An Ounce of Prevention: Proper Classification of Employees

This week’s answer to “HOW DO WE NOT GET SUED BY EMPLOYEES?” is to properly classify them under the federal Fair Labor Standards Act (FLSA). I’ve represented clients from sole proprietors to Fortune 500 companies in claims involving misclassification. Like most claims, they could usually have been prevented, and also like most claims, they often hit small businesses harder than large corporations. Most misclassifications stem from employers trying to cut corners  or simplify their workload in payroll, taxes, or paperwork.

Although classification of workers and providers of services can be a complex process, there are basically three types: Independent contractors, employees that are exempt from FLSA laws, and employees that are not.

Independent Contractors work for themselves and hire themselves out to clients. There isn’t a bright line test, but they should make their own decisions about when, where, and how to do the work, be a professional or have some kind of license or certification, provide their own equipment and be free to do work for others. Independent contractors could be tattoo artists, bookkeepers, comedians, or (ahem) workplace mediators. There is a temptation for employers to treat workers as independent contractors because they don’t have to provide them benefits, withhold taxes, keep track of hours and overtime, or pay the 7.65% of their wages for social security and Medicare, but there are many risks of misclassifying a worker as an independent contractor:

Injury: If a worker gets injured on the job, worker’s compensation insurance isn’t there to cover their claim and limit employer liability. This could expose the employer to penalties.

Unemployment: If the worker files for unemployment compensation when the relationship ends, and the employer can’t defend the independent contractor status, there could also be penalties.

Taxes: For non-independent contractor employees, employers are required to pay half of the social security and unemployment tax, and most must also withhold federal and state taxes. If an employee misclassified as an independent contractor doesn’t report the income, the employer could be required to pay the taxes that should have been withheld, plus penalties.

Overtime: A true independent contractor can be paid a fee for services regardless of whether they work over 40 hours a week. If misclassified, a disgruntled worker could claim entitlement to overtime pay.

Additionally, a claim involving any one of these areas could end up with the involvement of all the others, leading to a legal debacle of grand scale. In summary, make VERY SURE your independent contractors really fit the bill. Remember that even if there is a written agreement to independent contractor status, none of the agencies that administer these laws are bound by it.

Employees are classified as either Exempt or Non-Exempt. Non-exempt employees are those paid an hourly wage, and are protected by the FLSA’s minimum wage and overtime pay provisions. Exempt employees are exempt from those laws, and paid a salary to get the job done, no matter how long it takes. The three main categories of exempt employees are executive/managerial workers, administrative workers, and professionals such as doctors, teachers, or engineers. Exempt employees must be paid at least $455 a week and treated as salaried workers, for example, not docked pay if they miss part of a day. There are other exempt employees, like outside sales staff and computer professionals, with slightly different rules.

Risks of misclassifying employees as exempt relate primarily to liability for overtime wages. Often the employer doesn’t require exempt employees to track hours and therefore has no way of refuting someone’s claim to have regularly worked 50 hours a week. If the employee turns out to have been misclassified, the employer is liable for all the unpaid overtime going as far back as three years. Generally, backpay awarded is doubled and the employer has to pay the employee’s attorney fees as well as their own. The cost adds up quickly if there is more than one similarly situated misclassified employee.

For example, Ride Aid recently paid $20.9 to settle a class-action lawsuit from 6,000 employees claiming they were illegally classified as exempt and thus denied overtime pay. Although the employees’ official job title was “co-manager,” they had almost no supervisory functions and spent most of their day doing manual labor.  McDonalds, Burger Kind, and CVS have all been involved in similar class-action claims. On the other hand, I recently mediated a claim between a small, 20-person company and an employee who claimed that when the business switched hands, her managerial duties disappeared, making her misclassified. She claimed to have been working 65-hour weeks, and her total demand for payment was around $50,000.

Although it can be tempting to misclassify workers to save money in the short-term, it leaves employers exposed to multiple liabilities. Don’t do it! Consult a human resources professional to properly classify employees, and protect your business from a world of lawsuits.