On April 21, 2010, the Connecticut Legislature passed House Bill No. 5204, “An Act Implementing the Recommendations of the Joint Enforcement Commission on Worker Misclassification.” Significantly, the Act increases the civil penalty for employers who incorrectly classify employees as independent contractors from $300 per violation to $300 per day for each day that the worker is misclassified. The Act specifically provides that “each day of the violation constitutes a separate offense.” The Connecticut Legislature stated that the Act will result in “a potential significant revenue gain for Connecticut.”
In order to facilitate complaints about worker misclassification, Connecticut’s Joint Enforcement Commission on Worker Misclassification also announced that it will launch a website through which workers will be able to file complaints regarding misclassification issues on an anonymous basis. Such complaints will be investigated by the Connecticut Department of Labor (CT DOL), and possibly by other agencies such as the Connecticut Department of Revenue Services. If such agencies conclude that an employer improperly has classified employees as independent contractors, the employer could be ordered to pay certain state employment-related taxes, such as unemployment premiums, in addition to the civil penalties.
Employers should take note that federal lawmakers also are focusing on the worker misclassification issue. Senators from Ohio and California introduced the Employee Misclassification Prevention Act (EMPA) in the United States Senate one day after passage of the Connecticut Act. If passed, EMPA would amend the Fair Labor Standards Act (FLSA) to require employers to maintain written records of independent contractors who perform labor or services for remuneration and to penalize employers that improperly classify employees as independent contractors. EMPA’s significant proposed provisions include:
- imposing a fine of $1,100 per employee for the first violation by employers who misclassify an employee as an independent contractor, and increasing that fine up to $5,000 per employee for every subsequent misclassification;
- requiring employers to notify workers in writing of their classification as an employee or an independent contractor;
- creating an “employee rights website” to inform workers about their federal and state wage and hour rights;
- permitting the United States Department of Labor (U.S. DOL) and the Internal Revenue Service (IRS) to refer incidents of misclassification to one another; and
- directing the U.S. DOL to perform audits targeted on employers in industries that allegedly frequently misclassify employees (such as the consulting, pharmaceutical, financial and construction industries).
In addition to EMPA, Congress is currently considering Senate Bill No. 2882, which aims to eliminate the IRS safe harbor rule that allows companies to avoid back taxes for employees incorrectly classified as independent contractors if the company can demonstrate a reasonable basis for the classification. If passed, the bill also would require the IRS to notify both the employee and the U.S. DOL where it has determined that an employer has misclassified an employee as an independent contractor, which could prompt additional enforcement action by the U.S. DOL.
The misclassification of workers can result in employer liability beyond civil penalties and can include liability for unpaid federal, state and local income tax withholdings, unpaid Social Security and Medicare contributions, unpaid workers’ compensation and unemployment premiums, and attendant penalties and interest. Such liability arises because employers do not withhold income taxes, Social Security or Medicare payments from compensation paid to independent contractors, whereas employers generally have a legal obligation to withhold such taxes and payments from compensation paid to employees. An employer’s tax-qualified benefit plans also may be at risk of losing their tax-qualified status for failure to meet nondiscrimination requirements where workers have been excluded from participation as a result of their misclassification as independent contractors. Finally, misclassified workers may have claims for periods when they were denied employee benefits such as vacation pay, sick leave and personal days.
In light of the increased legislative focus and greater penalties related to the misclassification of workers, employers may wish to undertake an internal audit or external analysis of their current employees and independent contractors to ensure that they have correctly classified their workers. It may be prudent to have such audit or analysis performed by counsel and subject to attorney-client privilege. Specifically, employers may wish to consult guidelines promulgated by the CT DOL, the U.S. DOL and the IRS regarding the different factors that these agencies consider in determining whether a worker is an employee or independent contractor. The CT DOL guidelines can be found at http://www.ctdol.state.ct.us/uitax/abctest.doc, the U.S. DOL guidelines can be found at http://www.dol.gov/elaws/esa/flsa/docs/contractors.asp, and the IRS guidelines can be found at http://www.irs.gov/businesses/small/article/0,,id=99921,00.html. In addition, employers should discuss the results of any internal audit or external analysis with legal counsel to determine the potential impact of any misclassification and/or reclassification of workers.