The Costs of Worker Misclassification: Part 2

July 8, 2015

In part one of this series, we discussed how independent contractor misclassification has arisen and its costly consequences. Part two addresses the regulatory and legislative crackdown and efforts by plaintiffs’ class action lawyers and union organizers to target companies that are believed to be misclassifying employees as independent contractors.

Federal and State Regulatory Enforcement Initiatives

U.S. Department of Labor

With funds authorized by the Obama administration in each of its budgets released since 2011, the DOL has embarked on a multifaceted enforcement approach. First, it has been hiring more investigators to "detect and deter" independent contractor misclassification. Second, it has been prosecuting more companies that fail to pay overtime or minimum wages to employees whom the DOL believes are being misclassified as independent contractors. Third, the DOL has made grants to state workforce agencies to identify misclassification and recover unpaid unemployment taxes.

To finance these enforcement activities, the last three budgets submitted to Congress by the president all included $10 million for the DOL to distribute to state workforce agencies to increase their enforcement efforts, as well as almost $4 million to hire and retain additional federal personnel to investigate and prosecute misclassification.[1] In 2014, a total of $10.2 million was awarded to 19 states to help finance their crackdown on independent contractor misclassification, with four states receiving "high-performance bonuses" due to improved detection of worker misclassification.[2]

The DOL has also commenced a "Misclassification Initiative," in which it has entered into memoranda of understanding with an increasing number of state workforce agencies from coast to coast. The dual objectives of these federal-state partnerships are to coordinate enforcement efforts and to share information between the state and federal agencies about noncompliant companies. By the end of 2014, the DOL had announced that it had entered into such agreements with agencies in 18 states.[3] In January 2015, the DOL announced that two more states had signed memoranda of agreement,[4] and, in May 2015, it announced 21 states had signed one.[5]

The DOL has itself successfully investigated and prosecuted hundreds of businesses that it concluded were misclassifying employees as independent contractors. These include both small and large enforcement actions, some resulting in seven-figure settlements. Among the more notable cases in the last three years were:

  • A $1.075 million consent judgment against a cable company for allegedly misclassifying its cable installers and failing to pay them overtime.
  • A $1.3 million consent judgment against a text message and Internet information provider for misclassifying its "special agents" who answered text messages from website users and failing to pay them minimum wage.
  • A $560,000 consent judgment against a telemarketing company for misclassifying telemarketers and failing to pay them minimum wage and overtime compensation.
  • A $1.5 million judgment in a federal lawsuit brought against a cable installation company providing installations for Time Warner by the DOL on behalf of 250 former cable installers, who were found to have been misclassified as independent contractors and denied overtime compensation.
  • Back wages totaling $687,000 collected from a drilling rig company for misclassifying roughnecks and crane operators and failing to pay them overtime compensation.
  • A $395,000 consent judgment against a construction contractor for misclassifying carpenters, electricians, masons, laborers, painters and drywall hangers and failing to pay them overtime compensation.
  • A $277,000 assessment against a janitorial service subcontractor and its payroll services company found to be a joint employer of 233 low-wage custodians misclassified as independent contractors.

Internal Revenue Service

The IRS has also been active in seeking to restore what it estimates are billions of dollars in lost tax revenue due to the misclassification of independent contractors. As far back as November 2007, the IRS announced that it had entered into agreements with nearly 30 state revenue commissioners and workforce agencies as part of its Questionable Employment Tax Practices ("QETP") program to share information and enforcement techniques about employers suspected of misclassifying employees.[6] That QETP program remains a priority of the IRS, and at least 37 state workforce and revenue agencies have signed a QETP memorandum of agreement with the IRS.[7]

In February 2010, the IRS announced that it was commencing a three-year employment tax national research project to conduct line-by-line audits of 6,000 businesses, focusing on, among other things, employee misclassification.[8]

In September 2011, the IRS unveiled a new program, the Voluntary Classification Settlement Program ("VCSP"), to permit taxpayers to voluntarily reclassify independent contractors as employees for federal employment tax purposes. The VCSP was modified in December 2012 and updated in 2014. Enrollment in the voluntary program has been relatively scant, as companies recognize that this form of "amnesty" may be an invitation to state and federal workplace agencies and plaintiffs’ class action lawyers to treat a company’s reclassification as a tacit admission of past wrongdoing.[9]

In early 2014, the IRS launched an enhanced effort to promote its SS-8 program, which allows individual workers to file a Form SS-8 to initiate a review of their independent contractor status if they feel they have been misclassified.[10] More recently, the IRS announced in June 2014 that it is increasing its corporate audits of S corporations because it has found that many are misclassifying their workers as independent contractors.[11]

In addition, the IRS has entered into a memorandum of agreement with the DOL. That agreement seeks to reduce incidences of misclassification of employees as independent contractors by providing for the sharing of information and collaboration by the tax and labor agencies, as well as employment tax examinations of questionable taxpayers brought to the attention of the IRS by the DOL.

In addition to the above initiatives, the IRS continues, of course, to use its regular audit processes to examine the classification of independent contractors. In 2007, the IRS assessed FedEx Corp. a $319 million penalty in an employment tax audit, taking the position that FedEx had failed to comply with the employment tax laws with respect to its ground division drivers. That assessment for unpaid taxes was just for 2002. But, in 2008, the IRS withdrew that assessment.[12] Although there was no announcement regarding why the assessment was withdrawn, it is likely that FedEx was able to successfully use the “safe harbor” provisions of the Revenue Act of 1978 to shield itself from that assessment.[13]

State Workforce Agencies

State workforce agencies have been equally vigorous in their regulatory and enforcement efforts. Most state workforce and tax agencies have substantially increased the number of random and targeted audits they conduct each year. Some states have done so as part of a coordinated enforcement effort among various state agencies. To date, at least 21 states have created task forces designed to identify and remediate independent contractor misclassification.[14]

Many state workforce agencies have been as aggressive as the DOL. For example, the most recent figures from the New York Labor Department show that, in 2014, it completed more than 12,000 audits and investigations. Through these audits, the department found 133,000 misclassified workers and assessed more than $40 million in unpaid unemployment contributions.[15] Similarly, Massachusetts reportedly audited more than 18,000 businesses in 2013 and recovered $15.6 million from companies found to have misclassified independent contractors.[16] Likewise, Illinois audited more than 3,500 employers in 2013 and recovered $5.1 million in unreported unemployment contributions attributable to wages of employees found to have been misclassified.[17]

California has also been diligent in pursuing businesses that are believed to have misclassified employees as independent contractors. In March 2014, the California labor commissioner’s Division of Labor Standards Enforcement ordered a large logistics company to pay $2.2 million in back pay, attorneys’ fees and interest for having allegedly misclassified seven short-haul drivers.[18] In May 2014, the commissioner issued citations of more than $1.5 million to two janitorial companies for allegedly misclassifying 52 workers as independent contractors.[19]

An even more effective way in which regulatory agencies are focusing on independent contractor misclassification is through the unemployment and workers’ compensation claims process. Local claims offices are more frequently issuing initial determinations of "employee" status in benefit claims filed by workers, including individuals who have signed independent contractor agreements or who are receiving compensation on a 1099 basis. Many workers who regard themselves as independent contractors are nonetheless applying for unemployment benefits — and more claims examiners are finding that such workers have been misclassified and are entitled to unemployment benefits as "employees."

When a business has not paid unemployment contributions to a state fund on behalf of a worker, the initial determination can have the same effect as an adverse audit if an administrative law judge or referee upholds the determination that the worker has been misclassified as an independent contractor. Once a single worker is found to have been misclassified, the business is then normally charged for unpaid contributions for "all similarly situated" workers, along with costly penalties and fines. Thus, prudent employers treat even a simple claim for unemployment benefits as having the potential for resulting in a regulatory "miniclass action." Further, some businesses that have become the objects of class actions can trace the genesis of their litigations to a successful claim for unemployment benefits by a single employee found to be misclassified as an independent contractor.[20]

State attorneys general have also taken an active role in regulatory enforcement in the area of independent contractor misclassification. Companies that have failed to remit unemployment taxes and/or withhold state income tax have been forced to resolve such claims with various state attorneys general. FedEx is one example. It agreed with the attorney general of Montana to pay $2.3 million to settle an unemployment tax proceeding and agreed with the attorney general of Massachusetts to pay $3 million to settle claims that it failed to pay state unemployment and workers’ compensation taxes.[21] Other state attorneys general were also reported to have filed claims against FedEx, including those from New York and Kentucky, relating to unpaid state taxes and violations of other state labor laws. [22]

Legislative Initiatives

State Laws Designed to Curtail Misclassification

Since July 2007, at least 26 states have enacted legislation intended to curtail misclassification of employees as independent contractors.[23] Some states have passed multiple misclassification bills. Most of these new independent contractor laws provide for civil and criminal penalties, debarment from state contracts, presumptions in favor of employee status and/or private rights to bring individual or class actions for misclassification of employees. Some of the state laws create the misclassification task forces described earlier.

The majority of state laws enacted since July 2007 apply generally to all industries, such as the California Independent Contractor Law, which became effective on Jan. 1, 2012. It prohibits "willful misclassification" by businesses; adds hefty penalties for violations, especially those pursuant to a "pattern or practice"; and imposes joint liability on any outside nonlegal consultant or other person who "knowingly advises an employer to treat an individual as an independent contractor to avoid employee status" if the individual is found not to be an independent contractor.[24]

A number of the new laws, however, have targeted specific industries where misclassification is regarded by legislators as more prevalent. One such industry is construction, which has been the subject of new laws in Delaware, Illinois, Maine, Maryland, New Jersey, New York and Pennsylvania. Similarly, Maryland has passed a law that specifically addresses the use of independent contractors in the landscaping industry.

In 2013, New York enacted a law seeking to curtail the use of independent contractors in the commercial goods transportation industry.[25] That bill went into effect in 2014, and similar bills are likely to be introduced in the legislative chambers of other states.

In September 2014, California passed a law that imposes liability on businesses that use staffing companies and other "labor contractors." Under that law, client companies "share with a labor contractor all civil legal responsibility and liability for all workers supplied by that labor contractor for ... the payment of wages and failure to secure workers’ compensation coverage ..."[26] Thus, companies using staffing firms have more reason than ever to ensure that their staffing companies have an enhanced understanding of independent contractor compliance.

Notably, although more than two dozen states have enacted laws pertaining to independent contractors since July 2007, all of those statutes permit the continued use of properly classified independent contractors. Thus, the key under virtually all of these new laws is whether an independent contractor relationship is structured, documented and implemented in a compliant manner or, where a new law has changed its test for independent contractor status, whether the relationship needs to be restructured, redocumented and reimplemented in a manner that complies with a new statutory scheme. We discuss this issue further in part three of this three-part series.

Federal Bills Aimed at Misclassification

Congress has tried to follow suit, but none of its initiatives in this area have become law. In 2008, the Employee Misclassification Prevention Act ("EMPA") was introduced in both houses of Congress. It was reintroduced in both the House of Representatives and Senate in a different form in 2010 and again in 2011. If passed, the bill would have, for the first time, made misclassification of employees as independent contractors a federal labor law violation, imposed substantial record keeping and notice obligations on businesses (even those that properly classify their independent contractors), and subjected businesses to hefty penalties for noncompliance with the proposed new law.[27]

In 2011, and again in 2013 and 2014, Congress introduced the Payroll Fraud Prevention Act. This was a trimmed-down version of the earlier EMPA and, like EMPA, would have made independent contractor misclassification a federal offense. [28]

Another misclassification bill, the Fair Playing Field Act, was first introduced in September 2010 and reintroduced in March 2012, and reintroduced yet again in November 2013. This bill would have eliminated a long-standing "safe harbor" found in Section 530 of the Revenue Act of 1978 that many businesses have relied on for continuing to classify certain workers as independent contractors.[29] As noted above, it is likely that FedEx used the safe harbor to escape a $319 million back tax assessment by the IRS related to its classification of drivers in its ground division as independent contractors.

None of the federal bills, if passed, would have foreclosed the use of independent contractors that are properly classified as such.

Class Actions

Businesses that either use independent contractors to supplement their workforces or that operate on the basis of independent contractor business models have also been targeted increasingly by plaintiffs’ class action lawyers. Independent contractor misclassification lawsuits have mushroomed against both large and small businesses. Almost no industry is free from these types of lawsuits, although some industries have been harder hit and others are particularly vulnerable.

Among the businesses that are particularly vulnerable to misclassification class actions are Silicon Valley startups and other on-demand companies in the sharing economy that use hundreds or thousands of low-wage independent contractors that are often indistinguishable from low-wage employees.[30]

A representative sampling of class actions that were resolved in the last few years in favor of workers who claimed they were misclassified as independent contractors include the following:

  • A nationwide courier services company — FedEx — that settled a misclassification class action by drivers for its ground and home delivery divisions for $228 million.
  • A newspaper publisher that lost a class action brought by its newspaper carriers, who were awarded $11 million by a state court in California, and another newspaper that settled a misclassification lawsuit for $3.2 million.
  • A home improvement retailer that settled with its installers for $6.5 million.
  • A New York adult entertainment club that settled with exotic dancers for $8 million.
  • A cleaning and janitorial services company that paid $10 million to settle a class action in Massachusetts brought by more than 100 custodians, who alleged that they were misclassified as "franchisees" instead of employees.
  • A nationwide food distribution company that paid $3.5 million in allegedly unpaid employee benefits to settle one of a number of class actions brought by bakery food drivers who made deliveries in Connecticut and Massachusetts.
  • A nationwide workforce management-staffing company supplying "outsourcing and contact center services" for the financial services, retail, technology, e-commerce, telecommunications, travel and hospitality industries that paid $1.25 million in settlement to more than 200 customer and technical support service workers in California.
  • A car service company that paid $3.5 million to 489 drivers and their lawyers.
  • An oil and gas company that settled for $2 million with oil field workers that monitored oil and gas wells.
  • A nationwide logistics and last-mile delivery company that settled class actions filed by drivers in Oregon and Washington for $2.25 million.
  • An airport shuttle company that settled with more than 3,000 drivers for $11.9 million in damages and legal fees.

These examples highlight the value of independent contractor misclassification cases to plaintiffs’ class action lawyers, who typically receive between 25 to 33 percent of the settlement as an attorneys’ fee award, or the full amount of their legal fees if higher, when they secure a settlement or judgment in favor of their class member clients. In addition, companies beset by these types of lawsuits incur "hidden costs," including their own legal fees and the distraction of key management personnel that are needed to defend class actions of this nature.

Impact of Labor Organizations and Potential for Unionization

Under federal labor law, only employees can be unionized; independent contractors are not covered by the National Labor Relations Act and have no right to organize. Recognizing that independent contractors are beyond the reach of labor organizations, unions have been at the forefront of the regulatory and legislative efforts to curtail the use of independent contractors.

Labor organizations have actively supported state legislative initiatives resulting in new laws, such as those referenced above, which seek to curtail the use of independent contractors in two heavily unionized industries: construction and the courier delivery-transportation business. Following the passage of state laws that set forth stringent requirements for construction employers to classify workers as independent contractors, union membership in the construction industry has undoubtedly risen in those states that have passed such laws since 2007, including New Jersey, Pennsylvania, Illinois and New York, among other states.

After years of effort by the Teamsters Union, the National Labor Relations Board in 2014 certified a Teamsters local union as the collective bargaining representative of drivers in Connecticut for FedEx Home Delivery, following the NLRB's finding that such drivers were employees and not independent contractors or separate business entities, as argued by FedEx.[31]

Similarly, years of efforts by the Teamsters to organize drivers who had been classified as independent contractors by drayage companies operating at the ports of Los Angeles and Long Beach, California, have recently succeeded. As of January 2015, a number of those drayage companies that previously classified drivers as independent contractors converted to employee business models and have begun to bargain with a Teamsters local union for an initial collective bargaining agreement.[32]

How to minimize or eliminate independent contractor misclassification liability is the topic of the upcoming third and last part of this series.

[1] See Fiscal Year 2016 Department of Labor, Budget in Brief, at 24, available at; Fiscal Year 2015 Budget of the United States, Department of Labor, at 108, available at; Fiscal Year 2014 Budget of the United States, Department of Labor, at 126, available at; Fiscal Year 2013 Budget of the United States, Department of Labor, at 146, available at $3.8 million was dedicated to the hiring of an additional 35 full-time investigators. See Fiscal Year 2015 Department of Labor, Budget in Brief, at 37, available at

[2] See Press Release, Department of Labor, $10.2 million awarded to fund worker misclassification detection, enforcement activities in 19 state unemployment insurance programs (Sept. 15, 2014), available at

[3] By year-end 2014, the Department of Labor had announced that it had signed memoranda of understanding with 18 states: Alabama, California, Colorado, Connecticut, Hawaii, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, Montana, New Hampshire, New York, Utah, Washington and Wyoming.

[4] The Department of Labor announced on Jan. 13, 2015, that it entered into a cooperation agreement with Florida. See Press Release, Department of Labor, Department of Labor signs agreement with Florida Department of Revenue to reduce misclassification of employees (Jan. 13, 2015), available at On Jan. 20, 2015, it announced that it signed a cooperation agreement with Wisconsin. See Press Release, Department of Labor, Department of Labor and Wisconsin Department of Workforce Development sign agreement to reduce misclassification of employees (Jan. 20, 2015), available at

[5] The Department of Labor announced on May 7, 2015, that it entered into a cooperation agreement with Rhode Island. See News Brief, Department of Labor, Department of Labor signs agreement with Rhode Island Department of Labor and Training to protect misclassified workers (May 7, 2015), available at

[6] See Press Release, IRS, IRS and States to Share Employment Tax Examination Results (Nov. 6, 2007), available at

[7] See IRS to Reinvigorate its QETP Program in Effort to Crack Down Harder on Independent Contractor Misclassification (May 16, 2013),

[8] See Tax Blog Report on IRS National Employment Tax Research Project (May 6, 2010), available at

[9] See IRS Confirms Valid Use of Independent Contractors (Feb. 28, 2012),

[10] See March 2014 Monthly Independent Contractor Compliance and Misclassification Update (April 3, 2014),

[11] See June 2014 Monthly Independent Contractor Compliance and Misclassification Update (July 7, 2014),

[12] See FedEx Corp. Form 10-Q, filed with the U.S. Securities and Exchange Commission for the quarterly period ending Aug. 31, 2009, available at

[13] See The Fair Playing Field Act of 2012: Congress Is Trying Once Again to End ‘Safe Harbor’ for Businesses that May Have Misclassified Employees as Independent Contractors (March 4, 2012),

[14] Those states include Connecticut, Illinois, Iowa, Maine, Maryland, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Tennessee, Utah, Vermont, Virginia, Washington and Wisconsin.

[15] See 133,000 Misclassified Workers Detected in New York in the Course of 12,000 Audits and Investigations in 2014, According to the State’s Newest Task Force Report on Employee Misclassification (Feb. 5, 2015),

[16] See 2013 Annual Report of the Joint Enforcement Task Force on the Underground Economy and Employee Misclassification, at 4 (July 2014), available at

[17] See Press Release, Illinois Department of Employment Security, Misclassified Employees Force Taxpayers To Subsidize Costs, Harm Economy (Aug. 11, 2014), available at

[18] See March 2014 Monthly Independent Contractor Compliance and Misclassification Update (April 3, 2014),

[19] See Press Release, California Department of Industrial Relations, California Labor Commissioner Cites Two Janitorial Companies More Than $1.5 Million for Multiple Wage Theft Violations (May 8, 2014), available at

[20] See, e.g., Coverall North America v. Commissioner of the Divsion of Unemployment, 447 Mass. 852 (Mass. 2006) (which led to custodians, who were found by an unemployment agency to have been misclassified, to commence a class action against the company in Awuah v. Coverall North America, 707 F.Supp.2d 80 (D. Mass. 2010)). See also Unemployment Benefit Claims and Independent Contractor Misclassification Liability: A Single Claim by One Worker Can Lead to Disastrous Results (Feb. 5, 2013),

[21] See FedEx Ground Settles with Montana Attorney General Over Misclassification of Drivers as Independent Contractors (Oct. 10, 2010),

[22] See New York is Next State to Sue FedEx for Misclassification of Its Ground Division Drivers as Independent Contractors (Oct. 24, 2010),

[23] See IC Laws: State Laws Enacted and Federal Bills Proposed (Since July 2007),

[24] See California Joins Growing Number of States to Enact Independent Contractor Misclassification Legislation: State adds new, costly penalties for willful misclassification, but protects the right of businesses to continue to legitimately use independent contractors (Oct. 12, 2011),

[25] See New York State Cracks Down on Independent Contractor Misclassification in the Transportation and Delivery Industry (Jan. 15, 2014).

[26] See New California Law Imposes Costly Risks to Companies Using Independent Contractors Supplied by Staffing and Recruiting Firms — But Risks Can Be Minimized (Oct. 1, 2014),

[27] See Congress Reintroduces the Employee Misclassification Prevention Act that Would Make Misclassification of Employees as Independent Contractors a Federal Offense (Oct. 17, 2011).

[28] See With No Fanfare, Congress Reintroduces the Payroll Fraud Prevention Act of 2014 to Crack Down on Independent Contractor Misclassification (May 20, 2014),

[29] See Fair Playing Field Act of 2012: Congress Trying Again to End ‘Safe Harbor’ for Businesses that May Have Misclassified Employees as Independent Contractors (March 5, 2012).

[30] See Silicon Valley Misclassification: ‘New York’ Magazine Focuses on How the 1099 Economy May Be Exposing Tech Start-Up Companies to Costly Liability for Their Use of Independent Contractors (Sept. 18, 2014),

[31] See FedEx Hit with Avalanche of Independent Contractor Misclassification Rulings (Oct. 6, 2014),

[32] See Press Release, International Brotherhood of Teamsters, Teamsters: Port Truck Drivers From Major Drayage Firm Serving Twin Ports of Los Angeles and Long Beach Reclassified as Employees; Elect to Join Teamsters Following Neutral Unionization Process (Jan. 9, 2015), available at