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How do courts decide misclassification penalties?

Insureon Staff.
By Insureon Staff
July 3, 2014
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J&A services, a Colorado-based gas and oil monitoring and maintenance company, settled a lawsuit for misclassifying employees as independent contractors for $2 million.
A worker walks toward a large pipe used for transporting oil.

When employers misclassify their employees as independent contractors, it can cost them big bucks. Just ask J&A Services, a Colorado-based oil / gas monitoring and maintenance company that allegedly misclassified several current and former employees. According to HR.BLR.com, a resource for business compliance issues, J&A recently settled the collective-action lawsuit for $2 million.

J&A still denies that it misclassified the employees, but decided to settle out of court anyway. You can be sure that if this complicated case went to trial, it would have taken a lot more time and a lot more money.

How do the courts decide that an employee is misclassified?

Generally speaking, there are two ways someone can work for your business: as an employee or as an independent contractor. Businesses hire employees when they want a long-term commitment to a job. Employees must follow a business’s protocol. In exchange, employers must follow certain employment laws. For example, businesses pay half of their employees’ Social Security and Medicare tax obligations. Businesses may also offer employees optional benefits, such as retirement plans and health insurance. On the other hand, independent contractors are generally hired for short-term gigs and one-time projects. They don’t receive benefits from their employers.

Now, the distinction between these two types of workers may seem cut and dry, but the IRS doesn’t formally define “independent contractor.” Instead, it uses a series of factors to determine whether someone is a contractor or an employee.

That’s what spurred the J&A lawsuit. Flow testers at the company thought they were being asked to work more like employees – but without the benefits. They were working overtime, but were denied overtime pay due to their independent contractor status.

3 factors that courts consider when determining if a worker is an employee or independent contractor:

Which aspects of the work does the company control or have the right to control? 
Employees must complete work the way their employers tell them to complete work. Independent contractors usually have more freedom when deciding how to complete tasks. However, the degree of instruction is often dependent on the type of work. The flow testers argued that J&A controlled the way they worked as though they were employees. They were told how, when, and where to work and were required to attend company meetings and training sessions.

Does the company control financial aspects of the job? 
The flow testers were paid an hourly wage. Employees are usually guaranteed a set wage for a certain amount of time (hourly, weekly, etc.). Independent contractors are usually (though not always) paid a flat fee. Additionally, because the flow testers worked so much, they were unable to contract with other businesses.

How does each party perceive their relationship with one another? 
Employees generally receive benefits from their employers, but a lack of benefits does not mean that a worker is not an employee. In this case, many of the flow testers worked for J&A for years at a time, which suggested an employee-employer relationship, rather than a contractor-employee relationship.

As you can see, there is quite a bit of gray area here – which is why you must be careful when deciding to classify a worker as an independent contractor. For more information, visit the IRS’s guide to employee classification.

What happens if I accidentally misclassify an employee?

Based on the flow testers’ allegations, it seems pretty clear that they were being treated as employees and should have been receiving their benefits. But based off the IRS’s classification criteria, an employer could feasibly misclassify an employee accidentally. What happens then?

Unfortunately, it doesn’t matter whether you intentionally or unintentionally classify a worker as an independent contractor when they should really be employees. The workers can always file a lawsuit.

The good news is there’s an insurance policy for just that. It’s called employment practices liability insurance, and it helps pay for your legal defense and damages when your workers sue you over employment issues. It can also help you pay for settlements if your business can reach an agreement out of court, like J&A did with its flow testers.

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