As an employer, one of the first things you do when engaging someone to perform work or services for your organization is to classify that worker. Is the worker an “employee?” Or is the worker an “independent contractor,” “volunteer,” “student intern,” or some other non-employee classification? The classification you select will have significant implications for both your organization and the individual. Thus, as part of the “Back to Basics” theme of this edition of the Water Cooler, we have provided a brief overview of the implications of classifying someone as something other than an “employee,” the most commonly used non-employee classifications, and the consequences of misclassification.
Why the “Employee” Label Matters
The federal Fair Labor Standards Act (FLSA) and Ohio’s minimum wage law require most Ohio employers to, among other things, pay minimum wage and overtime to any “employee.” The FLSA (and Ohio law) very broadly defines an “employee” as “any individual employed by an employer.” “Employ” means “to suffer or permit to work.” As a general rule, individuals who are “suffered or permitted” to work are “employees” and must be compensated for the services they perform for an employer. Additionally, whether someone is classified as an employee impacts: (a) whether you, as the employer, are required to withhold and/or pay income taxes, Social Security, Medicare taxes or unemployment taxes from any compensation paid to the individual, (b) whether the individual is protected by certain federal and state anti-discrimination laws and (c) whether the individual is entitled to certain employee benefits.
Common Non-Employee Classifications Independent Contractors
One of the most commonly used non-employee classifications is the independent contractor classification. This classification is appealing to many employers—particularly those striving to cut costs during a weakened economy—because when someone is an independent contractor, as opposed to an employee, the employer has no obligation to pay overtime, withhold income taxes, withhold and pay Social Security and Medicare taxes, pay unemployment tax, or provide workers’ compensation coverage.
However, simply labeling someone an independent contractor does not automatically make the individual an independent contractor under the law. Generally, an individual is an independent contractor if the person or entity hiring that individual has the right to control or direct only the result of the work, but not the means and methods of accomplishing the result. However, whether or not someone is properly classified as an independent contractor is a complex determination. Moreover, different federal and state agencies apply different rules; thus, the determination may vary depending upon the purpose for which the inquiry is being made (e.g., federal income tax purposes vs. state unemployment compensation purposes vs. wage and hour purposes, etc.).
Another exception to minimum wage and overtime requirements is for certain individuals who, without pressure or coercion, volunteer their services without any expectation or receipt of compensation. Again, because you label someone as a volunteer—even with that person’s consent—does not mean that they are not legally viewed as an employee entitled to, among other things, minimum wage and overtime. Significantly, the volunteer exception is generally only available to public employers and certain religious, charitable or not-for-profit organizations (e.g., non-profit hospitals). Even as to these employers, the exception has significant limitations. For example, an individual cannot be employed by a public agency to perform the same type of services as those the individual is volunteering to perform. Additionally, applicable regulations and administrative guidance suggest that the individual must provide his/her services for civic, charitable, or humanitarian reasons and, at least in the private, non-profit sector, the individual must not displace other employees.
There are also some circumstances under which individuals who participate in internships or training programs may do so without compensation. Unlike with the volunteer exception, private for-profit employers may take advantage of this exception. But this exception is also subject to significant limitations.
Generally, the following six criteria must be satisfied in order for an individual to be properly classified as an unpaid student intern:
- The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment
- The internship experience is for the benefit of the intern
- The intern does not displace regular employees, but works under close supervision of existing staff
- The employer that provides the training derives no immediate advantage from the activities of the intern and, on occasion, its operations may actually be impeded
- The intern is not necessarily entitled to a job at the conclusion of the internship
- The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.
Employers should also note that the Department of Labor’s Wage and Hour Division recently noted that it is reviewing the need for additional guidance with respect to student interns in the public and non-profit sectors vis-à-vis the existing volunteer exception discussed above.
Implications and Risks
In most cases, determining an individual’s appropriate classification is a highly fact-intensive inquiry. But it is an important inquiry for employers to undertake, for misclassification of an individual can be fraught with risks of significant liability.
Both at the state and federal level, the government has stepped up its enforcement plans and efforts. In large part this is because the misclassification of employees reduces income tax revenues, unemployment compensation tax contributions, and workers’ compensation premiums collected by the state and federal governments. Thus, the IRS announced it would conduct random audits beginning in February 2010 of 6,000 domestic employers for employment tax compliance and proper classification of workers over the next three years. The Ohio Attorney General also recently announced its plans to collaborate with the Ohio Department of Jobs and Family Services, Ohio Department of Taxation and the Ohio Bureau of Workers’ Compensation to release and exchange information in support of efforts to reduce the number of misclassified workers.
If an employee is found to have been misclassified, the employer may be liable for a variety of damages and penalties, including unpaid wages or overtime, liquidated damages, payment of back income tax withholdings and interest, IRS fines, and/or potential criminal charges. Thus, employers should be cautious about classifying someone as something other than an “employee.” When opting to classify someone as a volunteer, student intern or independent contractor, employers would be wise to memorialize in a written agreement the employee’s consent to and understanding of the implications of the classification. And if there is any doubt as to whether the classification is appropriate, the employer should consult with legal counsel.