BLOG: Legal and Financial Risks for IT Staffing Firms to Misclassify Their Employees

The risk of misclassifying employees as independent contractors (IC) is a growing problem for companies nationwide. While most states have laws that regulate worker classification, the U.S. Congress is considering passing a federal law that would override existing state laws. In February, the U.S. House of Representatives passed the Protecting the Right to Organize (PRO) Act, which legal experts say is parallel to California’s rigid IC law known as AB5. The federal bill needs to pass the Senate and be signed by President Joe Biden before it can go into effect.

Chris Leddy, a corporate partner with Becker LLC, says IT staffing firms that misclassify employees as ICs take on a substantial legal and financial risk under current state and federal laws.

“If you classified someone as an IC and you fail the applicable test, such as the ABC Test, IRS Test, Economic Realities Test, she or he is then reclassified as an employee and you will likely owe penalties, fines, and back taxes. Also, if they worked more than 40 hours and you failed to properly track their time and/or pay them premium pay when required, well now you have a potential wage-and-hour lawsuit on your hands where you could potentially be liable for such premium or overtime pay, as well as a multiplier of damages depending on what law applies,” said Leddy. “Further, if a wage-and-hour violation is found, most laws mandate you pay the plaintiff’s attorney’s fees and interest. These type of issues could also lead to class action suits which could be valued in the millions to the tens of millions of dollars depending on the number of workers at issue,” he added.

What if you are about to sell your company?

“If you’re looking to go to market. Having ICs for all the reasons that we discussed increases your risk profile, and by increasing your risk profile, you could be decreasing your multiple or creating greater holdbacks than necessary, longer earn-out periods, and/or greater indemnifications,” he said.

No Company Is Exempt

Martin L. Borosko, the managing partner at Becker LLC, notes that all states have tests to determine whether someone is an IC or employee. The ABC Test started trending and people started taking notice last year when California incorporated it into a worker classification law called AB5.

“Folks should realize that it’s not just if you’re in California; it’s not just if you’re on the East Coast,” he said, referring to recent class-action lawsuits in Alabama and Kentucky as examples of why business nationwide must take IC misclassification seriously.

He added that no exemption was available for IT or Business to Business (B2B) companies. “Many staffing firms believe that B2B somehow completely absolves them from the independent contractor test,” he said, “And the reality is it does not…It may help, and it may lessen risk, but the risk is still there unless done in accordance with the letter of the law.”

How to Mitigate Risks?

Leddy advised IT staffing firms to generally not consider ICs unless they can pass a “smell test” to determine if they are an IC, by asking pertinent questions, such as:

  • Is the contractor a business entity? If yes, how many employees does the company have? Do they have a certificate of good standing?
  • Is the contractor only relying on you for income? If not, how many other clients are they servicing?
  • Do they have business insurance?
  • Is the work being performed or to be performed work that your W-2s do?
  • Does your contractor have a website, a company phone line, company email, physical location, and business card?

“What is the first thing any of us do when we’re looking up a potential client?” he said. “We Google them, right? If they don’t show up, that’s a problem because that’s exactly what auditors are going to do.”

Finally, Borosko and Leddy discussed pertinent contractual provisions that should be in all contracts with ICs, including, but not limited to, indemnifications, limitation of liability, insurance coverage, paid when paid clause, anti-assignment provisions, assignment of works created, and thorough representations and warranties from the IC.

Members can access Who Is Your Employee? Independent Contractor Classification for IT Staffing Firms webinar through the TechServe Online Learning Center.

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