Danger Ahead: Are You Misclassifying Workers?

May 30th, 2023
Human Resources, Payroll Management

By: Laurey West, SHRM-CP
Director of Operations

Is your company at risk for financial or criminal consequences for misclassifying workers?

Last year, the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) agencies signed a Memorandum of Understanding under the “Misclassification Initiative” and agreed to work together for the purpose of uncovering misclassification of workers in businesses. Since 2008 the DOL has hired thousands of additional investigators to audit businesses and their practices.

When a company is audited by the Department of Labor (DOL) and it is discovered in the audit that the company unintentionally misclassified a worker, the company will be subject to $50.00 for each unfiled W-2, 40% of the worker’s FICA contributions, and 100% of the employer’s matching FICA contributions on wages not paid. As a result of the misclassification, a business owner will also be responsible for compensating workers for lost wages with interest and repayment for employee benefit payments that resulted from the misclassification. The purpose of applying interest on back pay awards is to compensate the victim(s) for the loss of the use and purchasing power of their income. Interest on back pay is calculated at the same percentage rate as the Internal Revenue Service’s (IRS) underpayment formula.

If the DOL finds that a company purposefully misclassified a worker to avoid paying taxes, the company can be subject to large penalties and possible criminal penalties and jail time.

One example of how a business owner can be charged with criminal penalties and jail time is when Papa John’s franchisee owner Abdul Jamil Khokhar decided that he was not going to pay his employees overtime. Mr. Khokhar created fictitious employees to take credit for the overtime hours worked by his “real” employees. He would then pay his “real” employees their regular rate of pay regardless of how many hours they actually worked.

Eventually, one of his real employees reported his payroll practices to the U.S. Department of Labor and an audit uncovered what he was doing. Mr. Khokhar eventually pled guilty to the crime and he was sentenced to 60 days in jail in addition to paying $230,000 in restitution to his employees. His company pled guilty to falsifying records, which was a felony.

Misclassifying workers may also result in costly class-action lawsuits.

In the news recently, there have been several examples of companies that were audited and faced hefty judgements and penalties. A Louisiana home healthcare provider had to pay $158,000 in back pay and liquidated damages to 77 misclassified workers. The DOL just obtained a judgement against a drywall contractor who will have to pay $132,5000 in back wages and an equal amount in liquidated damages to 182 workers.

On May 9, 2023, a federal court jury reached a judgement for a large battery manufacturing company for $22.25 million for wage and hour violations. The company failed to pay employees for time spent putting on and taking off required uniforms before actual work began or concluded. The jury also found that the company did not act in a knowing or reckless disregard of the law. This actually is the largest recorded jury verdict under the Fair Labor Standards Act per the Department of Labor.

How can you protect your business? Start by auditing your current workforce. We recommend using the IRS 20-point guide when conducting your audit. Here are a few questions to ask during your audit:

• Do you set the worker’s hours? Independent contractors/1099 workers are masters of their own time.
• Does the worker work for more than one company at a time?
• Do you provide the tools, materials or equipment? Independent contractors generally supply their own materials for the job and use their own tools and equipment.
• Do you have the right to give the worker instructions about when, where, and how to work? This shows control over the worker.

Does your company have a clearly defined written subcontractor contract/agreement that outlines the scope of work, payment terms, and clearly states the independent worker is free from you control? Verify that your contract or agreement states that the independent worker will be responsible for providing his or her own workers’ compensation coverage. Have the independent worker provide you with a certificate of insurance listing your company as the certificate holder. We also recommend having the carrier add a thirty-day cancellation clause so you are notified if the coverage is cancelled at any time.

Provide all independent contractors with Form 1099NEC as required by the IRS.

Complete and file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS if you question whether a worker is an employee or independent contractor.

It is also imperative to have an employee handbook with employee classifications defined as well as current job descriptions.
Some additional practical tips include keeping accurate time records and pay for actual work hours, rather than scheduled shifts. Pay employees for time spent on activities that are necessary and indispensable to their work.

What can ERA do to help? Part of our service offerings include providing our clients with the tools they need to help stay compliant and mitigate risk. We assist in creating job descriptions, custom handbook generation, offering time-keeping solutions including web-based and biometric time-clocks, providing ongoing training and checklists about all federal and state employment laws and offering HR advice.

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Employee Resource Administration, L.P. has made this web site and the materials shared on it available to the general public for informational purposes only. We are not employment lawyers or licensed to practice law; therefore, it is important for you to know that the information provided is not a legal opinion or legal advice of any kind. The content of this web site contains general information and may not reflect current legal developments, employment law verdicts or settlements. Employee Resource Administration, L.P. expressly disclaims all liability in respect to actions taken or not taken based on any or all of the content of this site. We recommend seeking professional legal counsel before acting on any information provided in this web site.