Beware of the Pitfalls of Misclassification

Businesses sometimes engage a person’s services as an independent contractor, instead of hiring that person as an employee.  The main benefit of engaging an independent contractor instead of hiring an employee is avoiding the expense of FICA taxes, workers compensation insurance, and unemployment insurance tax.   The business is also freed from having to deduct tax withholdings and file payroll tax returns for that person.

The general standard for determining whether a person is an independent contractor or employee is the extent of supervision, direction and control exercised by the employer over the services provided.  There are a number of factors which are considered in making this determination, and the cases are often not clear cut.  The more factors which show the exercise of supervision, direction and control, the more likely the worker will be found to be an employee.

It is more difficult than ever to engage a person’s services as an independent contractor in New York State.  The New York Joint Task Force is comprised of several State agencies, including the Labor Department, Tax Department and Workers Compensation Board, and is charged with aggressively pursuing cases where workers are found to be “misclassified” as independent contractors instead of employees.  These agencies actively share information about misclassified employees.  Governor Cuomo’s 2016 Executive Order establishing the permanent Joint Task Force refers to misclassification as a form of “worker exploitation”.

The consequences of misclassification can be costly.  These cases typically begin when someone who was treated as an independent contractor files a claim for unemployment insurance benefits.  If the Labor Department determines that this person was actually an employee, the employer receives a notice of this determination and that it owes unemployment insurance tax.  A short time after receiving this notice from the Labor Department, the employer usually receives notices from the Tax Department and Workers Compensation Board. The Tax Department asks for proof of tax withholdings.  The Workers Compensation Board asks for proof of Workers Compensation insurance, and warns of a penalty of $2,000.00 for every ten days of non-compliance.

The safest way to engage an independent contractor is to deal with someone who actually operates their own business and offers their services to others.  The person should have their own corporation or LLC, their own Employer Identification Number, their own workers compensation insurance, and file their own payroll tax and unemployment insurance tax returns.   Engaging someone who just has a DBA can be risky if they do not do these things.

If a person is engaged as an independent contractor, it is important to have a written agreement which lists the factors favoring independent contractor status.  However, if the Labor Department or another agency investigates they will be interested in the reality of the relationship, and not just what the agreement says.

Please contact our firm if you have any questions or concerns about engaging independent contractors in your business.  It is important to have good legal advice before heading down this path.