Strippers, Contractors and Employee Misclassification
If caught misclassifying employees, you could wind up owing unpaid taxes and
employee benefits and be assessed tough penalties.
In July 2015, about 120 exotic dancers filed
a lawsuit against Christies Cabaret, a Phoenix strip
club, alleging a variety of unfair labor practices. The suit came on
the heels of a $6 million settlement achieved by 4,000 dancers in a
similar lawsuit filed in Florida.
In the News:
to Pay $48,000 in Back Wages, Damages (Arizona Republic, July 26, 2016)
At the root of both suits and other
lawsuits filed in several states around the country is the
allegation that clubs illegally classified the dancers as
independent contractors, rather than employees, in order to avoid
expenses associated with overtime, minimum wage, FICA, unemployment
compensation, health insurance, workers compensation, sick time,
vacation time and other costs and benefits required under the Fair
Labor Standards Act (FLSA) and other federal and state laws.
That may sound all too familiar to
contractors. Since the FLSAs passage before World War II, the
construction industry far more than the strip club industry has
consistently attracted U.S. Department of Labor (DOL) scrutiny for
dubious employment practices that include employee misclassification
(i.e., treating as an independent contractor a worker who should be
treated and paid as an employee), abuses of piece work payment, and
This article appeared in the
September 2015 issue of "The Contractor's Compass,"
published by the American Subcontractors Association, and in
the August 2015 issue of "The
Construction Advisor," published by Lang & Klain, P.C.
to the Construction Advisor
The Significance of Classification
If a business classifies a worker as an
employee, it must pay taxes for Social Security, Medicare,
unemployment and payroll. The business must also comply with a whole
slew of federal, state and local rules and regulations. And with
every additional employee, the business increases its headcount for
purposes of complying with the Affordable Care Act (ACA or Obamacare), thereby
potentially increasing health insurance costs and reporting
requirements. The impact of all this is that each employee can cost
a business a substantial amount of time and money every year.
However, if a worker is classified as an
independent contractor, the business does not have to worry about
complying with these burdensome and expensive rules and regulations.
Moreover, businesses do not have to provide independent contractors
with health insurance, retirement plans, paid vacation and other
costly fringe benefits. Thus, there is great incentive to classify
workers as independent contractors. The biggest downside is that
employers have less control over their day-to-day activities.
Employee vs. Independent Contractor: Basic
To determine whether a worker is an employee
or an independent contractor, over the years the DOL and Internal
Revenue Service have generally relied on three categories of
control and independence rules:
Behavioral. Does the company
control or have the right to control what the worker does and how
the worker does his or her job?
Financial. Are the business
aspects of the workers job controlled by the payer? How is the
worker paid? Are expenses reimbursed? Who provides tools, supplies,
Type of Relationship. Are there
written contracts or employee type benefits (i.e., pension plan,
insurance, vacation pay, etc.)? Will the relationship continue? Is
the work performed a key aspect of the business?
However, as FLSA violations continued to
mount, and employers became
more creative in dodging the classification rules, the factors
described above have proven to be inadequate in ensuring proper
classification and payment of employees.
At the very least, an independent contractor
relationship is substantiated by an independent contractor agreement
between the contractor and the company using his or her services,
along with the issuance of a W-9 form by the contractor to the
company. However, as strip club operators are learning, the
existence of an independent contractor agreement is not a cure-all.
The fact that the worker has signed an
agreement stating that he or she is an independent contractor is not
the final say, because the reality of the working relationship is
far more important than the label given to the relationship in an
agreement. In addition, the fact that the worker has incorporated a
business or is licensed by a government agency has little bearing on
determining the existence of an employment relationship.
If you enter into an independent contractor
agreement, include terminology and provisions that affirm the
independence of the worker. For example, refer to the worker as a
contractor; acknowledge that the contractor is free to perform
services for other companies; avoid requiring full-time hours or
daily presence at the company or job site; make payments due when a
project (or a phase of the project) is completed; include a contract
expiration date and renewal/extension provision; specify what
expenses will be reimbursed and the terms of reimbursement.
Economic Realities Test
Even if you use an independent contractor
agreement, the DOLs Wage and Hour Divisions new guidance, in
connection with an economic realities test, could have a big
impact on differentiating between employees and independent
The DOL has stated that the goal of the
economic realities test is to determine whether a worker is
economically dependent on the employer (and is therefore an
employee) or is really in business for him or herself (and is
therefore an independent contractor). [Emphasis added.]
According to the DOL, the following factors are generally
considered when determining whether, under the FLSA, a worker is an
employee as opposed to an independent contractor:
Whether the work is an integral part of
the employer’s business. If a workers work is integral to the
employers business, he or she is more likely to be economically
dependent on the employer and less likely to be in business for
himself or herself. Work is probably integral to the employers
business if it is a part of its production process or is a service
that the employer is in business to provide.
Whether the worker has a managerial role.
This factor focuses on whether the worker has a managerial role, for
example, of hiring and supervision of workers, whether the workers
managerial skill affects his or her opportunity to advance in the
The relative investments in facilities and
equipment by the worker and the employer. To be classified as an
independent contractor, the worker must make some investment
compared to the employers investment (and bear some risk for a
loss). That may include investment in tools and equipment, so long
as a workers investment compares favorably enough to the employers
that they appear to be sharing risk of loss.
The workers independence and initiative.
Both employees and independent contractors may be skilled workers. The DOL focuses on whether the workers skills demonstrate that he
or she exercises independent business judgment, and whether he or
she has personally invested in training, education or development of
skills. The fact that a worker is in open market competition with
others would also suggest independent contractor status.
Whether the employer/worker relationship
is permanent. A permanent relationship with the employer suggests
that the worker is an employee. However, the lack of permanence does
not necessarily mean independent contractor status, because the
impermanent relationship may be due to industry-specific factors, or
the fact that an employer uses staffing agencies.
The employers level of control over the
worker. This factor focuses on who sets compensation and hours, who
determines how the work is performed, and whether the worker is free
to work for others and hire helpers. This is a complex analysis that
requires careful review, because the employer may have little
control in certain situations involving both employees and
independent contractors. In those instances, the DOL will look to
who has meaningful, substantial control over various aspects of the
working relationship. Thus, a worker can be found to be an employee
even if the employer exercises less day-to-day control over the
worker. Note that this factor does not hold any greater weight than
the other factors.
Beware Form SS-8 and the Disgruntled Former
The IRS allows both businesses and workers
to file a
Form SS-8, Determination of Worker Status for Purposes of
Federal Employment Taxes and Income Tax Withholding. The filing of
an SS-8 will trigger the IRS to issue its opinion on whether the
worker is an employee or an independent contractor and can alert
the IRS to any classification problems your business may have. Not
surprisingly, disgruntled former workers often file the form in
conjunction with a claim that their employer improperly classified
him or her as an independent contractor to avoid paying benefits and
taxes. If the IRS believes that your business has classification
issues, it may initiate an official audit. Thus, if a former worker
files a Form SS-8, it is best for businesses to contact their tax
and legal advisors before responding to the IRS.
According to a recent statement by the DOL,
its Wage and Hour Division continues to receive numerous complaints
from workers alleging misclassification, and the Department
continues to bring successful enforcement actions against employers
who misclassify workers." As detailed above, there are myriad
reasons businesses prefer to classify workers as independent
contractors, even if it means less control over a worker's
day-to-day activities. But employers must be careful not to
misclassify their employees. The DOL is cracking down on improper
classification, especially as it tries to stamp out attempts to
dodge insurance obligations under the ACA.
If caught misclassifying
employees, your company could wind up owing unpaid taxes and
employee benefits, and could be assessed significant penalties.
Thus, it is best to keep in mind the DOLs own economic realities
test when deciding whether your workers are employees or independent
contractors. Doing so will go a long way to ensure that your company
stays out of the DOLs crosshairs.