Articles Posted in Independent Contractors

Independent contractor or employee? It’s a hot question these days, for sure. A recent decision from the Delaware Superior Court answers the question in an unusual way–yes and no. In Colon v. Gannet Co., Inc.,

No. N10C-04-007-MMJ (Del. Super. July 26, 2012), the court held that the plaintiff was an independent contractor but that the employer still could be found liable for harm caused to him during the course of his work.

The plaintiff, Jesus Colon, was selling newspapers as a street hawker when he was struck and injured by a motor vehicle. A street hawker, according to the court, is an “independent contractor who purchases and resells copies of the newspaper at predetermined locations.”

Employers in the construction industry should, by now, be painfully aware of the Delaware Workplace Fraud Act, signed into law in 2009. The Act imposes stiff penalties on construction-services employers who misclassify employees as “independent contractors.”
Delaware Misclassification

As a result of amendments signed into law on July 12, 2012 (HB 222.pdf), the General Assembly has added more teeth to the law, in the form of public shame. Now, the name of any employer that has violated the Workplace Fraud Act will be posted on the Department of Labor’s website for a period of 3 years from the date of the final determination.

The DDOL will maintain something akin to a sex offender registry for misclassification–or affix the offending contractor with a Scarlet “M”–to use a more literary analogy. Regardless of how you may feel about this new penalty or its effectiveness as a deterrent, it makes clear that this issue remains a top priority for legislators. So far, Delaware’s attempts to expand this law to other industries have not succeeded but, if Delaware follows the national trend, this won’t last long. All Delaware companies would be well advised to ensure that they are not wrongfully labeling employees as “independent contractors,” in light of the state and national focus on this issue.

All individuals performing work for an employer should be classified as employees or independent contractors. Employees are then further classified under the Fair Labor Standards Act as “exempt” or “non-exempt” for purposes of overtime compensation. Proper classification of employees and independent contractors can be difficult, and misclassification can lead to significant financial liability in the form of back taxes and overtime pay. Red 3D Figure Raising Hand_thumb

In an attempt to address misclassification of independent contractors for tax purposes, the IRS launched the Voluntary Classification Settlement Program (VCSP). The goal of the VCSP is to properly classify workers, while collecting unpaid payroll taxes for employees improperly classified as independent contractors. As the IRS explained, “this new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.” An employer’s voluntary participation in the VCSP removes the burden of interest and penalties that would be assessed if the misclassification were discovered as the result of an IRS audit.

Despite the many benefits offered by the VCSP, many employers were reluctant to participate because it was unclear whether the facts surrounding the employer’s participation would be shared with other government agencies. Of particular concern is the Department of Labor’s Wage and Hour Division, which is responsible for enforcing the Fair Labor Standards Act. Employers’ concerns were legitimized by the earlier announcement that the IRS, the Department of Labor, and several states would be joining forces to identify wage and hour violations and impose significant fines on non-compliant employers.

The Third Circuit gave employers new reasons to worry about misclassifying their employees in its decision in Figueroa v. Precision Surgical, Inc., (PDF), C.A. No. 10-4449.  A former employee brought suit seeking to invalidate the non-competition provision in his independent-contractor agreement (“ICA”).  The plaintiff alleged that his former employer had materially breached the contract and, therefore, could not enforce it against him. approved-stamp

During the course of his 6-years with the organization, the plaintiff’s relationship became more like that of an independent contractor.  For example, the company required that the plaintiff: (1) devote 100% of his energy to selling the company’s products; (2) report to his supervisors daily and attend monthly meetings; (3) abide by a dress code; and (4) obtain permission from before giving quotes to certain prospective customers.

As the supervision and reporting requirements became more onerous, the plaintiff objected and, eventually, requested a new contract that clarified his status as an independent contractor.  The company refused and stated that it intended to convert all sales positions to employees, eliminating all independent contractor positions.  When he refused to make the conversion to employee status, his contract was terminated. 

Pennsylvania now has a misclassification law that mirrors Delaware’s law. Delaware’s Workplace Fraud Act, enacted in 2009, imposes stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on  business costs and avoid paying appropriate taxes. Sheldon Sandler previously posted about Delaware’s law.caution sign road barrier

Similarly, under Pennsylvania’s Construction Workplace Misclassification Act, an individual who performs services in the construction industry is considered an independent contractor in limited circumstances. The individual: (i) must have a written contract to perform services, (ii) be free from control or director over performance of such services both under the contract of service and in fact, and (iii) with respect to the individual’s services, the individual must be customarily engaged in independently established trade, occupation, profession or business.

In addition to this criteria, Pennsylvania’s law has particular requirements to prove that an individual is “customarily engaged” in an independently established trade, occupation, profession, or business. The law takes effect 120 days from October 13.

Employers’ use of independent contractors instead of traditional employees has been on a steady incline over the past 20 years. Some employers feel that they can save money by using independent contractors instead of full-time employees. The contractors themselves may value the autonomy and economic perks that the status provides. Also, the specific skills and knowledge that independent contractors can bring to a short-term project can be critical and, therefore, worth a premium but not sustainable in the long term. But the use of independent contractors is not as perfect as these mutually beneficial points may seem.

A report prepared by the U.S. Government Accountability Office (GAO) in the Fall of 2009 concluded that employee misclassification is a “significant problem” with “adverse consequences” because it reduces tax revenues flowing to the government. In fact, the misclassification of employees as contractors is estimated to cost the Treasury Department over $7 billion in lost payroll tax revenue over the next ten years.

So the theory goes, since independent contractors are, by definition, self-employed, they are not considered “employees” and thus not covered by various tax withholding laws. Independent contractors also are not subject to most employment laws, so in addition to avoiding taxes, some employers may reclassify employees as independent contractors in order to avoid payment of overtime and benefits, and workers’ compensation liability.

President Obama’s administration will seek more funding for the U.S. Department of Labor (DOL), including more funds to enforce wage and hour laws and pursue employers who misclassify employees as independent contractors. In a press release yesterday, Secretary of Labor Hilda L. Solis outlined the president’s fiscal year (FY) 2011 budget request for the DOL, which is built around the vision of “good jobs for everyone.”

The FY 2011 budget requests $117 billion, with the majority to be used for unemployment insurance benefits for displaced workers and federal workers’ compensation. The DOL’s discretionary request of $14.0 billion overall includes $1.7 billion for worker protection programs, a four percent increase over the prior year’s budget.

According to Secretary Solis, “[t]he FY 2011 budget will help to make the vision of good jobs for everyone a reality for America’s workers. This budget invests in innovation and reform that will play a critically important role in building long-term economic security for workers. At the same time, the budget reflects our commitment to fiscal responsibility, investing in what works and carefully evaluating our programs to make sure that we obtain results that produce good jobs.”

Delaware has become the latest state to impose stiff penalties on construction industry employers who improperly classify employees as independent contractors to save on business costs and avoid paying appropriate taxes.

On July 31, 2009, Delaware Governor Jack Markell signed into law House Substitute No. 1 for House Bill No. 230, which imposes significant monetary and other penalties on “construction services” employers who willfully misclassify employees as “independent contractors.”

The Delaware action follows similar recent enactments in Maryland and Colorado. Other states that have similar statutes include Illinois, Indiana, Minnesota, New Hampshire, New Jersey, Rhode Island, and Washington. 3d man holding up roof of house

Independent Contractor Update: A bill targeting the construction industry has been introduced   in the Delaware General Assembly. “The Construction Industry Independent Contractor 3d construction man with hard hat and blueprintAct,” HB129,   which is similar to one that failed to pass during the last legislative session, creates a presumption that an individual performing a service “in the making of improvements to real property” is an  employee rather than an independent contractor.  To overcome that heavy burden, an employer must prove that the individual is free from control or direction over the performance of that service, the service is outside the usual course of the employer’s business or performed outside of all of the employer’s places of business [seemingly impossible to prove in the context of a construction employer, who travels from place to place], and the individual is customarily engaged in “an independently established trade, occupation, profession or business.”

And woe to the employer who misclassifies, either unwittingly or knowingly.  The law not only contains criminal fines and imprisonment penalties, it also authorizes civil suits, including class actions, and allows attorney’s fee awards to prevailing plaintiffs. An employer who knowingly misclassifies an individual can also be debarred from working on public projects. The law also makes the Secretary of Labor the judge, jury and executioner, authorizing administrative monetary penalties if he or she decides that there has been a violation, subject only to a hearing that can be requested after the initial decision has been made.

Since the Act only applies  to individuals, employers wishing to engage legitimate independent contractors may wish to require them to incorporate or form limited liability companies before entering into an agreement for construction-related services.  As an alternative, the cautious employer may want to rely heavily on temporary job services, with the individual remaining an employee of the service company, which would be responsible for taxes, withholdings and other legal requirements.  Of course these approaches will cost more money, and one wonders why, in the midst of an economic crisis, the Delaware General Assembly would want to create additional financial burdens for companies. The only message that can be inferred from this one-sided legislation is that Delaware is less friendly to business than it used to be.

Independent Contractor Update:  Earlier this year, legislation was introduced that would prevent employers from improperly classifying employees as “independent contractors” in order to avoid paying them overtime and benefits. The Employee Misclassification Prevention Act (H.R. 6111) hasn’t seen any activity since June, when it was referred to the House Ways and Means’ Subcommittee on Income Security and Family Support. (Readers may recall that this was the same time that the Delaware and Pennsylvania state legislatures were reviewing similar legislation). 

In light of the impending change in the White House and the pro-union legislative efforts that are sure to follow, it may be time to take a second look at the Employee Misclassification Prevention Act. (Especially since President-elect Barrack Obama was one of two Senators to introduce S. 2044, called the “Independent Contractor Proper Classification Act of 2007,” which would repeal section 530 safe harbor for classifying workers as independent contractors.)

Aside from clarifying that misclassifications are a prohibited act under the FLSA, the proposed bill would also increase penalties under appropriate circumstances and require the U.S. Department of Labor (DOL), and the states to work together to better detect misclassification. In addition, the bill would: (1) require employers to designate on their employee’s records whether they are an “employee” or “independent contractor;” (2) require employers to notify workers of that classification and their right to challenge it; and (3) require state unemployment insurance agencies to audit employers to identify employers who are misclassifying employees.

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