FLSA Pitfalls & Options Synopsis
By Kathleen Pohlid Founder & Managing Member, Pohlid, PLLC | August 05, 2012
Trimming expenses is a critical concern to most businesses in a tough economy, but efforts to cut payroll costs can present legal pitfalls. The use of independent contractors is such an example. Some employers consider using independent contractors as a cost savings measure, but misclassification of workers is illegal under federal law and also under many state laws. Federal and state governments are cracking down on these and other cost saving practices, including improper use of tip credits and fluctuating workweek payment methods. It is important to know and avoid these pitfalls.
Replacing employees with independent contractors may be a significant temptation for establishments seeking to reduce payroll expenses. However, establishments who do so may find themselves in violation of federal and state laws as well as facing legal actions by employees for back wages. Last year, the U.S. Department of Labor and the Internal Revenue Service entered into a memorandum of understanding as part of cooperative attempts to crackdown on employers who improperly designate employees as independent contractors.
The DOL and IRS MOU is a response to what both state and federal governments call an "alarming trend" of misclassification of employees as independent contractors. Accordingly, DOL's Wage & Hour Division has intensified its investigations and enforcement of Fair Labor Standards Act requirements. The classification of a worker as an "employee" vice as an "independent contractor" poses significant implications to state and federal revenues. Employers are not required to withhold federal or state taxes or to make contributions to Social Security or Medicare for independent contractors. Additionally, employers who utilize independent contractors may avoid paying employee benefits and have a significant advantage over those employers who properly classify their employees.
The use of independent contractors is not per se illegal. However, the misclassification of employees as independent contractors is a violation of the FLSA. The federal government has estimated that up to 30 percent of employers misclassify employees as independent contractors, resulting in a loss of over $2.72 billion in federal revenue. On October 13, 2011, the Employee Misclassification Prevention Act (EMPA), was re-introduced in Congress as H.R. 3178. If enacted, employers will be required to keep wage and hour records for non-employees who are engaged in the employer's trade or business and for whom the employer must file an IRS 1099. Additionally, employers will be required to notify independent contractors that they are not classified as employees and direct them to DOL sources for more information.
States are also taking measures to address the issue of misclassification. For example, on January 1, 2012, California SB 459 went into effect implementing fines of $5,000 to $10,000 to employers who "voluntarily and knowingly" misclassify employees as independent contractors.
The government crackdown on misclassification poses challenges for employers seeking clarity for compliance with the FLSA. There is no bright-line test to satisfy the independent contractor status. Instead, the Supreme Court has held that the underlying economic reality of the employment relationship determines if the worker is an employee or independent contractor. Although no single factor is controlling, the following factors are considered:
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