Tips to Avoid Employee Misclassification Lawsuits

The United States Department of Labor (DOL) is cracking down when it comes to employee misclassification. In fact, they’ve teamed up with the Internal Revenue Service (IRS) with the signing of aMemorandum of Understanding (MOU) that allows the agencies to share information in an effort to reduce the misclassification of employees and to ensure that businesses are complying with existing labor laws.


Why are These Two Forces Teaming Up?


Many people are curious about why the powerful IRS and DOL are joining forces in an effort to curb employee misclassification. What’s in it for them if employees sue the companies they work for due to misclassification? The truth of the matter is that the government stands to collect millions of dollars’ worth of tax withholding that hasn’t been withheld because of misclassification of employees. According to U.S. Bureau of Labor Statistics estimates, there are more than 10.3 million workers in the U.S. The Government Accountability Office (GAO) believes that as much asfifty percent of those are misclassified as independent contractors when they, in fact, meet the IRS standards for employees.


What are the Potential Consequences of Misclassification?


Businesses that have a history of misclassification have a lot to lose. In addition to the back tax withholding (on federal, state, and local levels), there’s Social Security and Medicare contributions, unemployment insurance premiums, and unpaid overtime compensation to pay as well.


The big expense, or consequence, if you will, comes in the form of employee and former employee lawsuits once the classifications have been clarified. Class action lawsuits are distinct possibilities and may include high dollar items such as benefit package reimbursement in addition to reimbursement for legal fees and retirement funds.


Avoiding Employee Misclassification Lawsuits – What Should You Do?


The bottom line is that prevention is the best defense when it comes to avoiding lawsuits for employee misclassification. How do you avoid making costly mistakes when classifying your own employees?


1)  Don’t Treat Independent Contractors Like Employees


Many businesses make this mistake and it’s one the IRS is really cracking down on. These are a few of the most common ways business owners accidentally cross the line (be aware, there are plenty more – in fact the IRS employs a 20 factor test actually).


  • Establishing working hours
  • Disallowing working for other companies
  • Paying hourly versus by project
  • Providing all the equipment the worker needs to do his/her duties


Keep in mind that one factor or the other won’t make or break a classification. The IRS looks at the totality of the arrangement in making an employee vs. independent contractor determination.


2) Seek IRS Clarification of Employee Classification


If you have any doubt at all about the status of an employee, it’s in your best interest to get the facts sooner rather than later.IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding is what you need. Be warned, it can take up to six months to receive a response. However, if you have several employees you’re concerned about, it’s worth the wait to find out.


3) Consider Employee Leasing Companies


This process gives you some of the benefits of hiring independent contractors without the risks of exercising too much control over the ICs you hire and treating them as though they are employees. The benefit, however, comes at a higher cost than hiring them on your own would. Just remember that all negotiations must be made with the leading agent and not the actual employee. Otherwise, the IRS could view you as a joint employer.


The lines between employee and independent contractor can be incredibly vague. It’s worth your while to take the time to learn where the lines are easily crossed. Then, you must make sure your business isn’t crossing them so that you can avoid the costly legal ramifications associated with employee misclassification lawsuits. In the event that you are hit with an employee misclassification lawsuit, make sure you’re covered with the proper business insurance, and ask about employment practices liability insurance as well.