Worker Misclassification and Co-Employment

SPOILER ALERT.  For those of you who want a quick synopsis of this longish blog post, here it is...  What worker misclassification and co-employment boils down to is that our Federal and state governments don't like it when employers treat contractors like employees, and, if you do, these government entities and the contractors want to "get paid."  And that liability can be huge in terms of back taxes and employee benefits levied against your company.  So, if you don't want to be that company, then don't treat your contractors like employees.  It's that simple.  END OF SPOILER ALERT.

Worker misclassification is a hot topic for procurement professionals (and human resources folks) and it has also stirred up the co-employment spectre of yore (remember the $97 million Vizcaino v. Microsoft case?).  Oh yeah, before I get too far ahead of myself, if you want more information on the subtleties between worker misclassification and co-employment—as well as to get a better understanding of all of those crazy tests that different government agencies and regulations apply—download my article on Worker Misclassification and Co-Employment.

The aforementioned article is a little lengthy, so here's a quick description / differentiation of worker misclassification and co-employment...  Co-employment is where a Contingent Worker is "treated" like an employee and it arises when two separate entities manage / control some aspect of one individual's employment relationship (so, two "employers" and one worker).  (P.S. Wherever I use the term "Contingent Worker" in this blog post it means a worker who is NOT on your payroll.)  Misclassification is where an individual is classified as an independent individual contractor (1099) but should be classified as an employee (W2) because of how the contractor is treated.  In other words, co-employment can arise when you have a direct contractual relationship with an individual contractor or when you have a contractor through, for example, a "staff aug" agency.  Misclassification can only occur in the former instance, i.e., a direct contractual relationship with an individual.  One of the reasons for the distinction (and another reason why misclassification is so hot), is that 1099s make it easy for Federal and state governments to go after employers.  It's an easy identifier for auditors, enforcement staff, and investigators: if your company issued a 1099, it's easy to spot and easy to ask questions about.  Co-employment, on the other hand, usually only arises when the workers themselves complain to a government agency and / or files suit.  Now, with misclassification, it's the government agencies on the prowl.

Like I mentioned in the Spoiler Alert, governments and individuals want to get paid when it comes to misclassification and co-employment.  It's not illegal (yet), but, for example, the IRS wants the withholding taxes, the DOL wants to make sure overtime wages were paid, Unemployment and Workers’ Compensation entities want taxes and payments, and workers want back benefits.  When it does become "illegal"—and that's likely—you'll have to pay civil penalties on top of everything else you have to pay.

There are two major thoughts around why misclassification and co-employment is "bad" for everyone.  The first is public policy and here are some applicable quotes to give you a sense of the thinking that's out there:
  • “Independent contractors do not receive overtime and are ineligible to receive unemployment benefits.  That's not fair.”
  • “Honest businesses—who are trying to comply with state and federal labor and employment laws—are forced to compete with ones that don’t pay their fair share”
  • “Employers will not have to make contributions to Social Security, unemployment insurance, workers’ compensation, and health insurance, will save the administrative expense of withholding, and will be relieved of responsibility to the worker under labor and employment laws."
  • "We don't want workers to become wards of the state because they didn't receive benefits that they were rightly entitled to but for an employer trying to skirt the law."
The other rationale is—and this is the real reason in my mind—tax revenue.  In a bummer economy, that's what Federal and state governments are dying for.  Here are some applicable quotes to help frame the rationale:
  • “It's cheating the government and affected employees.”
  • “Reduces receipts in Treasury and the Social Security, Medicare and Unemployment Insurance Trust Funds.”
  • “In 2009, GAO reported that misclassification has cost the U.S. government $2.72 billion.”
So why the big push for companies to get their act together?  Because all signs point to serious:
  • 2010: “The 2011 Budget for DOL includes an additional $25 million to target misclassification with 100 additional enforcement personnel and competitive grants to boost States’ incentives and capacity to address this problem.”
  • 2011: “$8 billion over five-years in the Internal Revenue Service’s enforcement and modernization programs…will target critical areas of non-compliance.”
  • 2011: Departments of Labor and Treasury pursuing joint proposal that eliminates incentives in law for employers to misclassify their employees.
  • 4/2011: House introduces “Payroll Fraud Prevention Act.” System of record keeping and notice requirements, backed by fines and penalties, to compel compliance with classification requirements.
  • 9/2011: IRS announces Voluntary Classification Settlement Program, allowing employers to voluntarily reclassify (as employees) workers that have been incorrectly treated as independent contractors for employment tax purposes, with partial relief from back federal employment taxes.
  • 9/2011: DOL and IRS entered into MOU with eleven states (VA not included) where DOL will share information with IRS derived from investigations by its Wage and Hours Division into worker classification issues that may relate to payroll tax compliance. The IRS, in turn, will share that information with participating states.
  • 10/2011: Senate introduces “Employee Misclassification Prevention Act.” Similar to bill introduced by House.
  • 10/2011: California passes broad sweeping law requiring notice, reporting, and significant penalties (other states expected to follow).
In other words, when you see government agencies investing in enforcement staff, the Federal government sharing information with states, bills being introduced, and voluntary correction programs being implemented, it's time for you to take things seriously.  I mean, if you can't spot what's coming from all of the foregoing, then hitting you in the head with it probably wouldn't work.  So what do you do?  Well, that's the real thrust of this article...  Here's a list of some (not all) actions that you can take to help mitigate worker misclassification and co-employment at your company.  Some of these actions may not seem intuitive (they do correlate / counteract elements of the "tests") and will make better sense if you read the article that I link to earlier in this blog post.
  • Use "Professional Employer Organizations" wherever possible and avoid contracting directly with individuals, sole proprietors, and one-member LLCs (just this action alone will go far in protecting you from worker misclassification).  There are also other practical reasons to do this such as insurance issues and supplier rationalization.
  • Require maximum service durations (limiting workers to a max of 1,000 hours is helpful to avoid "substantially full-time" categorization) and require breaks in service (usually 30-days).
  • Enter into fixed-fee arrangements and avoid the use of time and materials contracts—you should be buying a product or service, not a person (this helps to avoid some of the financial control elements used in many co-employment tests).
  • Don’t permit Contingent Workers access to company amenities that are made available to employees.
  • Differentiate Contingent Workers from employees wherever possible.  Some examples: use different security badges (a red color badge is common), different cube / office nameplates (like using red lettering), different email addresses (e.g., betty.sue-contractor@yourcompany.com instead of betty.sue@yourcompany.com), mandatory email signature blocks (e.g., including "Contractor to YourCompany").  Some of these actions also help to avoid "apparent" and "implied" agency issues.
  • Don’t include Contingent Workers in company events (such as social events and potlucks), staff meetings, company directories, company org charts, and rewards / awards / recognition.
  • Don't allow Contingent Workers access to any thing or program that is subsidized or sponsored for employees such as parking, cafeteria meals, membership in company-related organizations (e.g., Toastmasters), or a discount program (like movie tickets).
  • Minimize Contingent Worker use of company assets such as, for example, cellphones and tools.  By the way, it's better if Contingent Workers don't use company email at all and have their own addresses.
  • Don't provide business cards to Contingent Workers.
  • Don't permit the use of company letterhead by Contingent Workers (unless an employee is going to sign the letter).
  • Don't require Contingent Workers to work on company premises.
  • Don't monopolize Contingent Workers by requiring set hours (e.g., 9 to 5), requiring full-time work, or mandating an exclusive relationship (in other words, allow Contingent Workers to have other customers).  Never require a non-competition agreement.
  • Don't require that Contingent Workers seek approval for "time off" and vacations.
  • Don’t interview, counsel, or terminate Contingent Workers (do that through their agency).
  • Don't reimburse Contingent Workers directly for anything (e.g., travel)—only reimburse through their agency.
  • Don't allow Contingent Workers to manage employees.
  • Don't provide company training.
  • Avoid giving large deposits or pre-payments to Contingent Workers (they start looking like wage advances).
  • Don't require that Contingent Workers abide by company policy and don't require them to sign a company policy handbook.  Do create Contingent Worker guidelines for Contingent Workers and employees responsible for Contingent Workers to document all of the above and to make it clear that there is no intent to create an employer / employee relationship.

Posted by Stephen Guth at 2/4/2012 11:03 AM
Categories: Vendor Relationship Management, Rantings, Customer Service
Tags: Contracting Best Practices Co-Employment Worker Misclassification
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