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Federal, State Governments Take Keener Interest in Employee Classification

December 3, 2010

A government crackdown on employers that misrepresent employees as independent contractors is racking up substantial costs for some business owners and is prompting others to reassess the way they classify workers even before investigators come knocking.

Both federal and state bodies have ramped up efforts to identify employers who misrepresent workers and subsequently avoid paying into such funds as state unemployment and workers’ compensation.

Though such misclassifications have been a problem on “some radar screens over the years,” laws regarding the issue were not seriously enforced, said Ohio Attorney General Richard Cordray. Ever-tightening state budgets, however, have made it hard to stay passive about misclassification, which, according to a report by the Attorney General’s Office, costs the state an estimated $790 million a year in unpaid income tax revenue, workers’ compensation premiums and unemployment compensation.

During the past two years, the Wage and Hour Division of the Labor Department has hired more than 350 investigators to uncover employment violations, including misclassification. President Barack Obama has requested $25 million in the fiscal 2011 budget to target the issue further.

And in 2009, the Ohio Job and Family Services Department began conducting targeted audits—in addition to the random audits it historically has done—to find those employers who misclassify employees as independent contractors.

In addition to the government crackdown, class-action lawsuits brought against employers accused of misclassifying employees have increased, said John Cernelich, who co-chairs the labor and employment group at Calfee, Halter & Griswold.

Also, Sen. Sherrod Brown, D-Ohio, in April introduced the Employee Misclassification Prevention Act; the bill and a House version are pending in committee.

Some Northeast Ohio employers have been subject to state and federal employment audits, and even those that have not are asking legal counsel to review their classification of employees, local lawyers say.

Mark Floyd, partner and head of the employment litigation department of Walter & Haverfield, said one of his clients is appealing a finding by the Labor Department that it misclassified workers. The projected back pay, penalties and interest owed by the business, which Floyd declined to identify, total six figures, Floyd said.

“It can be devastating to small employers,” he said.

David Campbell, a partner with Vorys, Sater, Seymour and Pease who concentrates on labor and employment, agreed. He’s had more than five clients investigated since 2009, including two that were found to have misclassified employees but were later vindicated. Campbell declined to identify them.

The audit process—and appeals process, if pursued—are long and expensive, even if companies end up not owing back pay, penalties and interest, Campbell said.

“I see all too often, companies that are doing it right ... live for months thinking their company will be shut down,” he said.

Business sectors commonly under the misclassification microscope include trucking, construction, manufacturing, information technology and home health care, according to lawyers and government officials.

Federal and state agencies have varying reasons to investigate worker misclassification. Between Oct. 1, 2009, and Sept. 30, 2010, the federal Wage and Hour Division collected $2.2 million in back wages for 5,261 workers who were misclassified in some way. Of that amount, $256,730 was collected for 415 workers in the Midwest region, which includes Ohio and nine other states.

After his election in 2008 to attorney general, Cordray convened a task force of state agencies to better tackle the problem. As a direct result, the Ohio Job and Family Services Department began targeted audits in 2009.

The department completed 88 targeted audits that year and found 80 employers that had misclassified 3,545 workers as independent contractors, spokesman Ben Johnson said. Through September of this year, the department has completed 64 audits and found 60 employers who’d misclassified 2,045 workers. Employers have a right to appeal.

Nearly 40 percent of the misclassified workers were found in less than 2.5 percent of the audits, Johnson said.

“That tells you that most of the people out there are doing the right thing,” he said.

As a result of the misclassifications, the state has found it is owed back unemployment tax of more than $468,000 for 2009 and more than $195,000 for the current year, Johnson said.

Misclassification of employees as independent contractors is about more than government pockets, though, Cordray said.

“It’s doing three things,” he said. “It is cheating governments out of appropriate revenue. It is cheating law-abiding businesses (because) you are undercutting them by violating the law. The third aspect is cheating workers themselves.”

Cordray said workers can suffer if they’re laid off or injured and discover only afterward that their employer hadn’t paid into unemployment or workers’ compensation on their behalf.

Bill Hoag, president of A&H Trucking Co. in Cleveland, isn’t sorry the government is putting the hammer down.

“They should crack down on it because it’s not right,” said Hoag, whose company has not been subject to an audit. He said the use of independent contractors “is real common in the trucking business, and, yes, there are people that I think they have employees, but they’re treating them as independent contractors.”

“I have to compete with somebody that’s not following the rules,” Hoag said. “They’re not paying the payroll taxes, they’re not paying the workers’ comp, and the guy’s doing the same thing my guy’s doing.”

The end of the year is commonly a time for contract renewals, and thus an appropriate time for employers to reassess employee classification if they haven’t done so already, Calfee, Halter’s Cernelich said.

Resources, such as the Internal Revenue Service’s three-category guide, can be helpful. Most with knowledge of the issue said an employer’s control over a worker is the dividing line.

Local attorneys agreed, however, that the issue is not black and white, and Cordray acknowledged the law has been “kind of confusing in this area.”

“I think we try to be sensitive to whether it is unintentional or intentional,” he said. “But penalties are important. There are a lot of people we know who are deliberately violating the law. There have to be penalties.”   

Filed by Michelle Park of Crain’s Cleveland Business, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.

 

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