The Employment Classification Trilogy – Part II of III: Employee/Independent Contractor Dilemma
By Michael C. Schmidt Partner, Cozen O'Connor | May 07, 2010
Despite recent news that the economy may be on an upswing, hotels (like many other large and small businesses) continue to look for ways to reduce costs. One method has been to increasingly engage independent contractors in lieu of employees, and to re-classify current employees as independent contractors.
However, this strategy can land hotels in hot water, as individuals or classes of individuals may not be properly classified as independent contractors, leading to abuses both to the federal and state government and to the individuals themselves. In our prior Part I of this three-part classification trilogy, we discussed the pitfalls attendant to the misclassification of hotel employees as “exempt” for purposes of wage and hour laws. In this article, we turn to the second of three classification issues: the employee/independent contractor dilemma.
According to recent IRS data, more than 3 million workers have been misclassified by employers as independent contractors when in fact they should be classified and treated as employees. From the government’s perspective, misclassification results in unpaid federal, state and local tax withholding, as well as unpaid Social Security and Medicare contributions. By misclassifying an individual, companies also avoid paying unemployment insurance and state workers’ compensation premiums. For workers, misclassification means they will be excluded from coverage from virtually all anti-discrimination and wage and hour laws, resulting in the potential loss of monetary relief and benefits.
The problem is no longer being swept under the rug, as all three branches of government have significantly stepped-up efforts to audit companies and recoup (with penalties and fines) the monetary losses sustained due to misclassification. This year, on April 22, 2010, Senator Sherrod Brown (D-Ohio) introduced The Employee Misclassification Prevention Act to amend the federal Fair Labor Standards Act, which would impose specific record keeping requirements on companies with regard to individuals who work as independent contractors, and provide special penalties for the misclassification of those workers. Similar legislation was introduced in the House of Representatives.
On the federal executive branch side, the IRS has recently determined to perform its most expansive and widespread audit initiative in recent history. Specifically, the IRS will audit the federal tax returns of 6,000 companies to assess compliance with tax and labor regulations, beginning with the IRS studying the returns of 2,000 companies in each of 2010, 2011 and 2012. This determination was likely prompted, at least in part, by the United States Government Accountability Office advising that the IRS and the United States Department of Labor should step up efforts to reduce company misclassification of independent contractors, and to curb abuses in the areas of payroll taxes, fringe benefits and executive compensation. While there has been little disclosure concerning the method and precise focus of these audits, it is clear that the IRS intends to target a wide spectrum of industries to assemble statistical data for future auditing purposes and develop “red flags” for future audits.
State legislatures have also increased their focus on this issue.
More than a dozen states, including New York, New Jersey, Maryland, Delaware and Pennsylvania, have either enacted or proposed legislation setting rules for classifying independent contractors and providing steep financial penalties in the event of non-compliance. Hotels operating in multiple states must consider the laws and rules in their particular jurisdictions. And, on the judicial front, at least one court recently refused to grant a hotel’s motion for summary dismissal of a lawsuit seeking unpaid overtime and minimum wage compensation, determining that the plaintiff was entitled to have a jury determine if he truly was an independent contractor rather than an employee of the hotel.
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