What is a Hot Issue in Employment Law? Misclassification of Employees as Independent Contractors

Author: Lynn Perry Parker Date: 03/07/2012

Categories: Corporate and Business Law, Employment Law & Litigation


We advised our readers a few months back about the IRS’s new Voluntary Classification Settlement Program (VCSP). The VCSP offers employers that have misclassified their employees as independent contractors the opportunity to remedy their misclassifications and comply with the appropriate employment laws prospectively. The program began in September 2011 and, to date, a termination date has not been announced. The purpose of this article is to advise that all levels of government are working together to expand enforcement and the penalties for misclassification are increasing. Why the new surge in enforcement? Because all levels of government are desperate to increase tax revenues!

Enhanced Enforcement

On September 19, 2011, the U.S. Department of Labor (DOL) and the U.S. Internal Revenue Service (IRS) entered into a Memorandum of Understanding (MOU) to share information and coordinate enforcement efforts to eliminate employers’ misclassification of workers. Additional MOUs between the DOL and various states followed, including one with the Maryland Department of Labor, Licensing, and Regulation.

The MOUs among the agencies will make it easier to identify employers that misclassify workers as independent contractors and to hold those employers accountable. In addition to increasing the collection of applicable taxes, the MOUs have two specific and related objectives: (1) to protect the rights of workers to receive the benefits that they are entitled to under state and federal employment laws, including overtime pay, worker’s compensation, and unemployment insurance; and, (2) to “level the playing field” for those employers that play by the rules (i.e. those who pay all employment-related taxes).

Maryland already has a similar coordinated reporting structure under the Workplace Fraud Act of 2009 (MDWPFA), but that law only applies to construction and landscape workers1. Like the MOUs, the MDWPFA allows a Maryland state agency to notify other Maryland state agencies in the event it discovers an employee classification violation. The MDWPFA imposes fines up to $1,000 for mistaken classifications that are not reported within 45 days upon discovery, penalties up to $5,000 per misclassified worker for intentional misclassifications, and significantly increasing penalties for continued violations.

Non-Compliance is Now Risky Business

The legislative trend is clear ─ the state and federal governments are cracking down on the misclassification of workers as independent contractors. The risk of getting caught is far greater now. Given that the IRS has offered employers the VCSP, it will not likely show mercy to employers who failed to take advantage of it and continue to misclassify workers. Employers will be responsible for the taxes due as well as penalties and interest.

Perhaps an even greater risk to employers than an audit by the IRS or DOL is a claim brought by a worker against the employer. Because misclassification is such a “hot topic,” workers are much more informed about their rights. Workers that have been improperly designated as independent contractors can pursue claims for overtime, unpaid wages and unemployment compensation as well as appeal their tax treatment to the IRS. As jobs remain scarce, more employees are pursuing legal rights, especially since recovery of attorneys’ fees is provided for under many of the employment law statutes. As such, at a minimum, employers should conduct internal audits to insure that their workers designated as independent contractors qualify as independent contractors under the law.

While the relevant agencies and governing statutes have different analytical criteria to determine whether a worker is an employee or a legitimate independent contractor and no single factor in any of the tests is determinative, the critical questions in all of the tests are “what services does the worker perform” and “how much control does the employer exercise over the performance of those services.” If the services are an integral part of the employer’s business and the employer controls the manner in which the services are performed, the worker is an employee not an independent contractor. If a worker does not meet the criteria to qualify as an independent contractor, the worker cannot be treated as an independent contractor or waive his “employee” rights. Any such arrangement between the employer and worker is illegal and unenforceable.

If you would like assistance with your workplace audit, or have any questions about how to classify your workers, please contact us at (301) 251-1180.