reducing their liability for acts of independent contractors, not being subject to federal and state discrimination laws covering only employees, and not needing to provide certain employee benefits such as insurance retirement plan, paid vacation, etc.
Consequences for Misclassification
Many misclassification lawsuits are making their way through the court system by private litigants. These lawsuits include both individual suits, as well as FLSA “collective actions” comprising many litigants, who are challenging their “non-employee” status.
Under Illinois, misclassifying an employee may subject you and your business to multiple violations under various Illinois employment laws. Some of these laws include the Minimum Wage Law, the Illinois Wage Payment and Collection Act, Workers’ Compensation Act, and the Unemployment Insurance Act, among others. Certain consequences for misclassification under these laws include the following:
· Interest on delinquent unemployment insurance trust contributions at an annual rate of 24 percent.
· Financial penalties for failing to report wages paid to employees.
· Financial penalties for willfully failing to make contributions to the unemployment insurance trust.
· Officers and employees who willfully cause a business to fail to make payments into the system can be held personally liable for the payments due from the business.
· An employer that knowingly and willfully fails to obtain workers’ compensation insurance for an employee may be fined up to $500 for every day of noncompliance, with a minimum fine of $10,000.
In addition to Illinois legal liability, misclassification of a worker may also result in federal liability. The Department of Labor, through a new initiative, is increasing its enforcement of worker misclassification and is actively working with the Illinois Department of Labor. Most notably, in May 2012, the U.S. Department of Labor announced that it had obtained a $500,000 judgment, including $75,000 in civil penalties, against two Chicago cleaning companies that had misclassified 135 cleaners as independent contractors. Moreover, in Texas, the Department recently obtained a $105,000 overtime assessment against an employer that had considered workers to be independent contractors for their first 90 days with the company.
Furthermore, if an employer is audited and cannot prove that a worker paid their own income taxes, the employer can be required to pay the tax it should have withheld from the payments to the workers. A retroactive determination that payments to a worker were in fact wages paid to an employee can have serious consequences, in terms of potential taxes, interest, and penalties to the government. The amount that the IRS assesses, in part, will depend on the employer’s intent in misclassifying workers. If the IRS determines that the employer has deliberately misclassified workers, it can hold the employer responsible for all employment taxes that should have been paid.
Our law firm has personally witnessed and been involved in two separate cases recently whereby our clients have faced liability for misclassification of workers, and in addition to any monetary fines or penalties, the legal fees can cost tens of thousands of dollars to resolve the situation.
Owners in many business areas attempt to characterize its workers as independent contractors to restrict tax liability. If you are concerned about misclassification of your workers, Hurley Stanners & Matsko LLC can help assist you and your business with finding the right resources and guidance in avoiding this potential legal pitfall.
THE INFORMATION CONTAINED ABOVE DOES NOT CONSTITUTE LEGAL ADVICE. IF YOU HAVE ANY QUESTIONS ABOUT ANY ISSUES CONTAINED IN THIS BLOG PLEASE EMAIL US OR CONTACT US AT (708) 848-0800.