Independent Contractor or Employee: Why you need to get it right! (Part 2)

Part 2: The High VERY HIGH Cost of Misclassifying an Employee as an Independent Contractor.

Misclassifying an employee as an independent contractor can be a very expensive mistake for a business.  Once the issue is on the table, the vultures start circling and you are in for a very unpleasant and costly ride.

The misclassification is typically discovered when something bad happens to the worker.   Often, the worker suffers an on-the-job injury and looks for workers’ compensation coverage and the Workers’ Compensation Division (WCD) determines the worker is really your employee.  Or the worker can’t find work and files for unemployment and the Oregon Employment Department (OED) determines the worker is really your employee.  Or the worker feels harassed or feels mistreated by you for some other reason and files a complaint with the Bureau of Labor and Industries (BOLI) or the Equal Employment Opportunity Commission (EEOC) and the agency determines the worker is really your employee.

Sometimes, but less frequently, the misclassification is discovered during a routine wage and hour audit, workers’ compensation audit or tax audit.  The investigator reviews your records and finds fewer employees on the books than expected or notices significant non-payroll payments to individuals for services performed.  Red flags go up and the investigator digs deeper to be sure you are paying all of the taxes or premiums you should be paying.

Regardless of the reason the misclassification is discovered, be prepared to have your business turned inside out and to open your wallet.

For example, if the worker is injured on the job and doesn’t have insurance to cover medical bills or lost wages, he and the attorney he consults, will look for a way to get coverage and you are the deep pocket they will turn to.  This once happy “independent contractor” will file a workers’ compensation claim and if you misclassified the worker, you are on the hook…and it’s a big hook.

If the WCD accepts the claim and determines that you are a “noncomplying employer,” i.e., the worker is an employee and should have been covered by your workers’ compensation insurance policy, bad and expensive things happen.  Most significantly, you lose the protection from lawsuits that a complying employer receives. The injured worker (or his estate, should the worker die from work injuries) can sue you for his or her injuries, medical bills not covered by the WCD, lost income, emotional distress and even punitive damages.  If as an employee, the worker would receive employee benefits, the worker can sue you for paid vacation, health insurance, paid sick leave and any other benefits you failed to provide.

The WCD will go after you for any medical bills WCD pays for the worker and will impose a substantial civil fine.  And don’t think your company can get rid of this problem by going out of business or filing for bankruptcy; the liability is also yours personally (as may some of the tax-related liabilities discussed below).

Your problems don’t end with the thousands of dollars you’ll pay the employee or the WCD civil fine.  BOLI and the DOL may come knocking at your door to check if you’ve misclassified other workers, and if you have, whether you owe them back wages for minimum wage violation or overtime violations, which can also produce additional damages of double or triple the wages owed.  BOLI and the DOL can also impose hefty civil fines.

You know who comes next: the tax man.  The EOD Tax Section, the Oregon Department of Revenue (DOR) and Internal Revenue Service (IRS) want the payroll taxes you failed to deduct from the employee’s compensation, such as income taxes, social security taxes, Medicare taxes, unemployment taxes, transit taxes, etc.  You’ll also be hit with significant penalties and interest, and, in some cases, may even be required to pay the employee’s share of certain taxes.

Through all of this, you will pay your own lawyers, accountants and other professionals thousands of dollars.  Of course, the misclassified worker will also get a lawyer.  If you misclassified other workers, the lawyer is likely to gain some of them as new clients, as well.  To pour salt on your wounds, many of the claims a misclassified employee can bring against you provide that you must pay the misclassified worker’s attorneys’ fees if he prevails (but you have to pay your own attorneys’ fees whether you win or lose!).

The bottom line is that most workers should be treated as employees, particularly if the facts make it difficult to say with any certainty that the worker is an independent contractor.  The tens or even hundreds of thousands of dollars you’ll pay for misclassifying an employee as an independent contractor pales in comparison to the cost of workers’ compensation insurance, payroll taxes and the other costs of simply treating the worker as an employee from the very beginning.

Misclassifying an employee is a costly mistake that you can easily avoid by doing your homework on the front end of the relationship.  If you’re thinking of hiring an independent contractor and there’s any doubt, talk to your lawyer before plunging into the independent contractor minefield.