May 6 Tip of the Week

“Misclassification: An Expensive Mistake”

One of the most important things that an employer can do is to classify their employees correctly.  An incorrectly classified employee can lead to huge damages if the employee or an enforcement agency learns of the misclassification.  There are two primary areas of misclassification – the first is whether an individual is an employee or an independent contractor.  This type of misclassification involves the way that employment taxes are paid (or not paid) and involves the IRS and other agencies.  The second area of classification involves how the employee is paid – are they are an exempt employee who, based on their duties and responsibilities, is not eligible for overtime?  Or are they a non-exempt employee who is eligible for overtime pay and is paid based on the number of hours worked?  These classification issues are becoming increasing important as they are a new area of focus for the United States Department of Labor. 

With respect to employee or independent contractor decisions, there are a number of violations that can be found if an employee is misclassified an independent contractor.  The first violation is the lack of I-9 form; employers are not required to complete an I-9 form regarding an independent contractor’s ability to work legally in the United States.  If the independent contractor is really an employee, the employer will be subject to penalties under immigration law.  These penalties can include civil fines, criminal penalties, and debarment from federal contracts.  One of the most expensive costs of improper classification of independent contractors is under the wage and hour laws.  Independent contractors are not subject to the Fair Labor Standards Act and are not required to be paid minimum wage or overtime.  If an individual is improperly classified as an independent contractor, the employer may be on the hook for unpaid wages, unpaid overtime, and other massive penalties including liquidated damages and attorneys’ fees that are incurred in defending against the misclassification claim.  An employer who improperly classifies an employee as independent contractor may also be in violation of the workers’ compensation and unemployment compensation laws, and may be subject to penalties for failing to pay state and federal payroll taxes on behalf of the misclassified independent contractor.  Other issues can arise under other statutes that apply to employees and not to independent contractors, including those that involve employee benefit eligibility and FMLA leave.  Given the breadth of the impact of a misclassification of an independent contractor, employers should always err on the side of finding an individual to be an employee if there is any question as to the appropriate classification. 

With respect to exempt and non-exempt employee issues, it is important to focus on the duties and responsibilities of the job that the individual employee is performing.  The amount of payment and the method of payment (such as hourly or salaried) do not dictate whether an employee is exempt or non-exempt, rather it is the actual duties performed by the employee in the course of their employment that dictates whether they are exempt or non-exempt.  The amount of pay earned by the employee is also important – once the employee is determined be performing the duties that make them eligible for an exemption (administrative, executive, or professional), they must also earn a certain amount of salary.  That number is currently set (as of 1/1/2025) at $1,128 weekly or $58,656 annually by the federal Fair Labor Standards Act, but may be higher in states with their own minimum salary amounts.