South Carolina Lawyer
SC Lawyer, January 2010, #4.
Independent Contractor or Employee? Getting It Wrong Can Be Costly
South Carolina LawyerJanuary 2010Independent Contractor or Employee? Getting It Wrong Can Be CostlyBy Debbie Whittle Durban Imagine you are the owner of a small business and you have decided that the most cost efficient way to run your business is to treat your workers as independent contractors, not employees. Because your business will not have to pay payroll taxes or provide employee benefits to these workers, it will save thousands of dollars a year. The decision appears to be a no-brainer. Everything goes great for the first few years until you happen to terminate a contract worker who then files a claim for unemployment benefits. Or a contract worker gets injured on the job and files a claim for workers' compensation benefits. Suddenly, the classification of your workers as independent contractors is being questioned, and the burden will fall on you to prove that the workers are truly independent contractors and not employees. How will you do this and what are your chances of succeeding? What happens if you fail? What will happen if the IRS gets involved? What should you do if other workers, realizing their status as independent contractors is being questioned, begin demanding benefits and rights that are normally given only to employees? This article will attempt to answer these and other questions while describing the costs businesses face if they are found to have wrongly classified their workers, the different tests used to determine whether workers are employees or independent contractors, IRS enforcement policies regarding worker misclassification, and the current state of the law in South Carolina pertaining to worker classification issues.
Advantages and disadvantages of using independent contractors
Businesses that opt to treat workers as independent contractors rather than employees enjoy significant benefits. Most importantly, there is a significant financial motivation for using independent contractors in place of employees. Even if companies end up paying independent contractors more per hour than they pay employees, they can save untold dollars in payroll taxes, workers' compensation premiums and employee benefit programs. Second, businesses can limit their exposure to lawsuits and resulting liability under state and federal employment laws because such laws are interpreted, in most cases, to apply only to employees. Examples of potential claims that could be avoided by treating workers as independent contractors include: claims brought for overtime compensation under the Fair Labor Standards Act and comparable state wage and hours law; claims for discrimination, harassment and retaliation under Title VII, the Age Discrimination in Employment Act, the Americans With Disabilities Act and others; claims under the National Labor Relations Act, ERISA and the Family and Medical Leave Act; and claims for wrongful termination under state laws.
Companies that may have vicarious liability for acts of employees done within the scope of employment may be able, in some instances, to escape vicarious liability for acts done by independent contractors. Companies may also enjoy greater staffing flexibility with independent contractors and may have greater leeway in hiring and firing. Finally, independent contractors, if they are highly skilled, may bring greater efficiency to the company.
On the other hand, there are also disadvantages to having a workforce made up of independent contractors, not the least of which is the very significant risk associated with misclassifying workers. Independent contractors often have much greater autonomy and freedom to come and go as they wish, thus possibly disrupting work schedules. Independent contractors may have less loyalty to the company than an employee, and a company's right to terminate an independent contractor may be limited by contract. Notably, even though the company may not have to provide workers' compensation insurance to independent contractors, the company will not have the protection of the workers' compensation laws that can limit potential damages for workers' injuries. Lastly, companies may discover that they do not own copyrights on materials created by independent contractors.
Costs associated with misclassification
Wrongfully classifying workers as independent contractors when the workers should have been considered employees can cost businesses big money. Just ask FedEx Ground. In December 2008, FedEx Ground agreed to pay $27 million in damages and attorneys' fees to 203 FedEx Ground drivers in California. See Estrada v. FedEx Ground Packaging Sys., Inc., 154 Cal. App. 4th 1 (2nd Dist. 2007). Dozens of other suits against FedEx Ground are pending in state and federal courts throughout the country, and a federal multi-district class action lawsuit is pending in Indiana on behalf of 27,000 FedEx Ground drivers. The decision as to whether workers are independent contractors or employees, however, is never cut and dry. For example, just this year, a Washington jury, in contrast to Estrada, and based on similar facts, found 320 FedEx Ground drivers to be independent contractors. See Anfinson et al. v. FedEx Ground,...