The news from Washington, D.C. yesterday is that the U.S. Department of Labor is funding 19 states’ efforts to crack down on businesses that unwittingly or intentionally fail to make unemployment contributions for individuals misclassified as independent contractors. While class actions in court continue to receive the most attention, unemployment proceedings continue to plague many businesses that use independent contractors to supplement their workforce or carry out their business objectives – and the Obama Administration, supported by Congressional funding, is keeping its headlights focused on unemployment challenges to detect and deter independent contractor misclassification.

Labor Secretary Thomas Perez issued a press release on September 15, 2014 that carried out the Obama Administration’s continuing efforts to crack down on independent contractor misclassification. As noted in my March 4, 2014 blog post, the President has maintained his Administration’s commitment to “[i]ncreasing support for [state] agencies that protect workers’ wages and overtime pay, benefits, health and safety, and invest in preventing and detecting the misclassification of employees as independent contractors.”  To that end, Congress passed the Consolidated Appropriations Act of 2014 authorizing grant funding of no less than $10 million for “activities to address the misclassification of workers.”

Which States Received Grants?

The 19 states that received grants totaling $10.2 million were California, Delaware, Florida, Hawaii, Idaho, Indiana, Maryland, Massachusetts, New Hampshire, New Jersey, New Mexico, New York, Oregon, South Dakota, Tennessee, Texas, Utah, Vermont, and Wisconsin. According to the press release, the funds will be used to increase the ability of state unemployment insurance tax programs to identify instances where employers improperly classify employees as independent contractors or fail to report the wages paid to workers. The states selected for grants will reportedly use the funds for a variety of improvements and initiatives, including enhancing employer audit programs and conducting employer education initiatives.

Four states received “high-performance bonuses” totaling over $2 million: Maryland, New Jersey, Texas, and Utah. According to Secretary Perez, this innovative program rewards states with additional grant funds “due to their high performance or most improved performance in detecting incidents of worker misclassification.”

What Does This Mean to Businesses Using Independent Contractors?

In February 2013, I published a blog post that focused on how a single claim by one worker can lead to the administrative equivalent of a class action for independent contractor misclassification. Any business using independent contractors to supplement its workforce or to carry out its business model bears the risk that one or more individuals it classifies as 1099ers will file for unemployment benefits or that a state where one of those 1099ers resides will commence an audit of its unemployment and payroll taxes.

Use of independent contractors remains a highly risky business for those companies that do little more than hand those individuals an independent contractor agreement when they commence providing services and a Form 1099 shortly after year’s end. Even large and legally savvy companies have tripped over their own feet in the past few years, most notably FedEx Ground, which was the subject of an adverse federal appellate ruling only last month where it was found to have misclassified its drivers as independent contractors.  As noted in an earlier blog post, that courier company’s IC agreement was used against the company by the appellate court to conclude that FedEx sufficiently directed and controlled the work by its Ground Division drivers to turn them into employees.

The likelihood that these types of agreements will survive judicial or administrative scrutiny is low – unless the business takes affirmative and comprehensive steps to structure, document, and implement an independent contractor relationship in a state-of-the-art manner that not only serves the company’s business objectives but also can withstand a challenge under one of the many federal or state laws governing independent contractor status. While some independent contractor relationships may comply with federal tax or employee benefit laws, they may stand little chance of complying with a crazy quilt of state laws, which can differ greatly from state to state.

Many companies have begun to use a process such as IC Diagnostics™ to restructure, re-document, and re-implement their independent contractor relationships before they receive a summons for a class action lawsuit, a notice for a federal or state administrative audit, or an inquiry from the local unemployment office about an individual who is seeking benefits.  Both an audit and an unemployment claim can lead to the equivalent of an administrative class action, where an unemployment agency finds a single individual to be an employee instead of an independent contractor and orders the business to remit contributions for the employee “and all similarly situated employees.”  These proceedings can, in turn, lead to follow-up regulatory challenges by state workers’ compensation agencies, state tax commissioners, state wage and hour divisions, and of course the IRS and the U.S. Department of Labor – or a plaintiffs’ class action lawyer seeking an array of damages.

As described in my White Paper describing ways that companies can minimize the risks of misclassification liability, there are a number of alternatives that businesses can consider, including re-structuring, re-documenting, and re-implementing their business models, embarking on a voluntary or government-sponsored reclassification, or redistributing independent contractors through the use of a knowledgeable workforce management or staffing firm.

Increasingly, businesses are also making use of a process such as IC Diagnostics™ after they have received a summons, audit notice, or unemployment inquiry.  While pro-active steps are far more likely to produce positive results, a belated start to enhancing independent contractor compliance can serve to considerably mitigate legal exposure and substantially reduce or eliminate risks going forward.

Written by Richard Reibstein.