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Employee or Independent Contractor? Crucial Determinations in the Age of FLSA Class Actions and the Affordable Care Act’s Employer MandatePDF
2015 will continue the era of pressure on employers to be cautious in classifying individuals as independent contractors. On one hand, tax specialists warn that the Internal Revenue Service (I.R.S.) will start emphasizing the distinction between employees and self-employed independent contractors, in part because of the Employer Mandate.1 On the other, plaintiffs are increasing litigation on wage-hour issues, which means more actions under the Fair Labor Standards Act (“FLSA”). This perfect storm threatens fees and penalties on the I.R.S. front, and exorbitant attorney fees from FLSA litigation for employers.
I. An Improper Independent Contractor Classification Can Cost Thousands Under The FLSA.
The thrust of FLSA litigation comes from employers’ failure to pay independent contractors minimum wage or overtime. For the FLSA’s minimum wage and overtime provisions to apply, the worker must be an “employee” of the employer—an employment relationship must exist between the two entities.2 “Employ,” per the FLSA, is to “suffer or permit to work,” which covers work that the employer directs or allows to take place.3 The fact that a worker has signed an agreement that he/she is an independent contractor is not controlling, because the reality of the working relationship is determinative.4 Thus, even though an employer may have a written document stating that a worker is an independent contractor, in an FLSA action the worker may be classified as an employee, in which case minimum wage and overtime provisions would apply. The Supreme Court has said that there is no one definition that resolves all problems relating to this issue.5 The Supreme Court has also found that determination of the relation is not based on isolated factors, but rather on the circumstances of the whole activity.6 The goal is to determine the underlying economic reality of the relationship between the employer and the individual, and whether the individual is economically dependent.7
The reclassification of employees results in coverage under the FLSA. The FLSA generally requires that covered employees receive overtime “not less than one and one-half times” the regular rate of pay for all hours worked over forty. 29 U.S.C. 207(a)(1). FLSA violations have a two-year statute of limitations. 29 U.S.C. § 255. If the violations are willful, a three-year statute of limitations period applies. Id. Further, unless an employer acts in good faith, a plaintiff is entitled to double damages. Reich v. Lapatisserie, Inc., 1994 U.S. App. LEXIS 6608 (6th Cir. 1994). To utilize the three-year statute of limitations period and recover statutory damages, plaintiffs must prove that the employer had actual or constructive knowledge of the alleged off-the-clock work. Id. All this can apply if an employer erroneously categorizes an employee as an independent contractor, and wages were not as paid as required by the FLSA.
Per the FLSA, a prevailing employee is usually entitled to unpaid back wages, overtime, and “liquidated damages,” which is double the amount of back pay. 29 U.S.C.A. § 260. An employer can avoid paying liquidated damages if it demonstrates that it acted in good faith, and had reasonable basis to believe that his act or omission did not violate the FLSA. Id. An employer acts in “good faith” under the FLSA when it makes a specific investigation of the application of the FLSA to specific types of employees.8 However, even if an employer demonstrates this, an award of liquidated damages is subject to the court’s discretion. 29 U.S.C.A. § 260. All in all, employees are usually entitled to liquidated damages. For those employees near retirement, back pay awards might increase pension benefits.9 The employer must also reimburse out-of-pocket litigation expenses and pay an additional attorneys’ fee award—this forms the real thrust of FLSA litigation.10
There is no proportionality requirement for attorney fees won under the FLSA, unlike other actions that generally award attorney fees (i.e. §1983 actions). While any employer who violates the FLSA must pay the employee(s) in the amount of unpaid minimum wages or overtime compensation, there may be an additional equal amount as liquidated damages, and “reasonable attorney’s fees.”11 The amount of attorneys’ fees sought by a plaintiff can exceed the amount of any overtime owed. That is, an employee could only be owed $15,000 in overtime wages, but the attorney fees could ring in at $350,000. The FLSA does not define “reasonable,” and thus the amount lies within the court’s discretion.12
This can all be avoided by proper independent contractor and employee classifications at the outset—this allows employers to avoid costly lawsuits. If you are unclear about how to do so, please contact Reminger Co., L.P.A., and we will conduct a thorough analysis on your workers.
II. The Beginning of the ACA’s Employer Mandate: The Beginning of Heightened I.R.S. Scrutiny
Employers often prefer to hire independent contractors because this allows the employer to avoid paying certain federal and state employment taxes, federal and state unemployment insurance taxes, employee benefits, and workers’ compensation premiums.13 That is, contractors are responsible for paying their own Social Security and Medicare taxes.14 Employees, on the other hand, only pay about half these payroll taxes.15 Employers cover the other half, and if these employers have fifty employees or more, the Affordable Care Act (ACA) also requires employers to cover health insurance.16
The I.R.S. is now concerned that the increasing use of independent contractors in the workplace is causing a tax gap in lost payroll tax revenue. Throw in the ACA’s Employer Mandate (“the Mandate”), and it becomes more important for companies and businesses to correctly classify employees and contractors. One slip-up could have far-reaching consequences. The Mandate requires that all businesses with fifty or more full-time equivalent employees provide health insurance to at least 95% of their full-time employees and dependents up to age twenty-six, or pay a fee.17 Employers with one hundred or more full-time equivalent employees need to insure at least 70% of their full-time workers by 2015.18 The ACA defines a “full-time employee” as someone who works thirty hours or more a week on average during a one month period.19 So, while it may currently seem profitable to label someone as an independent contractor, employers should think twice before doing so. The risks of misclassification include liability for unpaid federal, state, and local income tax withholdings, Social Security and Medicare contributions, unpaid workers’ compensation, and unemployment insurance premiums.20
Deciding whether someone is an employee or an independent contractor is still a challenging task. If you are an employer and are still concerned about misclassification, there is a potential relief option. The I.R.S.’s Voluntary Classification Settlement Program (“VSCP”) permits some employers to correctly reclassify independent contractors as employees.21 In exchange for voluntarily reclassification, the employer pays a penalty of only 10% of the employer’s tax liability and will not be liable for any interest or penalties.22 The employer must, however, agree to treat the worker as an employee in the future and pay the proper taxes.23 In order to qualify for the program, the employer: (1) must have consistently treated the worker as an independent contractor; (2) must have filed all required Form 1099s for the preceding calendar year; and (3) must not currently be under audit by the I.R.S., the Department of Labor, or any state government agency.24 Employers must file Form 8952 at least 60 days before they want to start treating workers as employees.25 Employers will not be audited on payroll taxes related to these workers for prior years.26 These procedures are complicated and important—if you are at all unsure about how to proceed, please contact a Reminger attorney to have an analysis completed on your workers.