When the U.S. Department of Labor announced its “Misclassification Initiative” in September 2011, it was clear that employers utilizing independent contractors were doing so at their own peril. At a meeting of the Connecticut Bar Association’s Labor and Employment Law Section, representatives from both the Connecticut Department of Labor and the Hartford office of the federal Labor Department confirmed that as the one-year anniversary of their partnership agreement approaches, both agencies are continuing to increase their joint efforts to identify and penalize those employers who misclassify — even inadvertently — employees as independent contractors.

Misclassification Initiative

On Sept. 19, 2011, the U.S. Department of Labor, the Occupational Safety and Health Administrative (OSHA) and the Employee Benefits Security Administration (EBSA) entered into a memorandum of understanding with the Connecticut Department of Labor with the specific goal of pooling their resources to identify and pursue employers utilizing independent contractors. State officials also formed their own Joint Task Force consisting of representatives from the Workers’ Compensation Commission, the Department of Consumer Affairs and the Department of Revenue Services, among others.

In addition, the federal Labor Depatment also entered into a memorandum of understanding with the Internal Revenue Service for “enhanced information sharing and other collaboration.”

Impact On Connecticut Employers

The consequences of this collaborative effort are many. For example, instead of having just one agency knocking on your door following a complaint or random audit, there may be joint visits with representatives from both state and federal agencies present.

Far more significant, however, is the sharing of information amongst all applicable state and federal agencies. Gone is the day when an employer might receive a state Labor Department complaint, settle up with that agency for a minimal amount, revise its practices and be done with the matter. Now, instead of just wage and hour exposure from the state complaint, one can assume that information will be forwarded to numerous agencies so that employers may find themselves liable for unpaid payroll taxes, workers’ compensation penalties, unemployment payments and assessments, and other penalties and fines, in addition to wage and hour overtime payments.

Interestingly, a federal Labor Department representative noted that the department does not automatically contact the IRS following every complaint but instead will look at each complaint on a case-by-case basis. By doing so, the federal Labor Department can utilize the threat of potential IRS involvement as “leverage” in any investigation and related settlement discussions.

Not surprisingly, another critical component of the misclassification initiative is the amount of personnel and other resources devoted to conducting independent contractor-related audits and complaints. As the federal representative noted, more than 350 additional investigators have been hired nationwide with several of those assigned to Connecticut offices of the U.S. Department of Labor. Further, these investigators (many of whom are also lawyers) are all being supplied with laptops and other technological assistance so that they can complete their audits quicker and therefore, initiate even more audits.

The federal Labor representative also noted that approximately 40 percent of the Hartford offices’ investigators are involved in what he described as “directed investigations,” meaning that investigators will target a particular industry or even a large project and conduct an investigation — even absent a complaint. Some of the industries receiving the most attention are: construction, health care, restaurant, motor carriers, payroll services and nail salons.

As the state Labor Department representative noted with regard to investigations, it is not merely disgruntled individuals filing complaints. Rather, she noted that approximately 50 percent of the complaints are generated by upset business competitors. Apparently, in these difficult economic times when work is scarce, what better way to place a competitor at risk than by “dropping a dime” with the Connecticut Department of Labor that the competitor is alleged to be utilizing independent contractors.

Finally, all of this increased focus and effort has resulted in the collection of increased overtime wages, payroll taxes and fines and penalties or worse. For example, the state Labor Department recently issued stop work orders to 23 construction contractors in only a one-month period — Feb. 27 to March 30. Big Brother is not only watching, but also acting.

Practical Steps

So what options do Connecticut employers have when faced with this onslaught of federal and state resources in attempting to prudently and lawfully operate their businesses with independent contractors?

First, employers must realize that the ostrich-like “head-in-the-sand” approach will no longer be effective in minimizing their exposure. So, if an employer is going to utilize independent contractors, it must conduct an analysis of whether the contractors satisfy the applicable legal standards. For certain agencies, such as the U.S. Department of Labor, IRS, Connecticut Department of Revenue Services and Connecticut Workers’ Compensation Commission, this means satisfying what is essentially variations of the more traditional common law “right of control” test.

Unfortunately for those issues within the state Labor Department’s jurisdiction, employers are required to satisfy the far more rigorous so-called “ABC” test contained in Connecticut General Statutes Section 31-222(a)(1)(B). In fact, a scenario could arise in which an employer satisfies the “right of control” test but not the “ABC” test, thereby at least limiting its exposure to state wage and unemployment tax obligations.

In conducting their analysis, employers can also utilize labor and employment counsel, not only to participate in the analysis but also to prepare, if appropriate, an opinion letter explaining why the proposed independent contractor arrangement satisfies, or at least would appear to satisfy, all applicable legal standards. Reliance on such letters will not only assist in defending any complaints, but also should at least constitute a good faith defense, precluding any claim that the employer “willfully” disregarded the applicable independent contractor standards. Such a scenario is significant because government officials can seek damages for three years prior to the date of a complaint for willful violations instead of just two years for non-willful violations.

Finally, the Connecticut Department of Labor representative noted that employers concerned about whether or not their use of independent contractors complies with all legal requirements could voluntarily contact the department for a review. While the agency does not have a formal amnesty plan like the IRS’s, the representative noted that by voluntarily contacting it, employers will not only obtain a detailed response regarding their use of independent contractors but also they will minimize their exposure in the event it is determined that they have misclassified individuals as independent contractors instead of employees. Employers contemplating engaging a voluntary audit should, of course, consult with legal counsel before doing so.

The appropriate use of independent contractors can certainly contribute significantly to an employer’s effective operations and bottom line. Their use has always involved some risk but with state and federal governments looking for ways to increase tax revenues in these difficult economic times, the risks of utilizing independent contractors has never been greater — a scenario likely to continue for the foreseeable future as a result of the “misclassification initiative.”•