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Misclassification of employees as independent contractors remains a significant issue

November 4, 2013

In light of the implementation of the Affordable Care Act (ACA), and its various requirements tied to the number of employees a company maintains, businesses have been looking more closely at the proper classification of workers as employees versus independent contractors.  Companies are not the only ones focusing on this issue, however.  The U.S. Secretary of Labor recently opined that the misclassification of employees constitutes “workplace fraud,” and he vowed to pursue the issue aggressively.  Indeed, misclassification can be a hidden time bomb, both for ongoing businesses and for health care entities planning mergers, acquisitions or divestitures.  Besides the ACA implications, misclassification can result in violations of the Fair Labor Standards Act and state wage laws, make employers subject to additional discrimination liability, and give rise to violations of state and federal tax requirements. 

Given these recent developments, it is critically important to avoid misclassifying employees as independent contractors.  The analysis is not always easy, however, mostly because a variety of tests may apply.  For instance, each state has developed a classification test, and numerous states have multiple tests depending on whether the classification issue relates to discrimination laws, unemployment compensation or workers’ compensation.  In general, the state tests are similar to one of the following two federal tests:

  • First, the Department of Labor uses the “economic realities” test, which examines: (1) the degree of control over the person’s work by the company; (2) the individual’s investment in equipment and facilities; (3) the individual’s potential for profit or loss as in a regular business; (4) the length of the relationship; (5) whether the individual’s work is an integral part of the company’s operations; and (6) the amount of open market competition involved in the independent contractor’s business and success. 
  • Second, the IRS considers behavioral control (such as instructions and training), financial control (such as reimbursement of expenses, worker investment, manner of payment, the worker’s market presence and the worker’s profit and loss), and the relationship type (such as the parties’ written agreement, whether the worker receives employee-type benefits, the permanency of the relationship, and the extent to which the worker’s services are a key aspect of the company’s regular business).  In general, the greater the behavioral control by a company over the individual’s work, the more likely it is that the individual will be classified as an employee.

Since most situations in the health care setting are unique, the decision to classify a worker as an independent contractor requires careful analysis.  Likewise, clients that anticipate buying or selling a medical practice or hospital should be sure to consider this issue during the due diligence period and in crafting their representations and warranties.  If you have questions regarding the proper classification of employees, or for further information, please contact Sean Crotty or members of the Health Care Practice Group.