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Misclassification of Employees could be a Serious Matter

By: Santiago J. Padilla, Esq.

A large part of my practice at Fowler Rodriguez is advising foreign companies regarding establishing their U.S. subsidiaries or affiliates. One aspect of this work that is extremely crucial is employment matters. Indeed, the employment field is a veritable minefield of legal issues. This article will discuss employee misclassification, which has recently been the focus of the U.S. Department of Labor ("DOL") and is the subject of many DOL audits.

Most employment in the U.S. is covered by the Fair Labor Standards Act of 1938 (29 U.S.C. ยง201 et seq.) (the "FLSA"), which provides that employees are either "exempt" or "non-exempt." Nonexempt employees are entitled to overtime pay. Exempt employees are not. However, most employees covered by the FLSA are nonexempt.

Some employers accidentally or intentionally misclassify their employees in order to limit costs. Generally, there are two types of misclassification that the DOL looks for when they perform an audit. First, some employers misclassify their employees as "exempt" when they are actually "nonexempt." This allows the employer to avoid paying overtime compensation when employees work more than 40 hours per week. Second, some employers misclassify their employees as "independent contractors" instead of employees, which avoids the payment of employment taxes as well as overtime compensation. Both of these practices are illegal and could subject an employer to severe sanctions and liability. In fact, the 2008 case of Morgan v. Family Dollar Stores, Inc., Case No. 07-12398 (11th Cir. December 16, 2008), where a jury entered a verdict against the employer for over $35 million was upheld by the 11th Circuit Court of Appeals, should be a fair warning to all employers that these issues need to be carefully addressed.

Exempt or Nonexempt?

The majority of U.S. workers are covered by the FLSA's overtime provisions. Some jobs are specifically excluded from the FLSA, like many types of agricultural workers, and other professions, like truck drivers, are governed by other laws. However, unless the employee fits into one of the exempt categories, then the employee is nonexempt and is entitled to both the minimum wage and overtime pay. In order to be considered exempt for the purposes of the FLSA, the employee must make a salary greater than $455 per week and meet one of the following requirements:

  • Bona Fide Executive.- A bona fide executive must manage the whole business or a major part of the business, including supervising and directing at least two full-time employees. In addition, the bona fide executive must have the authority to hire and fire employees, or at least have their recommendations for hiring and firing be given particular weight. In addition, the "supervising" that is performed must be a regular part of the employee's job, and must be of other employees. Supervision of non-employees does not meet the standard. Also, "mere supervision" is not sufficient. The supervisory employee must have "management" as the "primary duty" of the job.
  • Learned Professional.- A learned professional performs work that requires advanced knowledge of science or learning acquired by attending educational instruction. Professional employees include lawyers, doctors, dentists, teachers, architects, etc. Also included are registered nurses (but not LPNs), accountants (but not bookkeepers), engineers, scientists (but not technicians), pharmacists, and other employees who perform work requiring "advanced knowledge" similar to that historically associated with the traditional learned professions. Professionally exempt work means work which is predominantly intellectual, requires specialized education, and involves the exercise of discretion and judgment. Professionally exempt workers must have education beyond high school, and in many cases beyond a baccalaureate degree. Advanced degrees are the most common measure of a professional employee.
  • Computer or IT Employee.- If an employee is skilled in the computer field performing the application of systems analysis techniques and procedures, or designing, analyzing, creating, documenting, modifying or testing computer systems, machine operating systems or programs.

If an employee does not fit into one of the foregoing categories, then that employee must be paid an hourly wage.

Independent Contractor or Employee?

Determining whether an individual is an independent contractor or an employee requires a complex analysis and is not based on whether the individual signed an agreement or received a Form 1099-Misc. Under the law, the status of employee cannot be waived by signing a contract stating that the person is an independent contractor. Thus, the fact that a contract may state that a person is an independent contractor is not controlling under the employment laws.

The courts have generally stated that the employer-employee relationship is tested by "economic reality" and not by applying technical concepts. There is no single test for determining whether an individual is an employee or an independent contractor. The facts and circumstances of each case must be carefully examined.

An independent contractor does not have the same rights and duties as an employee. For example, an independent contractor often has the right to choose where and when to perform the work (unless the contractor has agreed to specific locations and times required by the business). An employee must be at work where and when the employer requires.

Of course, an independent contractor is obligated to perform the work to the standards and schedule set by the business. Independent contractors, unlike employees, must pay their own taxes.

The Supreme Court has explained that courts must determine whether, as a matter of economic reality, an individual is an employee or an independent contractor. For example, in the case of Rutherford Food Corp. v. McComb, 331 U.S. 722, 728, (1947), among the factors the courts considered significant are:

  • The permanency of the relationship
  • The nature and degree of control exercised by the principal
  • Whether the services rendered are an important part of the principal's business
  • The amount of investment in equipment and facilities made by the alleged contractor
  • Whether the alleged contractor provides services to other principals
  • Whether the alleged contractor can dictate the manner and method of providing the services

No single factor is determinative, and courts must ultimately decide the degree of dependence of the alleged employees on the businesses with which they are connected. The determination of employee status is a question of law and fact.

Finally, it is immaterial who pays the individual, such as in the case of an individual paid by a payroll company or a staffing company. Most courts have reiterated time and again that what matters is the substance of the relationship, not the form of the relationship as may be indicated by documents signed by the parties (for example, independent contractor agreements).

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If you have any questions regarding the classification of employees or other employment law issues, please do not hesitate to contact me, Santiago J. Padilla, Esq., either at 800-483-7197, at spadilla@frfirm.com, or at Fowler Rodriguez LLP (786-364-8445), a full-service national law firm with multiple areas of legal expertise.

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