Risky Business: The Perils of Independent Contractor Misclassification

freelanceHiring independent contractors instead of employees often has a financial benefit for businesses due to savings in payroll taxes and employment benefits, and avoidance of wage and hour regulations. However, if a state or federal agency discovers that an independent contractor is misclassified, the business faces back pay, fines, interest, civil and criminal litigation costs, and business restructuring costs. All benefits gained from the misclassification are lost and more! If the business does not pay all associated fines and interest, the overflow debt may then be held against the owner’s personal accounts.

Several states and federal agencies monitor independent contractor misclassification; the misclassification identification in one agency often has a domino effect, brings all agencies and formerly misclassified employees pounding on your door, demanding money. The cost associated with this risky mistake can realistically drive you out of business. In case you are still unconvinced of the severity of the misclassification, the following article describes penalties associated with violations in Nevada.


The burden of proof rests upon the employer to determining whether an independent contractor relationship exists. The employer needs to demonstrate the existence of three factors.

  • The person has been and will continue to be free from control or direction from the employer regarding the performance of services;
  • The service is either outside the usual course of the business for which the service is performed or that the service is performed outside of all the places of business of the enterprise for which the service is performed; and
  • The service is performed in the course of an independently established trade, occupation, profession or business in which the person is customarily engaged, of the same nature as that involved in the contract of service.


They’re Watching You

The following Nevada agencies monitor independent contractor misclassifications:

  • Division of Industrial Relations, Nevada Department of Business and Industry
  • Employment Security Division (“ESD”)
  • Office of the Labor Commissioner
  • Nevada Department of Taxation
  • Department of Labor Standards Enforcement (“DLSE”)


The following federal agencies monitor independent contractor misclassifications:

  • Wage and Hour Division of the Department of Labor (“WHD”)
  • Equal Employment Opportunity Commission (“EEOC”)
  • Internal Revenue Service (“IRS”)


Agencies choose to investigate when…

  • Your “independent contractor” files an unemployment claim
  • Independent contractor complaints (e.g. By a competitor)
  • You independent contractor’s lawsuit against you
  • Random audits
  • Internet registration process


Heavy Consequences

  • Employment benefits including health insurance, retirement contribution, stock options, paid vacations, sick days, life insurance, disability insurance, etc.
  • Payroll taxes for each misclassification during each tax period including Social Security and Medicare taxes, federal unemployment insurance taxes, workers’ compensation insurance, etc.
  • Back wages, overtime pay, FMLA leave, and other employment law compliances fines
  • Interests and penalty on everything.
  • Gross misdemeanor criminal charges.
  • Civil action suits by the Nevada Attorney General and class action suits by misclassified workers.
  • Restructuring costs to ensure current and future workers will be properly classified.


Remember, these liabilities may pierce the corporate veil, becoming the liability of the owners and corporate officers, if not paid.


Learn from Microsoft’s Mistake

The IRS found Microsoft’s employment misclassification in the early 1990s and charged Microsoft millions in fees and penalties and caused Microsoft to restructure its human resources. After the federal government was finished with Microsoft, the company faced a civil suit for employment benefits from eight of the previously misclassified workers. Microsoft lost the suit in the circuit court and settled the case for $97 million.


Riskier than Ever!

Since 2011, the federal government has cracked down on employment classification, adding over a hundred monitoring agents and $25 million in funding to catch misclassifications. Specific task forces communicate between agencies to ensure that misclassifications are fully penalized by various agencies. This trend is not changing; in 2013, the federal government budgeted $14 million of grant money to assist states in identifying misclassifications. Now more than ever, business owners should be vigilant in employment classification.


Words Don’t Matter

Nevada has a counterintuitive definition for independent contractors. Designating the business relationship in an independent contractor agreement and actually perceiving your worker as an independent contractor is not enough. To proactively ensure that your workers are properly classified, call the lawyers at the Drinkwater Law Office.

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