This article was originally published on June 16, 2015 as a guest post on Forbes.com.
The U.S. Department of Labor, the IRS and state workforce agencies have been cracking down on businesses that are believed to be misclassifying employees as independent contractors. The Labor Department has a Misclassification Initiative website and has entered into a Memorandum of Understanding with 21 state workforce agencies to detect and deter misclassification.
The IRS has a Questionable Employment Tax Program and has entered into a Memorandum of Understanding with the Labor Department and 37 state agencies to identify “employment tax schemes and illegal [tax] practices.” There are also more than a dozen states that have multiagency misclassification task forces aimed at the coordinated enforcement of state wage and hour and unemployment tax laws.
The Industry 'Hit List'
Although companies in virtually every industry that use independent contractors are at risk if they have not structured, documented and implemented their independent contractor relationships in a compliant manner, the Labor Department, the IRS and state workforce agencies have targeted certain industries where misclassification is thought to be most prevalent.
Which industries are in the crosshairs of those regulatory agencies? Here’s a list based on public statements, press releases and congressional testimony by federal government officials over the last several years: janitorial services; construction; nursing; staffing; Internet services; transportation and trucking; cable companies; security; catering services; hotel/motel; oil and gas; landscaping; and car service/limousines.
The Labor Department itself has successfully investigated and prosecuted hundreds of businesses that it concluded were misclassifying employees as independent contractors and failing to pay them overtime or minimum wage. These include both small and large enforcement actions, some resulting in seven-figure settlements. Notable recent cases include:
- a $1.075 million consent judgment against a cable company for allegedly misclassifying its cable installers
- a $277,000 assessment against a janitorial service subcontractor and its payroll services company found to be joint employers of low-wage custodians misclassified as independent contractors
- a $1.3 million consent judgment against a text message and Internet information provider for misclassifying its “special agents” who answered text messages from website users, and
- a $395,000 consent judgment against a construction contractor for misclassifying carpenters, electricians, masons, laborers, painters and drywall hangers.
States Are Increasing Scrutiny
Although many states have informal lists of priority industries, at least one state, New York, recently published its list of industries found to have the “highest incidence of worker misclassification.” New York’s misclassification “hit list,” which has some overlap with those industries being targeted by the federal government, includes the following industries: construction of buildings; food services; publishing; ambulatory health care; performing arts, spectator sports; educational services; and motion picture and sound recording.
How prevalent is independent contractor misclassification? The most recent figures from the New York Labor Department show that, in 2014, it completed more than 12,000 audits and investigations. These audits led to assessments of more than $40 million in unpaid unemployment contributions. Similarly, Massachusetts reportedly audited more than 18,000 businesses in its last reported year and recovered $15.6 million from companies found to have misclassified independent contractors.
Last year, the California Labor Commissioner ordered a large logistics company to pay $2.2 million in back pay, attorneys’ fees and interest for having allegedly misclassified seven short-haul drivers. The Labor Commissioner also issued citations of more than $1.5 million to two janitorial companies for allegedly misclassifying 52 workers as independent contractors
Class Actions Are Biggest Concern
But enforcement actions by government regulators are not nearly as worrisome to companies using independent contractors as class action lawsuits by workers alleging that they have been misclassified. Thousands of these legal challenges have been filed by individuals being paid on a Form 1099 basis who seek allegedly unpaid overtime, minimum wage, employee benefits and work expenses.
Misclassification class actions have been brought against companies in various business sectors, but some industries have been the focus of plaintiffs’ class action lawyers. These include technology; transportation, courier services and logistics; adult entertainment; cleaning/janitorial services; staffing; car rental; communications; financial services; insurance; car service; media; publishing; security; fashion; pharmaceutical; cable installation; cosmetics; energy; sports; national defense; and delivery of home products and commercial goods.
In the last year alone, the following well-recognized companies have been involved in independent contractor misclassification lawsuits: FedEx, Macy’s, the NFL, Sleepy’s, Penthouse, Lowe’s, Jani-King, DirecTV, BMW and SuperShuttle. An increasing number of these class action lawsuits have been brought against companies in the on-demand, sharing or “gig” economy, such as Uber, Lyft, Handy, Google, Homejoy, Instacart, TaskRabbit, CrowdFlower, Postmates and Caviar.
Recoveries in a number of misclassification lawsuits have exceeded $10 million; indeed, this last Friday, FedEx announced that it had settled with drivers in California for $228 million. Some of the other notable recoveries in independent contractor misclassification cases include:
- a newspaper publisher that was ordered to pay its newspaper carriers $11 million
- a home improvement retailer that settled with its installers for $6.5 million
- a New York adult entertainment club that settled with exotic dancers for $10.9 million
- a nationwide overnight courier that was ordered to pay more than $20 million in unreimbursed work expenses and legal fees in a large state
- a large janitorial firm that agreed to pay $5.5 million to its franchised custodians who claimed they were employees, and
- an airport shuttle company that settled with drivers for $11.9 million.
Some companies have been found to have used independent contractors in compliance with the law. For example, in 2014, the U.S. Department of Labor was ordered by a Texas federal court to pay almost $600,000 in attorneys’ fees and expenses to Gate Guard Services, a limited partnership that provides services to oil field operators by contracting with gate attendants to log in vehicles entering and exiting oil field operation sites. The court found that the Labor Department’s threatened prosecution of the company for allegedly misclassifying its gate attendants as independent contractors was unjustified. Similarly, “black car” drivers providing services in New York City were found last year by a federal court to be independent contractors.
How Companies Can Comply
Although the misuse of independent contractor classification has been a priority of the U.S. Labor Department, U.S. Wage and Hour Administrator, Dr. David Weil, stated earlier this year that “the use of independent contractors [is] not inherently illegal, . . . [and] legitimate independent contractors are an important part of our economy.” Likewise, the Secretary of Labor, Thomas Perez, has recently stated, “there’s an important place for independent contractors, but I also believe that there’s ample evidence that that’s been abused.”
What does this mean for companies that may be in one of the targeted industries and use independent contractors? Comply. How is that done? For some companies, the quickest way is to reclassify independent contractors as employees or redistribute them through the use of staffing companies. But there are other ways to comply, including ways for those companies that wish to retain their independent contractor business model. Those businesses can restructure, re-document and re-implement their independent contractor relationships consistent with applicable federal and state laws.
So what are the applicable laws? At the federal level, the Department of Labor has published on its website a detailed six-part “economic realities” test for determining if a worker is an employee of independent contractor. Similarly, the IRS has publicized on its website the so-called common law “20 factor” test it uses to determine independent contractor status. This test has been reformulated into three comprehensive factors, each with many subparts; not surprisingly, the new standard includes virtually all of the twenty factors in the earlier IRS test.
While there is considerable overlap between the tests used by the Labor Department and the IRS, both agencies state that any and all information that provides evidence of the degree of control and independence will be considered.
While almost all states, allow companies to use independent contractors, the independent contractor laws different considerably from one state to another. While some state laws borrow the Labor Department’s “economic realities” test and others use a form of the common law test used by the IRS, state independent contractor laws often vary considerably from one state to another.
For this reason, one-size-fits-all and other universal solutions are usually ill-fitting. That does not mean, however, that enhancing compliance is either impractical or unattainable for most businesses. Companies can create practical, sustainable independent contractor business models where they are willing to genuinely reexamine their independent contractor relationships. Such businesses can substantially increase their level of compliance and minimize or eliminate misclassification exposure – even those are on the industry “hit list.”