Employee Misclassification & the Big Hammer of the IRS

As employers work to find the right talent mix to meet their needs, many are turning to independent contractors, who they classify as 1099 workers instead of W-2 employees, which is fine if they do it correctly. However, mistakes in 1099 classification are costing some of the biggest and best companies huge amounts of money, and other companies have been forced to close their doors. Why? Because the big hammer of the IRS and the legal system is swinging. Don’t let your company get hammered like the following companies did.

 Employee Misclassification Settlements Total Hundreds of Millions of Dollars


Employee Misclassification Settlements Total Hundreds of Millions of Dollars

  • Uber has an ongoing lawsuit over its drivers being classified as 1099 or W2 employees. A Boston attorney has negotiated a settlement of $100 million over misclassification of California and Massachusetts drivers. The settlement payout would reach the maximum of $100 million if Uber's market value expands by 50% ($30 billion). Even with this settlement, Uber is still vulnerable. The attorney who sued Uber makes it clear on her website that the case is being "settled - not decided," which means Uber could still be in for more financial hurt.

  • It's costing FedEx $228 million to settle a class action lawsuit brought by its California drivers over misclassification. In 2014, the Ninth Circuit court ruled that FedEx misclassified 2,300 drivers as independent contractors and paid them as such. As the company found out the hard way, the labeling wasn't enough. The job duties had to meet the criteria for independent contractor status for their drivers - and apparently they did not. This was a costly mistake. The $228 million settlement is one of the largest employment law settlements, and demonstrates the financial punishments resulting from misclassifying employees. FedEx may be financially sound enough to weather this financial catastrophe, but many smaller companies probably would not.

  • One company that couldn't survive misclassification of employees is Homejoy, an on-demand cleaning service. In July of 2015, the San Francisco company shut its doors after being hit with a lawsuit for classifying cleaners used to provide services as independent contractors. Since the company didn't have the deep pockets of a larger more established company, and the legal fees were huge, the owners decided to shut down the company rather than take on an expensive legal battle. Simple employee misclassification can end a business.

It Can Happen to Your Company Too

You may think your company is safe because everyone in your industry classifies the same groups of contributors as independent contractors, but think again. In addition to the IRS and state agencies, the NLRB and the Department of Labor are stepping up their enforcement against companies on a host of wage and hour issues, as well as unpaid benefits and payroll taxes. An increase in class action lawsuits is also impacting companies across the country, such as:

  • Hollywood Reporter: A class action lawsuit is proceeding against the publisher of the Hollywood Reporter by dozens of its freelance content producers who contend that they were denied overtime and benefits. The judge determined they were likely employees because they were each given office space, a computer, a company email and a dedicated phone line just like employees.

  • Landcaster Symphony Orchestra: The United States Court of Appeals for the District of Columbia Circuit recently ruled that orchestra musicians are employees, not independent contractors, making them free to unionize. Unlike solo musicians, the court ruled that the level of control exerted by the employer over members of the Lancaster Symphony Orchestra made them employees, not independent contractors.

  • NFL and NBA Cheerleaders: A judge in New York state recently granted class action status to the Buffalo Jills, the cheerleaders for the Buffalo Bills, who say they were deprived of overtime pay by being misclassified as independent contractors. The Oakland Raiders, Tampa Bay Buccaneers and Milwaukee Bucks are facing or have settled similar cases with their respective cheerleaders.

Don’t Fall into the Misclassification Trap

It’s critical for your company to avoid falling into the misclassification trap - and it can happen easily if you aren’t informed. As a starting point, check out our handy Employee Classification Scorecard and think about every group of 1099 contractors in your organization, including those you refer to as freelancers who are hired directly by your marketing, IT, accounting and other business functions. If you check too many boxes on our checklist, your company is probably at risk.

The next step is to study up on IRS federal regulations, as well as state and local laws regarding the classification of your employees, to determine what you need to do to change either the relationship with your contractors or shift their classification to W2 status.

To mitigate risks, the preferred option is to consider outsourcing these tasks to an organization that provides independent contractor management services and does all the work for you to correctly classify your employees and contractors to help avoid any financial catastrophes. Any misstep in this classification minefield can be deadly to your company’s financial health, so the investment to use a service will be well worth it.

If you need assistance in managing your independent contractor workforce to avoid legal issues, we’re here to help!

Free Employee Classification Scorecard