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Worker classification is a heavily scrutinized issue in employment law.
For businesses of all sizes, misclassifying employees as independent contractors – whether intentionally or inadvertently – can result in significant exposure, financial penalties, and reputational harm.
Independent Contractor v. Employee
Employees are entitled to a wide range of statutory protections and benefits, including: (1) minimum wage and overtime under the Fair Labor Standards Act (FLSA); (2) anti-discrimination protections under federal and state law; (3) family and medical leave protections; (4) unemployment compensation; (5) workers' compensation coverage; (6) employer contributions for Social Security and Medicare; and (7) eligibility for employer-sponsored benefits (e.g., health insurance, retirement plans).
Independent contractors, by contrast, generally are not entitled to these protections or benefits. They operate as independent businesses and are responsible for their own taxes, insurance, and business expenses. Thus, misclassification deprives workers of statutory protections and shifts tax and compliance burdens away from the employer – often unlawfully.
Under the FLSA, courts analyze worker classification using the economic realities test, that is, whether the worker is economically dependent on the employer. Some factors of this test include, the degree of control exercised by the company, the permanency of the relationship, the ability of the worker to seek other work, and whether the work is integral to the company's business. No single factor is determinative. By contrast, the IRS evaluates worker classification by looking at who directs how the work is performed, who controls business aspects (such as expenses and opportunity for profit), and the nature of the relationship between the worker and the company. Depending on which agency is reviewing the relationship, a different standard may apply. The common thread among all tests is who “controls” the work.
Similarly, Pennsylvania does not apply a single uniform test across all statutes. The Pennsylvania Minimum Wage Act (“PMWA”), Pennsylvania Unemployment Compensation Law, Pennsylvania Workers' Compensation Act, and Construction Workplace Misclassification Act all have varying standards.
Frequently, companies, mistakenly, assume that certain actions, such as having a contractor agreement, working on a project or short-term basis, a need for additional labor, or that a Form 1099 was issued, create a contractor status. None of these issues inform the contractor analysis.
Employer Exposure & Risk Mitigation
The financial exposure for misclassification can be substantial and often extends beyond just unpaid minimum wages. Employers operating in Pennsylvania must also comply with the PMWA and the Pennsylvania Wage Payment and Collection Law (“WPCL”) – both of which can expand potential exposure.
Workers can also recover unpaid overtime pay, liquidated damages (essentially doubling liability) and attorney's fees and costs. It is important to note that under both the FLSA and WPCL, individual officers and agents of the company may be held personally liable for unpaid wages. And, notably independent contractor misclassification triggers IRS/Department of Revenue liability for unpaid payroll taxes, state unemployment and workers' compensation exposure, retroactive benefits claims under ERISA plans, and penalties and fines from the Department of Labor.
Summary
Because the classification analysis for independent contractors is highly fact-specific, periodic review and a proactive approach to compliance is critical. Employers should regularly audit their workforce classification, review independent contractor agreements for consistency with operational realities, evaluate roles and job duties actually performed, and train their HR and managers on classification requirements.
Worker classification is not an exercise in paperwork, but rather a legal determination with significant financial impact. As enforcement increases and litigation surrounding this topic continues, employers should treat classification decisions as a critical compliance issue.
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.
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