Crackdown Highlights Risk of Labeling Fulltime Employees as 'Temps'

NEWARK, N.J., Nov. 9 /PRNewswire/ -- Cornered by both the economic crisis and the rising cost of healthcare, employers are more tempted than ever to classify some employees as "independent contractors" or "temps." But the risks of this practice are growing amid a crackdown by federal and state officials, said James P. Anelli, a Newark-based shareholder in LeClairRyan's Labor & Employment Group.

"The need for more state and federal tax revenue, the movement to boost the ranks of the insured in America and the strong support of organized labor are driving this trend," Anelli said. "A number of states, including New York, New Jersey, Massachusetts and Connecticut, have set up task forces or modified laws seeking to eliminate perceived abuses in this area. On the federal level, the Taxpayer Responsibility, Accountability and Consistency Act of 2009 specifically targets employee misclassification. It is now under consideration in the House."

The veteran attorney made those comments to an audience of business leaders, HR professionals and corporate attorneys during "Key Issues in Labor & Employment Law," a LeClairRyan seminar held last month in Florham Park, N.J. His co-presenters at the session on contractors were LeClairRyan attorneys Elizabeth K. Acee and Antonio Gutierrez.

Hiring independent contractors helps employers tap productive and creative talent for temporary projects without paying benefits. However, the legal definition of what constitutes an employee, independent contractor, subcontractor, consultant, temp or on-call worker can be difficult to assess, Acee noted. A 2007 study by the U.S. General Accounting Office estimated that some 15% of all employers misclassify 3.4 million workers as independent contractors each year.

"Little wonder the federal government is concerned about this," she said. "In inflation-adjusted figures, employee misclassification costs the government $2.7 billion in Social Security, unemployment tax and income tax revenues."

During the presentation, Acee outlined the classification and status tests used at both the federal and state level, and explained the traditional role of the common-law test of "master and servant" in determining employee status. The various classification systems tend to hinge upon questions such as the degree of company control over the worker, whether the equipment the worker uses is owned by the company, and the permanency of the relationship.

"Employers must be aware of and comply with the applicable federal classification criteria, such as those spelled out by the Internal Revenue Service and the Fair Labor Standards Act," said Acee, a partner based in the firm's New Haven, Conn. office. "But states, too, have a very strong say in how workers are classified."

For example, New Jersey's regulatory scheme exempts businesses from having to pay unemployment benefits to contractors who are beyond employer control, work outside the normal course or place of business and are engaged in an independently established trade, occupation or business. "Other states, including Massachusetts and Connecticut, use the same test," Acee noted. "Still, the onus is on employers to abide by the different classification schemes in all of the states in which they operate."

Meanwhile, employers and their legal counsel should pay close attention to the ongoing changes in federal and state approaches to employee classification. Even if the aforementioned House bill fails to pass, for example, a similar measure will likely become law in 2010 or 2011, Anelli predicts.

"The House bill proposes to close the so-called 'safe harbor' provision of Section 530, which has enabled many employers to avoid paying penalties for misclassifying independent subcontractors," he said. "Numerous state and federal agencies are also reviewing the construction industry. New Jersey has started to prosecute companies that 'knowingly' misclassify workers."

Technology, too, means employers' classification practices are more likely to come under scrutiny. "Both the states and the federal government now have the technology to track 1099 forms--the tax forms used by independent contractors," noted Gutierrez, who is based in the Newark office. "They can now target workers who only have one 1099 report and yet report significant income from that one source. This, of course, is a sign that the worker has been at that company long enough to be classified as an employee. This technology can establish separate search criteria and is highly efficient to catch companies that are abusing the process."

For employers, misclassification can amount to a costly misstep. FedEx, for example, came under fire for classifying its drivers as independent contractors, allegedly as a way to stop them from forming unions. In November 2007, the California Supreme Court affirmed lower court rulings that the drivers were, in fact, employees under company control. "Massachusetts fined FedEx $190,000, the IRS hit FedEx with a bill for $139 million in back taxes, and eight attorneys general have now demanded that FedEx change its business model," Anelli noted.

The LeClairRyan attorneys recommended specific steps employers can take to avoid litigation, including:

• Draft independent contractor agreements that define an independent contractor relationship
• Make contracts results-oriented as opposed to setting open-ended terms
• Provide the contractor with the right to set hours of work and schedules, and to determine what tools and materials to use
• Do not restrict the contractor's ability to work on other projects
• Provide contractual requirements for insurance, indemnification, and risk of loss
• When possible, contract with the corporation or company as opposed to the individual
• Do not compensate a contractor as an employee, i.e., with weekly or biweekly payments
• Provide a provision requiring that the contractor must seek reimbursement for expenses
  

About LeClairRyan
Founded in 1988, LeClairRyan provides business counsel and client representation in corporate law and high-stakes litigation. With offices in California, Connecticut, Massachusetts, Michigan, New Jersey, New York, Pennsylvania, Virginia and Washington, D.C., the firm has more than 300 attorneys representing a wide variety of clients throughout the nation. For more information about LeClairRyan, visit www.leclairryan.com.