Employers beware, misclassification cases are costly and common
Independent contractors and freelancers are more flexible and less expensive than full-time employees, and many businesses rely on them. Therefore, some employers take shortcuts by classifying employees as freelancers because it's cheaper and easier.
Studies have estimated that the U.S. government is losing billions of dollars in lost taxes per year due to the misclassification of workers, not to mention what is lost from off-the-books cash payments.
For an employer, classifying a worker as an independent contractor versus an employee can have considerable cost advantages, primarily associated with avoiding providing worker benefits and insurance. But beware because taking shortcuts to save costs by misclassifying workers can backfire in the long run.
The IRS warns that companies may end up paying more long-term due to this sort of workplace corruption. However, it is worth noting that many misclassification cases are accidental in nature.
Misclassification across the United States
California Attorney General Jerry Brown won a $13 million judgment against two companies that misclassified 300 janitors.
The Illinois Department of Labor was awarded $328,500 in penalty fees from a home improvement company that misclassified 18 of its workers.
In another example, New York State Commissioner M. Patricia Smith says her task force has identified more than 31,000 instances of misclassification, bringing in $11 million in unpaid unemployment taxes and $14.5 million in unpaid wages since late 2007.
United States cracks down on tax dodging through misclassification
Lyft decided to settle its misclassification case outside of court by agreeing to pay $27 million to quash a class-action lawsuit filed in 2013. Lyft, like so many others, has capitalized on the gig economy, dispatching workers as independent contractors even though these contractors fulfill core functions of the business.
The lawsuit alleged that Lyft exerted control over its drivers that is normally reserved for employees, such as exercising the right to terminate drivers at will, without warning.
The lawsuits over worker classification highlight growing pains for the burgeoning chauffeur, grocery-delivery, and errand-running industry as it navigates state and federal employment laws that challenge the standard business model of the on-demand economy.
As part of the settlement, Lyft will change its terms of service to treat drivers compliant with California law governing independent contractors.
If the company had not settled and lost in court, it would have had to recognize its drivers as employees, potentially putting it on the hook for back wages and expense reimbursements.
Lyft could have saved a lot of money if they had read
“Worker classification: Types of workers and how to manage them.”
How has the risk of misclassifying workers risen over the years in the U.S.?
The U.S. Government has continued to clamp down on lousy misclassification practices, meaning the repercussions of misclassifying workers are rapidly beginning to outweigh the benefits.
The U.S. implemented The Fair Labor Standards Act (FLSA) to protect worker rights and ensure employees had the right to a minimum wage, overtime pay, record keeping, and youth employment standards to protect workers' rights.
Still, despite the implementation of FLSA, misclassification has continued. The U.S. Department of Labor estimated that 10-30% of employers had misclassified their workers since the 2000s.
Misclassification cases have grown over the years
In December 2000, Microsoft agreed to pay $96.6 million to end an eight-year legal battle, informally as the "permatemp" case. The payment was made to approximately 8,000-12,000 temporary workers who claimed they should have been entitled to benefits under Microsoft benefits plans only to discover they had been misclassified as independent contractors.
In the same year, multinational multimedia company Time Warner, Inc. was made to pay out a $5.5 million settlement to the Department of Labor (DOL) due to the misclassification of workers excluded from pension plans.
Holland Acquisition Inc., which operated as Holland Services, will pay $42.3 million in back wages and liquidated damages to 700 workers after misclassifying them as independent contractors, the U.S. Department of Labor announced in 2021.
The workers provided services for the oil and gas industry. The department said an investigation found that the company improperly classified abstractors, title examiners, and landmen as independent contractors. It also said the company failed to pay overtime and did not keep accurate records of the people's daily and weekly hours.
The growing legal stance against worker misclassification in the U.S.
The most substantial misclassification case to date came in June 2015 involving FedEx, resulting in a $228 million settlement. FedEx had been classifying and paying 2,300 Californian drivers as independent contractors, with some claims dating back to 2000.
"The $228 million settlement sends a powerful message to employers in California and elsewhere that the cost of independent contractor misclassification can be financially punishing, if not catastrophic, to a business," said the prosecuting attorney for the FedEx case.
This California case is one of the 28 cases in multi-state litigation against FedEx because they allegedly labeled its drivers as independent contractors. By the end of 2016, FedEx had paid nearly $500 million in misclassification settlement payments.
The risk of misclassification for staffing and workforce solutions companies
The risk of misclassification also extends to staffing agencies when they are tasked with sourcing contract workers for their clients, only to be found liable when they have been misclassified.
In January 2013, a New York staffing agency faced 35 cases involving claimants who sought unemployment benefits despite being independent contractors. The New York State Unemployment Insurance Appeal Board made identical decisions on the 35 separate cases.
They stated that the workers supplied by the staffing agency to perform promotional work were employees, not independent contractors. As a result of this decision, the staffing company was held liable for contributions for all similarly situated workers.
In 2013, Apple and AT&T settled their misclassification lawsuit with Arise Virtual Solutions for a $1.25 million settlement in order to resolve accusations that their workers were misclassified as independent contractors.
It is crucial to remain compliant and classify your workers correctly as either employees or independent contractors. If you have any questions on how to engage workers correctly in the U.S. or abroad, get in touch!
Uber Settles Portion of Calif. Driver Misclassification Suit for $8.4
Uber Technologies Inc. and said plaintiffs, a group of approximately 1,330 drivers allegedly misclassified as contractors rather than employees, have settled their labor dispute. This $8.4 million settlement is the second in the case, and the previous, approved in 2019, was for $20 million on behalf of roughly 15,000 California and Massachusetts drivers.
Note: Smaller companies are not exempt from worker classification laws, and more well-known companies are held to the same standards of the law
A Des Moines contractor will pay about $125,000 for misclassifying workers after federal investigators accused the company of worker misclassification, and failing to pay overtime.
In a settlement with the U.S. DOL, A.J. Plumbing agreed to pay $106,000 to 34 workers who allegedly received less pay than the federal minimum standard. The settlement comes three weeks after the company agreed to pay workers $19,000 for failing to follow the federal overtime law.
In 2017, Instacart settled a class-action lawsuit for $4.65 million, brought on behalf of 31,000 Instacart shoppers alleging that the company had misclassified them as independent contractors and failed to reimburse business-related expenses.
Worksome indemnifies our clients in the case of an accidental misclassification, removing risks for our clients
Having the right workforce tools can mean the difference between time-consuming lawsuits, loss of good reputation, and costly revenue mistakes.
Accurate worker classification is one of the most important decisions when hiring because misclassifying your workers can have steep financial consequences.
This article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or tax advice.