Employers Beware: Misclassification Cases are Costly and Common

Many employers erroneously classify workers who should be employees as independent contractors, due to the significant tax savings. However, misclassification cases present major risks. The independent contractor status for a worker is not favored by the IRS, the Department of Labor (DOL), the states, and many agencies within the states including those enforcing workers’ compensation benefits and unemployment. As such, treating a worker who should be an employee as an independent contractor can result in costly litigation and even personal liability.

The biggest problem in classifying workers is that there is no uniform definition of “employee” or “independent contractor” under all the Federal and State labor and tax laws. The Fair Labor Standards Act, passed in 1935, has the broadest definition of “employee” and that has served as the model for most State wage hour laws. Additionally, there have been and continue to be many cases concerning this issue being litigated under Federal and State wage/hour statutes.

The Common Law Definition of Employee

  1. The extent of control which is exerted by the employer over the details of the individual’s work.
  2. Whether the individual is engaged in a distinct occupation or business, so that the individual has an opportunity for profit or loss.
  3. Whether the work is done under the direction of the employer, or by the individual without supervision.
  4. The skill, experience, and specialized training required by the individual’s particular occupation.
  5. Whether the individual supplies the tools, equipment, and place for performing the work.
  6. The length of time for which the individual is engaged.
  7. The method of payment, whether by the hour or by the project.
  8. Whether the work is part of the regular business of the employer.
  9. Whether the parties believe they are creating the employer-employee relationship.
  10. Whether the individual is, or is not, an independent business.

These elements are not given equal weight by reviewing courts and agencies. In fact, Number 9 is rarely given much weight. This case-by-case factual analysis gives the courts and agencies reviewing these cases wide latitude to “reach” the result they desire, as long as they support it with at least some of the major elements.

The IRS Common Law Standard

The IRS now groups the common law standards into three major categories to evaluate whether an individual is an employee or an independent contractor.

  1. Behavioral: Does the Company control or have the right to control what the worker does and how the worker does the job? To analyze this the IRS considers four factors:
    1. The type of instruction given;
    2. The degree of instruction;
    3. Evaluation systems; and
    4. Training.
  2. Financial: Are the business aspects of the job controlled by the employer? The IRS looks at 5 factors to analyze this category:
    1. Does the worker have a significant investment?
    2. Is the worker reimbursed for expenses?
    3. Does the worker have an opportunity for profit or loss?
    4. Are the worker’s services available to other employers in the marketplace?
    5. What is the method of payment?
  3. Relationship: The IRS breaks this category into four factors:
    1. Are there written contracts?
    2. Does the individual receive any benefits like vacation pay, insurance, retirement?
    3. Is the relationship regular and on-going, or for a limited time or specific project?
    4. Are the services provided by the individual a key element of the employer’s business, or are they ancillary to the employer’s business?

Obviously, each of these tests are similar in that they review the same factors. Over the years, case-by-case adjudication has been very fact sensitive, so there has never been a clear and universal test for determining whether a worker is an employee or an independent contractor.

Razak v Uber Technologies Inc., Case No. 16-573 (E.D. Pa. April 11, 2018), which was just decided by a Federal District Court in Pennsylvania, presents an interesting ruling on this issue. In Razak, the Court ruled that drivers for Uber were independent contractors, under the FLSA and Pennsylvania wage hour laws. At first blush, this decision by dismissing the Plaintiffs’ claims that they were employees may appear to be strong support for the status of independent contractors.

However, this decision emphasizes the unique nature of the relationship between Uber and its drivers. The Court pointed out that the drivers have absolute freedom to determine their working hours, work locations, and to decide how much they work, which determines the amount they can earn. Uber does not restrict its drivers from working for other employers, including its own competitors, even while the driver may be online on the Uber App. Uber drivers can go online as much or as little as they choose, and are free to accept or reject any requested rider. The Court also emphasized that all Uber drivers must either own or lease a suitable vehicle, and that none of the significant expenses of a vehicle were ever reimbursed by Uber. The Court agreed that Uber drivers had total economic independence, effectively operating as their own business organization.

This case highlights the difficulties an employer faces in trying to assert that a worker is an independent contractor. It is a rare relationship indeed that allows a worker to have complete discretion over how much, where and when the worker actually works. The investment by the worker in a car and iPhone in order to access the Uber App and render the service are also extreme. Finally, the entire Uber business model is predicated on its drivers being able to work for other employers, even competitors, at the same time they are performing services for Uber.

Since September of 2011, the DOL and the IRS have had a Memorandum of Understanding (MOU) to share information and pursue a joint initiative to prevent misclassification of employees as independent contractors. Recently, the IRS has received criticism from the Treasury Inspector General for Tax Administration. The report accused the IRS of failing to effectually implement the worker misclassification MOU. This could result in more enforcement efforts by the IRS. Even if the IRS terminates the program, many states are getting into this area. In a truly bipartisan effort, many states have recognized that the payroll taxes lost from employers misclassifying workers could be a significant, untapped source of revenue. As of a year ago, 32 states and the U.S. Department of Labor had announced a partnership to coordinate efforts to prevent misclassifications of employees as independent contractors. This partnership provides that all of these states, will share information and coordinate investigations with the Federal government to enhance enforcement of Federal and State Wage and Hour Laws. It also provides a framework under which Federal and State agencies, including the IRS, will work together to share information and resources to increase enforcement of misclassified worker laws. Therefore, even if Federal enforcement of misclassification cases may be less aggressive under the current Presidential Administration, it is clear that many states, will be aggressively pursuing the taxes available from employers which misclassify employees as independent contractors.

Finally, in addition to government investigations and actions, an employer with a large number of independent contractors could face a class action lawsuit, brought by private attorneys in either State or Federal court in any jurisdiction within which an employer has workers or operates.


Employers engaging any workers that they classify as independent contractors should carefully review those individuals to determine whether they should really be employees. Such a self-audit done in advance of a claim or an investigation could result in correcting any misclassifications before a claim is filed. The liability for unpaid wages and benefits, unpaid payroll taxes and the penalties set forth in the various Federal and State tax, wage-hour, and benefits laws can be significant, but could be easily avoided by working with competent counsel to be sure that your workers are properly classified.


About the Author:

James B. Perry is a Member in Dickinson Wright’s Detroit office where he assists clients in all areas of labor and employment law. He can be reached at 313-223-3096 or jperry@dickinsonwright.com.