There are two common types of employee misclassification:
- An employer wrongfully labels an employee as an independent contractor
- An employer wrongfully labels an hourly employee as salaried in order to avoid overtime and off-the-clock compensation
Employee misclassification allows an employer to pad their bottom line by skipping employment taxes, employer-sponsored benefit programs, and overtime pay. Employees are stripped of essential benefits, rights, and protections such as the minimum wage, overtime pay, family and medical leave, unemployment insurance, and workplace safety. Employee misclassification also robs the federal and state governments of critical tax income that the agencies use to fund employee benefit programs such as unemployment insurance and workers compensation.
Following is a brief discussion of employee misclassification issues along with the answers to some frequently asked questions.
What are the applicable labor laws?
There are four federal laws and two sets of state laws that apply to employee misclassification:
- The Fair Labor Standards Act (FLSA) – the FLSA mandates the minimum wage and overtime pay. It offers a fairly vague definition of employment, where a worker is considered an employee if an employment relationship exists between the worker and the employer.
- The Migrant and Seasonal Agricultural Worker Protection Act (MSPA) – the MSPA applies to wages, employment disclosure, safe housing, and safe transportation for migrant and seasonal agricultural workers. It uses the same broad definition of employment that was established in the FLSA.
- The Family and Medical Leave Act (FMLA) – the FMLA protects an employee’s rights to unpaid, job-protected leave for valid family and medical purposes. It uses the same employment definition as the FLSA, though it has a stricter definition when it comes to job-protected leave.
- The Internal Revenue Code (IRC) – the IRC governs an employer’s responsibility to withhold an employee’s income taxes, Social Security taxes, and Medicare taxes. Employers are also required to pay their share of Social Security and Medicare taxes. The IRC stipulates that a worker is considered an employee if the employer has control of the employee’s work.
- State Unemployment Insurance laws – while federal laws governing the classification of employment can be vague, state laws regarding employees who are eligible for unemployment insurance are often stricter, offering tests that assess whether or not there is a sufficient absence of control by an employer to qualify the worker as an independent contractor. In Arizona, labor laws are established in Arizona Revised Statutes Title 23. The state’s Department of Economic Security (DES) governs the state unemployment insurance regulations.
- State Workers’ Compensation laws – these laws also vary from state to state, but their tests for how much control an employer has over a worker are also usually more specific than federal law. In Arizona, the Industrial Commission of Arizona (ICA) governs workers compensation laws.
What constitutes an employee vs an independent contractor?
Differentiating between an employee and an independent contractor is unfortunately a bit of a legal gray area. At its core, the law dictates that an individual is an employee if the employer has the right to control their work. Where the matter gets tricky is in exactly how much an employer has control over your work. When considering the employee vs independent contractor relationship, you’ll need to ask the following questions:
- Does the employer have control over the worker’s behavior? If so, how much control do they have?
- Does the employer have control over the worker’s compensation? If so, how much control do they have?
- How much direction can the employer provide in regard to the means and results of the worker’s labor?
- Is there a possibility for profit or loss for the worker?
- Is the worker free to provide similar services to other businesses?
- What is the contractual relationship between the worker and the employer?
Note that a contract defining the worker as an independent contractor is invalid if the worker qualifies as an employee. Similarly, a worker who isn’t on the company’s payroll isn’t automatically an independent contractor (e.g. unpaid interns still qualify for benefits).
Why does misclassification happen?
Some cases of misclassification can be chalked up to an honest mistake, but in most cases, employers knowingly misclassify workers for tax evasion and financial gain. Every employer is required to pay Social Security taxes, Medicare taxes, unemployment taxes, and worker’s compensation for their employees, which takes a small chunk out of the company’s bottom line. Thanks to the Affordable Care Act, employers are also required to pay for their share of employee benefit programs, which takes another bite out of profits.
When an employer misclassifies an employee as an independent contractor, the business’s responsibility for these taxes and costs evaporates, leaving the worker in charge of paying their own taxes and purchasing private health insurance. While the cost savings vary, it’s estimated that a business can save up to 30% of their labor costs by using independent contractors instead of employees.
In the same breath, employees who are paid hourly are guaranteed overtime pay and cannot be forced to work off the clock. When an hourly employee is misclassified as a salaried employee, the company can save money by avoiding overtime compensation.
What is the statute of limitations for employee misclassification?
If you believe that you have lost wages and fair compensation due to employee misclassification, you have two years from the date of the wage violation to file a complaint with the Equal Employment Opportunity Commission (EEOC). If the employer willfully violated federal law in the employee misclassification, you may have up to three years to file a complaint. Once you have filed a complaint, you also have the right to file a civil lawsuit against the employer.
Does receiving a 1099 tax form from an employer mean that the worker is an independent contractor?
No. Receiving a 1099 tax form indicates how the employer classifies the worker for federal tax purposes, but that doesn’t mean the employer’s assumption is correct. If you receive a 1099 and you meet the legal requirements to be an employee, then the employer is guilty of misclassification.
If a worker receives payment from an employer through their own employee identification number (EIN) or LLC, does that automatically make the worker an independent contractor?
How an employer pays the worker is irrelevant. What matters is whether or not the law defines the worker as an employee or an independent contractor. It’s not uncommon to see employees who receive their income through their EIN or LLC as a tax pass-through vehicle.
Does working remotely or off-site disqualify a worker from being an employee?
Where you work is also irrelevant. An employer may not be able to dictate when a remote employee clocks in, clocks out, and takes breaks, but they can still maintain control over the work that they perform.
Are franchisees independent contractors?
Not necessarily. If the franchiser has substantial control over the franchisee’s work, then the franchisee is an employee even if the franchise contract says otherwise. If the franchiser exercises little control over the franchiser’s work, then it’s an independent contractor relationship.
Are employees in certain industries and occupations always classified as independent contractors?
No. Many people who work in outside sales perform their work and collect their commissions as independent contractors, but the popularity of this business model doesn’t trump the law. If the company paying the commissions has control over an outside salesperson’s work, that individual should be classified as an employee.
Need Help With An Employment Law Issue?
The state of Arizona is a great place to live and work, but knowing the employment laws will help you a lot. Whether you are a newcomer to the state or a lifelong resident, understanding your workplace protections is good for your career, and the more you know, the better.
Employment law issues can cause extreme distress and can affect productivity on the job. If you are being harassed at work, or dealing with any other employment issue, consider talking to our AZ employment law team to help you settle your case.
Call our Employment Law team at (480) 464-1111 to discuss your case today.