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Update on the Employee Misclassification Prevention Act
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In 2008, several state legislatures and Congress considered bills that would have imposed substantial penalties on employers that improperly classify workers as independent contractors. The proposed federal legislation was titled the Employee Misclassification Prevention Act (EMPA).
Stay current on federal changes to employment laws and regulations with the Federal Employment Law Insider
In light changes by the Obama Administration and the pro-union legislative efforts that we are already seeing, it may be time to take a second look at the Employee Misclassification Prevention Act. Aside from clarifying that misclassification is prohibited under the Fair Labor Standards Act (FLSA), the proposed federal bill would also increase penalties in certain circumstances.
The U.S. Department of Labor (DOL) and individual states would be charged with the task of coordinating efforts to better detect misclassification. Similarly, the DOL and IRS would also be required to share information on cases in which employers misclassify workers. In addition, the bill would:
- require employers to designate on personnel records whether workers are employees or independent contractors;
- require employers to notify workers of that classification and their right to challenge it; and
- require state unemployment insurance agencies to conduct audits to identify employers that are misclassifying employees.
Finally, the proposed bill would mandate that the DOL perform targeted audits focusing on employers in industries that frequently misclassify employees.
HR Guide to Employment Law: A practical compliance reference manual covering 14 topics, including overtime and FLSA requirements
Problems with misclassification
According to the latest comprehensive study by the IRS, 15 percent of employers in the United States have misclassified employees as independent contractors, affecting approximately 3.4 million workers. The IRS' findings are similar to those in the May 8, 2007, report by the Government Accountability Office. The report, titled "Employee Misclassification -- Improved Outreach Could Help Ensure Proper Worker Classification," concludes that there were 10.3 million independent contractors in 2005. That number grew from 6.7 percent of the total workforce in 1995 to 7.4 percent in 2005.
What's so bad about misclassification? For one thing, it costs the U.S. Treasury billions in lost revenue. It also artificially lowers costs for businesses that engage in the practice. In turn, the businesses that follow the rules are put at a competitive disadvantage. But the real focus of the legislation's proponents has been the potential harm to employees who don't have access to the benefits and protections they're entitled to under the law.
Misclassification violates the FLSA because it enables employers to avoid meeting mandatory minimum wage and overtime requirements. Independent contractors are not only exempted from the requirements of the FLSA, but they also aren't protected by workers' compensation and workplace discrimination laws and aren't entitled to unemployment insurance.
The employer's perspective is equally compelling. For a variety of reasons, including fluctuating work demands and seasonal business needs, many companies can't afford to maintain a workforce comprised exclusively of year-round employees. Independent contractors provide a solution to the need for personnel with specialized skills and knowledge that may be required for short-term projects. Additionally, the ability to set one's own schedule is seen by many as an attractive benefit.
Learn more about wage laws and correclty classifying workers n the Wage and Hour Compliance Manual
Bottom line
Employers that erroneously classify workers as independent contractors face substantial tax risks. They're also exposed to significant liability under the FLSA if the misclassified workers should have been receiving overtime wages. And although the potential risks are likely to worsen under the Obama administration, if shouldn't deter employers from assigning independent-contractor status when it's applicable. Simply putting everyone on the payroll may satisfy the sponsors of these proposed bills but would do very little to help the economy as a whole or individual employers.
The better solution is to classify correctly. That way employers avoid the risks and potential liability while still preserving the benefits of employing independent contractors. Employers should check with their local employment counsel to be certain about their classification choices, and then make the decision. Your independent contractors will thank you.
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Copyright 2009 M. Lee Smith Publishers LLC. DELAWARE EMPLOYMENTLAW LETTER. DELAWARE EMPLOYMENT LAW LETTER does not attempt to offer solutions to individual problems but rather to provide information about current developments in Delaware employment law. Questions about individual problems should be addressed to the employment law attorney of your choice.
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