Misclassification of Workers: The Harm to Workers and Penalties for Employers

The misclassification of workers as independent contractors rather than employees has profound implications for both employers and workers, reverberating across various facets of the labor market and the broader economy. This distinction carries significant legal, financial, and social ramifications, influencing issues such as worker rights, job security, and employer responsibilities. The debate over proper classification has intensified in recent years, fueled by the gig economy's rise and the evolving nature of work relationships. Understanding the impact of this misclassification is crucial for policymakers, businesses, and workers alike as they navigate the complexities of contemporary employment arrangements.

Among the consequences of mischaracterization, employers may not withhold taxes properly leading to potential tax liabilities for the worker. Employers could fail to pay their portion of Social Security and Medicare taxes facing penalties. Misclassified workers may be denied benefits such as health insurance, retirement plans, and paid time off that are typically offered to employees. They also may be deprived of rights under labor laws, such as minimum wage and overtime pay leading to legal action and penalties for the employer. Misclassified workers may be ineligible for unemployment benefits, and employers may face increased unemployment insurance costs. Employees are generally covered by workers' compensation insurance, which provides benefits for work-related injuries. Independent contractors may not be covered by health insurance policies leading to a lack of coverage.

Independent contractors are not covered by most worker protection laws such as wage and hour laws, anti-discrimination laws, and laws providing collective bargaining rights. They do not receive unemployment benefits when they are temporarily jobless or workers’ compensation when injured on the job. Independent contractors also are responsible for paying the full payroll tax contribution to federal Social Security and Medicare programs. They are excluded from the Worker Adjustment and Retraining Notification (WARN) Act, which requires advance notice of plant closings and mass layoffs; the Family and Medical Leave Act (FMLA), which provides individuals with up to 12 weeks of job protection for family and medical leave; and the Uniformed Services Employment and Reemployment Rights Act (USERRA), which provides certain protections for our men and women in uniform.

See the chart below for a summary of the differences between the benefits and protections for employees and independent contractors.

In addition to the financial consequences, misclassified workers may file lawsuits against employers for benefits, wages, and other entitlements they were denied. Employers could face legal expenses, fines, and court-ordered payments. The IRS and other government agencies may audit employers to ensure proper worker classification. Penalties may be imposed for misclassification, including fines and back taxes. Misclassifying workers can also harm a company's reputation, affecting relationships with clients, partners, and potential employees.

If the IRS conducts an audit and discovers that a company has misclassified an employee as an independent contractor, that company may be subject to up to 3% of the misclassified employee’s wages, 100% of the FICA taxes that the company failed to pay for the worker, up to 40% of the FICA taxes that the company failed to withhold from the employee’s wages, and $50 per W-2 tax form the company didn’t file for the misclassified employee. Employers could also face penalties of up to $1,000 per misclassified employee, jail time of up to a year, lawsuits with punitive damages and attorney fees, benefits insurance repayment, wage claim audits for the past three years, and other claims. That’s not all; since employers are obligated to keep properly completed Form I-9s on file for each employee, misclassifying an employee as an independent contractor could subject employers to further penalties that include civil fines, criminal penalties, debarment from government contracts, and court orders.

Some states have their own laws with penalties as well.

These penalties aren’t theoretical:

Two Massachusetts construction companies that intentionally misclassified 478 employees were assessed $2,359,685 in back wages and liquidated damages, ordered to take corrective actions to prevent future violations, and ordered to pay $262,900 in civil penalties.

A Pennsylvania company that provided land services for the oil and gas industry admitted liability for $43,276,638 in back wages and liquidated damages owed to 700 workers.

A Tennessee home healthcare services company misclassified 50 workers and was forced to pay $358,675 in back wages for unpaid overtime.

The owner of a construction company was found guilty of misclassifying 30 construction workers who should have been employees. Since the authorities determined this act was intentional with the objective of avoiding tax, the owner was sentenced to almost two years of prison with a 12-month-long consecutive probation period. The owner was found guilty of theft by unlawful taking and conspiracy to commit workers’ compensation fraud, both felonies, as well as improper classification of workers, a misdemeanor.

The Department of Labor investigated a Florida customer service provider for well-known national brands and forced them to pay back wages and liquidated damages to more than 22,000 workers for misclassifying them as independent contractors and failing to pay minimum wage and overtime pay.

How do you determine whether a worker is an employee or an independent contractor? That’s a discussion for another day.

If you have questions about this article or about other employment issues, please contact Mitchell Goldstein (mgoldstein@setlifflaw.com) at (804) 377-1269, or Steve Setliff (ssetliff@setlifflaw.com) at (804) 377-1261.