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Update on Independent Contractor Misclassification: The States Have Taken the Lead in Cracking Down

Monday, June 25, 2012

A version of this article was originally published in the June 2012 issue of The HR Specialist. It is reprinted here with permission.

When we last wrote about independent contractor misclassification for The HR Specialist two years ago, our article was titled “Feds on the Lookout for Misclassification.” Since that time, although the U.S. Department of Labor (DOL) and the IRS have increased their efforts to curtail the use of misclassified independent contractors (ICs), state legislators and regulators have taken a leading role in cracking down on companies that continue to classify workers as ICs without properly documenting or structuring their relationships with these individuals. Indeed, companies that use freelancers, consultants, per diems, long-term temps, and other contingent workers may be unaware that their greatest exposure is from violating state laws, not federal statutes.

Recent State Legislative Initiatives

In the past two years alone, 11 states passed laws curtailing the use of ICs or increasing penalties for misclassification: California, Connecticut, Florida, Kansas, Maine, Nebraska, New York, Pennsylvania, Utah, Vermont and Wisconsin. Ten states had passed laws of a similar nature prior to 2010,1 bringing the total number of states to 21 that have targeted IC misclassification. In addition, at least 18 state legislatures have proposed bills intended to limit the use of ICs or make misclassification more costly.2

One type of IC misclassification law getting a great deal of publicity in the past two years is legislation aimed at industries in which misclassification is regarded as prevalent. For example, Pennsylvania’s Construction Workplace Misclassification Act was passed on October 13, 2010 and became effective February 10, 2011. That law, like the laws passed in New York and New Jersey aimed at the construction industry, significantly narrows the definition of an IC, limits a business’s opportunity to contract with some ICs, and substantially increases the penalties for contracting with individuals who do not qualify for IC status under the new law.

Another state’s law that has generated a great deal of notoriety is California’s Independent Contractor Misclassification Law, which was signed into law on October 2011 and was effective January 1, 2012. That new law, which is applicable to all industries, imposes harsh financial penalties for companies that engage in “willful misclassification” of employees as ICs. The penalty for willful misclassification is a minimum of $5,000 and a maximum of $15,000 for each violation of the law, and $25,000 for each violation of the law if the business has engaged in a “pattern or practice” of willful misclassification.

State Regulatory Initiatives

Audits and Task Forces. Employers are subject to regulatory agency challenges to their classification of ICs either through audits by workforce and tax agencies. For example, Pennsylvania’s Office of Unemployment Compensation Benefits conducts several thousands of random audits of businesses as well as audits of companies in selected industries known to have a prevalence for misclassifying employees as ICs. Some state regulatory offices have informed the business sector that they are ratcheting up the number of audits. In New York, the Joint Enforcement Task Force on Employee Misclassification have conducted “joint enforcement sweeps” as well as audits initiated by calls to the state’s Misclassification Hotline and from information shared among task force members. New York is one of more than a dozen states with misclassification task forces, including Connecticut, Iowa, Maryland, Massachusetts, Michigan, Minnesota, New Hampshire, Oregon, Rhode Island, Tennessee, Utah and Washington.

Unemployment Claims. Another way in which regulatory agencies are cracking down on IC misclassification is through the unemployment and workers compensation claims process. For example, local offices are more often than ever making initial determinations of “employee” status in benefit claims filed by individuals who have signed IC agreements or are receiving compensation on a 1099 basis. As the economy continues its harsh ways for many workers, a larger number of workers who regard themselves as ICs are nonetheless applying for unemployment benefits – and benefiting from findings by some claims examiners that they have been misclassified and are entitled to unemployment benefits as “employees.” Where a business has not paid unemployment contributions to a state fund on behalf of such a worker, that initial determination can have the same effect of a comprehensive audit if an administrative law judge or referee upholds the determination that the worker had been misclassified as an IC. Typically, once one worker is found to have been misclassified, the business is then charged for unpaid contributions for “all similarly situated” workers, along with costly penalties and fines.

Takeaway

All states (with only one exception) permit the bona fide use of ICs, who provide a valuable and affordable supplement to a company’s workforce. But all too often, the business’s IC structure is imperfect and the very IC agreements that companies assume will protect them from misclassification liability are used by state agencies as evidence of employee status. For those companies that have business models that make legitimate use of ICs, there are steps that can be taken to avoid or minimize misclassification liability: undertaking a state-of-the-art analysis of its level of compliance, and then taking steps to enhance its IC compliance by properly structuring, documenting, and implementing its IC model.

Endnotes

1 Colorado, Delaware, Illinois, Indiana, Massachusetts, Maryland, Minnesota, New Hampshire, New Jersey and Washington.

2 States whose legislatures introduced such bills include Arkansas, Connecticut, Indiana, Iowa, Louisiana, Michigan, Minnesota, North Carolina, Nevada, New Jersey, New York, Ohio, Rhode Island, Texas, Virginia, Vermont and Washington, as well as the District of Columbia.

Richard J. Reibstein, Lisa B. Petkun and Andrew J. Rudolph

Written by

Richard J. Reibstein
Phone: 212.808.2722
Fax: 866.454.5857
reibsteinr@pepperlaw.com

Lisa B. Petkun
Phone: 215.981.4385
Fax: 215.981.4750
petkunl@pepperlaw.com

Andrew J. Rudolph
Phone: 215.981.4749
Fax: 215.981.4750
rudolpha@pepperlaw.com


The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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