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EMPLOYEE MISCLASSIFICATION ISSUES
By Kevin L. Connors, Esquire
I. The Problem:
Critical distinctions exist between employees and independent contractors.
If you hire it, it must be an employee.
Historically, the lines distinguishing employees from independent contractors have been ambiguous in certain fields, to include construction, service-related industries, transportation and delivery services, maintenance and janitorial services, and landscaping services.
Real problem = insuring for personal injuries.
Independent contractors do not carry workers’ compensation insurance, as they do not have Employees.
Employers carry both workers’ compensation insurance and general liability insurance.
II. Employee Definition:
There are four elements relied upon by Pennsylvania Courts, as well as courts in other jurisdictions, to determine the existence of a master/servant relationship, with the necessary nexus to characterize an employment relationship being:
§ The right to hire the worker;
§ The right to fire the worker;
§ The right to control the work performed by the workers; and,
§ The right to direct the manner in which the worker performs the work.
Direction and control are the critical factors, given the vagaries associated with hiring and firing.
In the absence of formal written contracts, direction and control of the work being performed trumps the vagaries of hiring and firing.
III. Direction and Control of Employees:
Factors evidencing direction and control include:
§ Providing employees with the tools to work with;
§ Training the employees to perform the work;
§ Directing the employee to perform the work or service;
§ Controlling the manner in which the employee performs the work or service;
§ Dictating when the employee must perform the work or service;
§ Exercising total control of an employee’s work product or service;
§ Also relevant is whether there is a written employment contract, as well as whether both parties agree that the employer retained the right to hire and fire.
IV. Factors Indicating Independent Contractor Status:
A written contract or subcontract;
The written contract/subcontract delineates the scope of work to be performed under the contract;
The type of occupation or business for which the independent contractor is being retained;
Whether the independent contractor provides the tools to perform the work;
Whether the independent contractor is paid for the work or project being performed, as opposed to the time to perform the work;
Whether the work being performed is not part of the regular business of the entity hiring the independent contractor, making it more likely that the contractor’s work is “independent”.
Also key is whether the contract controls how the work is performed, as well aswho performs the work.
V. Statutory Consideration:
Worker misclassification has generated a minefield of Federal and State statutes.
Statutes affecting worker classification include:
§ Pennsylvania Construction Workplace Misclassification Act (Act No. 72);
§ Federal Employee Misclassification Act;
§ Federal Payroll Fraud Prevention Act;
§ Federal Fair Playing Field Act;
§ Federal Independent Contractor Tax Fairness and Simplification Act;
§ Federal IRS Regulations;
§ Federal Fair Labor Standards Act.
VI. IRS Factors:
Factors implemented by the IRS for workers misclassification purposes are:
§ No instructions: independent contractor not required to follow, nor furnished with, instructions to perform a job;
§ No training: independent contractor not trained by hiring entity, as contractor uses own methods and manner to perform work;
§ Other workers can be hired: independent contractor can retain others to do the actual work;
§ Independent contractors’ work not essential to business; hiring entity’s success not dependent on the work performed by independent contractor;
§ No time clock: independent contractors set their own work hours;
§ No permanent relationship: independent contractors do not have continuing relationship with hiring entity;
§ Independent contractors control their own workers: independent contractors do not hire, supervise, or pay assistance at the direction of the hiring company;
§ Other jobs: independent contractors permitted to pursue other gainful work;
§ Location: independent contractors control where they work;
§ Order of work: independent contractors determine the order and sequence in which work is performed;
§ No reports: independent contractors are retained for the final result only, not required to submit progress or interim reports;
§ No hourly pay: independent contractors paid by the job, not by time. Payments can include periodic payments based on job percentages;
§ Multiple firms: independent contractors often work for more than one company at a time;
§ Business expenses: independent contractors generally responsible for their own business expenses;
§ Own tools: independent contractors provide their own tools, and can lease or borrow equipment from the hiring entity;
§ Significant investment: independent contractor able to work without the hiring company’s facilities (equipment, machinery, etc.);
§ Services available to the public: independent contractors make their services available to the general public, through business signs, business licenses, listing in business directory, and advertising.
VII. Pennsylvania Construction Workplace Classification Act:
Effective as of 2/10/11, Pennsylvania enacted the CWPMA.
The CWPMA classifies independent contractors, if the following criteria are met:
§ Work is performed under a written contract;
§ Contractually, the worker must be free from direction and control over his work;
§ The worker must in fact be free of control and direction over work performed;
§ The worker must be customarily engaged in an independently established trade, occupation, or business;
§ The worker must possess the essential tools, equipment, and assets to perform the work hired for;
§ The contract must provide that the worker performing the services is subject to a profit or loss for performing the services;
§ The worker must perform the services through a business in which that worker has a proprietary interest;
§ The individual must maintain a business location separate from the location of the hiring person or company;
§ The worker must perform similar services for others, likewise free of direction and control over performance;
§ The worker must hold themselves out to others for the same services; and,
§ The worker must maintain liability insurance for the term of the contract in an amount no less than $50,000.00.
Under the CWPMA, contractors can no longer classify workers as independent contractors to avoid paying payroll taxes, workers’ compensation insurance costs, and unemployment compensation expenses.
Violations expose contractors to civil penalties, stop work orders, and sanctions.
Civil penalties assessed at $1,000.00 for first violation, and $2,500.00 for subsequent violations.
Intentional violation of the CWPMA exposes the contractor to penalties under the Fair Labor Standards Act.
The CWPMA also includes an anti-retaliatory provision.
VIII. Federal Employee Misclassification Act:
This EMPA amends the Federal Fair Labor Standards Act, imposing strict recordkeeping and notes requirements on businesses with respect to workers treated as independent contractors, exposing the businesses to fines from $1,100.00 up to $5,000.00 per Employee for each violation of the Law;
§ Written notification to all workers performing labor or services that they are classified as either an Employee or “Non-Employee”;
§ Requires companies to keep records of the hours of work and wages of Employees, and to keep comparable records for “Non-Employees”;
§ Prohibits misclassifying a worker as being “Independent”;
§ Imposes a penalty for misclassifications;
§ Imposes triple damages for willful violations of minimum wage or overtime laws;
§ Establishes a misclassification website, enabling workers to file complaints online;
§ Amends the Social Security Act, establishing penalties for misclassifying Employees, or for paying unreported wages, in violation of Unemployment Compensation requirements;
§ Authorizes the DOL to report misclassification information to the IRS;
§ Directs the DOL to conduct “targeted audits” of industries with “frequent incidents of misclassifying Employees as Non-Employees”.
IX. Federal Payroll Fraud Prevention Act:
This Act is similar to the Federal Employee Misclassification Protection Act;
The FPFPA empowers the Dept. of Labor to perform targeted audits, focusing on employers in industries that frequently misclassify workers.
X. Federal Fair Playing Field Act:
The FFPFA amends the IRS Code:
§ Treasury Secretary required to issue perspective guidance clarifying employment status of individuals for Federal employment tax purposes;
§ FFPFA amends the provisions of the tax code, specifically with regard to penalties for failure to withhold income taxes;
§ FFPFA prevents retroactive tax assessments;
§ FFPFA repeals Section 530 Safe Harbor Provisions of the IRS Code, pertaining payroll tax reporting provisions.
XI. Independent Contractor Fair Tax and Simplification Act:
Introduced on 12/12/12;
Permanently codifies Section 530 of tax laws;
Creates new “safe harbor”, covering both employment and income taxes, as well as covering the service provider and service recipient.
Section 530 is a safe harbor preventing IRS from retroactively reclassifying independent contractors as employees, subjecting principals to federal employment taxes, penalties and interest for misclassification.
Requirements for Section 530 relief are:
§ Consistently treating workers as independent contractors;
§ Complying with Form 1099 reporting requirements;
§ Having a reasonable basis for treating workers as independent contractors.
XII. Classification Problems:
From a claims perspective, we are often working backwards, from reported claim of the injury, to determine classification status, i.e. employee versus independent contractor;
In workers’ compensation proceedings, companies claiming that their workers are independent contractors face procedural challenges, as workers’ compensation judges, in the absence of any formal contract, view the designation of “independent contractor”, as a sham for avoiding responsibility for workers’ compensation insurance coverage;
The WCJs also view the independent contractor designation as a sham in avoidance of taxes, other employer-paid benefits, as well as unemployment compensation.
XIII. More Problems:
Additional problems, distinguishing employees versus independent contractors, include:
§ Who or what is being insured?
§ Is insurance adequate for the risks being written?
§ Is the failure to insure contractors as potential employees implicate payroll/premium fraud?
§ Who decides: independent contractor versus employee?
§ How do you manage the potential risks, as to whether the worker is an employee versus independent contractor, typically determined by a workers’ compensation judge, or, in the context of a personal injury claim, where the company asserting employer status seeks summary judgment on statutory immunity grounds, with civil trial judges asking the employer if workers’ compensation insurance coverage was procured?
Independent contractor checklist: no employment application;
No written contract of hire;
No employment documentation, as to identification, proof of citizenship, and proof of tax declaration;
No training manual;
No employee handbook;
No on the job training;
No job description;
No time clock;
No time sheets;
No pay for time worked;
No reporting requirements;
No hourly pay;
No instructions or orders as to what work is to be performed, or how work is to be performed;
No reimbursement for travel or other business expenses;
No tools provided;
Contractor services are advertised to the general public;
Contractors advertise their business services in a business directory;
Contractors possess trade/skill-dependent license;
Contractors make real investment in business operation and continuation, in terms of equipment facilities, etc.;
Contractors have a profit and loss;
Contractors have oral/written contract/subcontract for job/work being performed;
Contractors cannot be fired/terminated, without potential liability for breach of contract;
Contractors use independent judgment in performance of work/job;
Contractors have personal/corporate reputations; and,
Contractors agree to perform specific job/services for agreed-in-advance prices or rates.
XV. Employee Checklists:
Contractors responsible for/liable to own workers/employees/assistants;
Employer advertises for employees;
Employer pre-screens employees, through application process, checks references, does background checks, requires pre-employment physical examinations;
Employer offers oral/written “contract-of-hire”, describing the job, duties, parameters, salary, policies, associated benefits;
Employer retains the right to fire the employee, hired “at will”, for any reason, not limited to poor job performance, subject to the termination being non-discriminatory;
Employer controls employee work hours, employee salary, employee job duties, employee reviews, and employee discipline;
Wages/salary based on time worked, and not driven by assignment or project;
Employer holds proprietary interest in all work completed by employee;
Employer provides on-the-job orientation/training;
Employer requires documentation of identification, citizenship, and prior work history/experience;
Employer provides employee handbook/manual, detailing employer business operation, and benefits of employment;
Yes, deductions for Federal and State taxes indicate employment, although the absence of deductions for taxes need not negate employment;
Work construction/work orders given by employer;
Employer review, on whatever timetable;
Employee promotions, with change in position, duties, title, and/or salary;
The right to discipline the employee, for job performance, and/or violation of employer policies;
Attendance records maintained;
Personal and sick leave provided;
Compensation for holiday leave;
Right to control what work is performed;
Right to control how the work is performed; and,
Right to suspend work.
XVI. Potential Independents:
Owner-operator truck drivers;
Commercial/residential cleaning services;
Delivery couriers (not Fed Ex or UPS); and,
Certain “skilled” professionals, working independently or through “temp” agencies, including attorneys, doctors, nurses, insurance agents/adjusters, accountants, actors, writers, taxicab/limousine driver, caterers, case managers.
· Classification dispute must be carefully analyzed on a case-by-case basis;
· Classifications are often subject to converse interpretations;
· Classifications are always fact-dependent;
· Classification results are not always consistent with work realities.
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