United States: The Many Potential Pitfalls Of Worker Misclassification

Worker classification is an area of major concern for domestic and international employers of all sizes. Our Labor and Employment Group recently alerted you to significant regulatory action by the US Department of Labor relating to classification of workers as employees versus independent contractors. Those regulations, along with continuing action by the National Labor Relations Board and the IRS in this area, highlight that worker classification issues are being closely scrutinized today. 

These issues will continue to present employers with the difficult task of managing service relationships to meet their business needs while ensuring proper classification of their workers under the various legal regimes that apply. The effects of misclassification can reverberate throughout an employer's Human Resources and employee benefit plan functions. To ensure a comprehensive approach to maintaining compliance, an employer must identify and tackle all of the many issues that arise from misclassification. Below is a list of misclassification issues for year-end review:

  • back pay (e.g., minimum wage and overtime pay);
  • failure to withhold and underpayment of Federal and state/local income and employment taxes;
  • failure to provide proper wage statements, such as Forms W-2;
  • failure to provide employee benefit coverage and appropriate remedial action;
  • failure to make employer and employee contributions to retirement and other employee benefit plans;
  • failure to provide required benefit plan disclosure and administrative notices;
  • excise taxes under the Affordable Care Act (the "ACA") for failure to provide required health plan coverage;
  • civil tort liability to a misclassified worker as well as third parties who are injured as a result of a misclassified worker's negligent acts; and
  • violations of state, federal and/or foreign labor laws, which may include civil penalties and/or notice requirements imposed by the government agency.

In the remainder of this Alert, we focus on the impact of the ACA and other misclassification risks that arise in the context of managing employer health and welfare plans and highlight certain global considerations.  We conclude with our recommendations on preemptive steps to avoid worker misclassification issues.

Impact of the Affordable Care Act

Many aspects of the ACA, including employer coverage responsibilities and the calculation of penalties for failure to provide compliant health coverage, depend on whether an individual is properly classified as an "employee," significantly increasing the adverse consequences of misclassification.  To make matters worse, one misclassification may trigger the assessment of ACA excise tax penalties based on the employer's entire full-time workforce.

Furthermore, the ACA has resulted in many employers struggling with "joint employment" and "co-employment" issues with their staffing or other service providers.   Abundant caution is necessary with worker classification in this area because a mistake could result in both ACA non-compliance as well as liability for misclassification as listed above.

One step employers should take now is to review existing contracts with staffing or other service providers to reduce their potential legal exposure. Employers should require that service providers provide ACA-compliant coverage to their full-time employees and acknowledge sole responsibility for the classification of those employees.

Service provider contracts also should address potential co-employment issues by stating that the provider's workers are solely its common law employees and that the provider exclusively manages all employee issues regarding compensation, performance issues, time off, and any other HR-related issues that typically are the responsibility of an employer.

Finally, the contract should contain indemnities specifically targeted to require the provider to indemnify employers for misclassification errors of their employees and any ACA penalties.

Other Misclassification Risks for Health Plans

Treatment of Misclassified Employees Under Plan Document

In light of the ACA, most health plans (both insured and self funded) exclude independent contractors from coverage.  Without an express provision to the contrary, an independent contractor that is reclassified as an employee may become eligible for coverage under a health plan – including retroactive coverage.  Some employers address this issue by including express language in their health plans that excludes reclassified workers from coverage. This type of provision can protect an employer from claims for retroactive coverage and enable the employer to exclude reclassified workers from future coverage. 

Often health insurance policies do not contain the appropriate language to exclude reclassified workers from coverage because insurers will not entertain changes to their standard format. We recommend that employers determine whether their insurance policies contain appropriate language to exclude reclassified workers because, without it, the insurance company could disavow financial responsibility for claims of reclassified workers, leaving the employer with that liability.

Misclassification also can impact the amount of an employer's health insurance premiums. Insurance companies underwrite their policies based on the number and claims experience of an employer's "employees." If that population changes due to reclassification, the cost of health coverage also could change.

Nondiscrimination Testing

The data that an employer uses to perform nondiscrimination testing for self-funded health plans and cafeteria plans does not include independent contractors. Depending on the size and attributes of the misclassified group, it is possible that the testing results could change. Thus, as part of its overall response to misclassification, an employer should assess and possibly re-run prior plan testing.

Legally-Required Notices for Employees

Employers are responsible for providing various types of health plan notices to their employees at different stages of the employment cycle. An employer whose independent contractors are reclassified as employees must evaluate not only which notices should have been provided, but also how to address the prior lack of notice. For example, an employer must consider the extent to which COBRA notices or a Summary of Benefits Coverage required under the ACA should have been provided, and the impact of failure to provide those notices at the required time.

Other General Misclassification Issues

Worker misclassification not only involves improperly classifying someone as an independent contractor instead of an employee, but also improperly classifying an employee as being exempt from overtime pay and meals and rest breaks. Both of these worker misclassification issues are especially present at the early stages of a company and, if left unaddressed, the company may be faced with a much larger problem in the future, such as a class action lawsuit. 

In some instances, a single employee filing a wage claim with the state may be enough to prompt an audit of the company by the state employment department/division. These audits can be extremely burdensome on the company's time and resources and could include a review of all of the company's "independent contractors" and pay practices. In addition, the IRS may, in turn, conduct a similar audit leading to a requirement to pay back wages along with various tax penalties as discussed above.

Global Considerations

In most countries outside of the U.S., misclassification risks are equally an issue. Independent contractors, agency workers, and even vendor employees are potentially at risk of reclassification. The big risks are:

  • claims for equity compensation, especially for companies that grant broad equity compensation awards;
  • claims for discretionary leave benefits, such as generous parental leave benefits;
  • the "domino effect" among employee classes and individual employees. Although class action is generally not available outside of the U.S., this area is closely followed by workers, regulators and employee representative bodies in most countries and a successful claim will likely lead to audits and further claims; and
  • equal treatment claims from agency workers. Even if agency workers are not reclassified as direct employees of the end user, there is a risk, especially in the European Union, that they will be able to claim a right to a wide range of discretionary benefit programs under "equal treatment" rights concepts.

Recommendations on Preemptive Steps to Avoid Misclassification

Employers should consider taking preemptive steps to avoid worker misclassification issues. One preemptive measure is to conduct a privileged examination of the work force to determine whether contractors are properly classified and, if necessary, take remedial action. Employers should also consider setting up strict requirements for hiring contractors and be vigilant in meeting those requirements. Employers may also choose to engage a third party to screen and hire its contractors, though the contract with the third party should include a strong indemnification clause to provide protection for the employer in the case of alleged misclassification.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.