Worker Misclassification: How a Seemingly Simple Mistake Can Cost Your Business Dearly

One of the critical tasks you will face as a business owner is ensuring that you properly classify your workers as either employees or independent contractors. There is a significant legal difference between your responsibilities if you employ an independent contractor versus an employee. Additionally, misclassifying a worker can result in legal issues. Even a seemingly minor mistake can result in massive fines and penalties for worker misclassification. 

If you own or manage a small or medium-sized business, an experienced attorney can ensure that you understand and comply with essential state and federal employment laws and properly classify workers. 

Why Has There Been a Rise in Employer Misclassification?

Understaffing and other employee-related issues have been a major concern for many small and medium-sized businesses in recent years. Many employers have had to make significant changes to their workforces, including outsourcing responsibilities to third parties, expanding remote work, and relying more heavily on independent contractors. 

This diversification of the types of workers businesses are utilizing has led to more opportunities for misclassification when the lines between employee and independent worker are not clearly defined. In fact, according to some sources up to 30 percent of employers have misclassified some workers.  

Independent Contractors Versus Employees

Many businesses work with both independent contractors as well as employees. Employees are typically relied on for ongoing business operations, while contractors provide services on an as-needed basis. However, the lines between the two can sometimes get blurred.

Every employer should understand when a worker should be classified as an independent contractor and when the worker should be classified as an employee. Consider the following questions when deciding how to classify a worker:

• Is the worker required to comply with specific work hours, or is he or she free to work on his or her own schedule?
• Does the company have direct control over when, where, and how the worker performs his or her job?
• How is the worker paid?
• What types of services does the worker perform? Are these services outside of the business’s normal operations?
• Does the worker buy his or her own supplies and equipment?
• Does the worker have his or her own company, e.g. an LLC?
• Is there a written agreement between the worker and the company?
• Does the worker bill the company in the name of his or her company?

Workers who work independently, outside of the employer’s direct oversight, are typically independent contractors. Contractors are generally expected to use their own supplies and equipment to perform the job. They do not work a set schedule and have much more freedom than employees. Contractors are paid a flat rate per unit of work performed. In most cases, contractors perform work that is not performed by regular employees.

Independent contractors typically sign a written agreement with the employer specifying the terms of their business relationship. Some independent contractors set up an LLC for tax savings and liability protection purposes. The contractor may bill the employer in the name of their company.

On the other hand, employees are generally required to stick to a certain work schedule, receive hourly wages or salaries, and are not expected to use their own equipment or supplies to fulfill their job responsibilities. 

Consequences of Worker Misclassification

Misclassifying workers can lead to significant adverse consequences, especially if the Department of Labor (DOL) finds that they are intentional. Businesses may be liable for wage law violations and may have to pay back wages under the federal Fair Labor Standards Act (FLSA). 

When a business hires an employee, income tax, Social Security tax, and other taxes are withheld from the worker’s paycheck. Full-time employees and some part-time employees also receive employment benefits, including health insurance and paid time off. 

Businesses that misclassify employees as contractors may be required to pay back taxes as well as fines and penalties. The misclassified employees may be entitled to overtime pay for any hours they worked above 40 hours per week, as well as other damages. 

Misclassifying employees can also leave businesses vulnerable to liability for employer I-9 verification requirements, which are required from employees and not independent contracts. Other possible consequences include:

• Issues with unpaid workers’ compensation
• Improperly excluding workers from benefits 
• Violation of anti-discrimination laws
• Failure to provide proper notice
• Violations of requirements to provide certain job-protected leave
• Reputational harm

Examples of Worker Misclassification

To better understand how worker misclassification occurs and some of the resulting consequences, it can be helpful to look at some examples:

• A construction company intentionally misclassified most of its employees as independent contractors to avoid its legal responsibilities. It was fined over $2 million by the DOL.
• A home care health services company was found to have misclassified several workers as independent contractors and had to pay hundreds of thousands of dollars of back overtime pay. 
• A company providing land services to the oil and gas industry was fined over $40 million in back wages and damages after years of litigation found that it was liable for misclassifying employees. 
• A home improvement company was fined over $300,000 by the Illinois Department of Labor for misclassifying 18 employees.

Common Worker Classification Errors

Some classification errors happen more often than others. Being on the lookout for these common classification errors can help businesses avoid misclassification: 

• Automatically classifying off-site employees as contractors: Whether a worker is an employee or independent contractor is not determined by whether they work offsite, but by the legal factors used to determine if a worker is an employee or independent contractor. 
• Relying on industry standards rather than legal tests for classifying employees: The relevant question is whether a worker is legally an independent contractor or employee, not what everyone else in the industry is doing.
• Relying on the employment contract: Although employment contracts do help define the worker/employer relationship, they are only one factor in the equation. Businesses should not rely on the employment contract alone. In fact, federal law prohibits misclassifying a worker in an employment agreement. 

Can I Adjust a Worker’s Classification After They Have Been Hired?

It is possible to adjust a worker’s classification after they have been hired. However, employers will have to notify all the government parties to ensure that any back pay, fines, employee benefits, and so forth are paid. The Internal Revenue Service (IRS) has a Voluntary Classification Settlement Program that allows employers to reclassify their workers as employees for employment tax purposes. 

Can I Settle a Misclassification Claim? 

It is possible to settle a misclassification claim. In fact, ridesharing giant Uber recently agreed to pay $8.4 million to settle a class action lawsuit alleging that it misclassified some 1330 drivers as employees. It is also possible to settle lawsuits with government agencies such as the DOL. 

Do I Need an Attorney if a Worker Accuses Me of Misclassification? 

Given the serious consequences that can occur after employee misclassification, an experienced attorney can advise you about your rights and responsibilities, navigate this complex area of law, and ensure that your rights are protected. An experienced attorney can also represent you in negotiations to settle your misclassification claim.

Contact our Naperville, IL Business Law Attorneys

Proper classification of workers is just one of countless legal concerns employers face. Our Naperville business attorneys provide comprehensive legal guidance regarding employment concerns, buying and selling a business, compliance and regulatory issues, and much more. Call our office today at 630-228-9413 to set up a consultation.