What’s the Big Deal about Independent Contractors, and Why Should I Care?

That is probably a question that many readers  are asking, with all of the publicity about DOL, IRS, and states cracking down on employers who treat workers as “contractors.”

 There is a perception that this focus by enforcement agencies is new.  The joint effort and publicity are, in fact, new phenomena.  However, the DOL has consistently viewed FLSA employment relationship concepts broadly.  While in on-the-job training, after being hired by the DOL Wage and Hour Division (and prior to the intensive four-week classroom training), I was sent with investigators to observe.  On the very first case, I watched while the seasoned investigator interviewed a carpet installer at a furniture/flooring store.  On the way back to the office, I said “Mr. McClure, he referred to himself as an independent contractor.  Why is there an overtime problem? ”  Investigator McClure advised me that it will all be clear after I receive formal training, but – in the meantime – he assigned some reading material about the FLSA employment relationship.  My point is that DOL has never taken the position that merely designating a worker as an independent contractor destroys an otherwise applicable employment relationship, even when the worker furnishes tools, equipment, and a vehicle.

During my DOL career, I found that efforts to enforce the FLSA when the employer contended that the workers were “contractors” were made more difficult because of lack of interest by the IRS and state agencies.  Employers and their representatives were ready and willing to “fight the battle” with DOL because they believed that the laissez-faire approach of other agencies should be adopted by the DOL.  Some of those investigations resulted in litigation so that DOL could prevent continuing violations and collect the unpaid overtime wages.

The IRS and state agencies are now paying attention to the rampant misclassifications.  They realize that employers who misclassify workers are ignoring statutory payroll taxes, and that allowing employers to treat workers as “contractors” requires more resources to collect federal and state income taxes.  The recent joint agreement between the DOL and numerous state agencies will greatly reduce the expense of enforcement, as the agencies will be sharing information.  The publicity will result in more confidential complaints, helping the agencies to focus their investigations directly on employers who are alleged violators.

It is true that the various laws do not have identical definitions of “employ,” “employee,” and “employer.”  In the FLSA, the Congress made it a point to leave no doubt.  To employ is to “allow or permit” to work (paraphrased).  Of course, there are legitimate business dealings between independent entities or persons, so removed from employment that it is not arguable, but there are often unclear scenarios that must be resolved.  The Supreme Court established FLSA employment relationship guidelines during the 1940s, and the DOL has applied these principles since.

Why should you care?  If you are paying individuals or small crews via 1099 (in lieu of W-2), you are vulnerable to IRS and/or state tax agency enforcement.  If you are using “contractor” classification as an excuse to not pay overtime wages, you are a prime candidate for DOL or state employment law agency enforcement. 

Overtime back wages are not the only possible employment law outcome.  Minimum wage violations are sometimes evident because the costs of furnishing equipment (e.g., a courier driver’s delivery vehicle) may reduce the effective rate to less than the minimum wage.  FMLA violations may be retroactively asserted because the “contractors” bring you up to the fifty-employee thresholds.  ERISA violations might have occurred because of the misclassifications.  There are other possibilities, such as EEOC implications.

Even if all of your contractors are legitimately in their own businesses, you should be concerned about whether they are treating their workers as employees and complying with applicable laws.  The FLSA includes a “joint employment” concept that could extend your contractors’ obligations to you.  Their failure to pay overtime wages, for example, might become your liability.  Their illegal employment of minors could result in your being assessed a substantial civil money penalty (see the November 2011 BizKeys newsletter for an excellent article about the costs of child labor violations). 

Another reason that you should be concerned is competition.  In 1938, the Congress enumerated several reasons for enactment of the FLSA.  One of those reasons was to prevent unfair competition.  In the DOL press release about the memorandum of understanding with the IRS and many states, one of the stated anticipated outcomes is to “level the playing field” among employers.  It is not fair for you to absorb the costs of treating your workers as employees while your competitors are avoiding the expenses of complying with tax and employment laws by treating workers as “contractors.”

The Wage & Hour Self-Audit Guide, in the Self Auditing section of www.BizKeys.com, contains an “Independent Contractor” topic.  That is a good place to start if you have classification concerns.  Also, see http://www.dol.gov/whd/workers/Misclassification/index.htm.