Business Litigation Blog

What’s In a Name? Independent Contractors and the Danger of Misclassifying Employees

Employers, including franchise operators and business owners, may receive special requests from employees regarding whether they can be paid as independent contractors, or may simply wish to hire independent contractors, which can be less expensive for employers and employees. However, before agreeing to issue a 1099 instead of a W2, or classifying employees as contractors, employers need to be aware of the applicable state and federal regulations to ensure the employee’s classification is correct.

Different states apply different tests to determine if 1099 employees are correctly considered “independent contractors.” In New York, there are numerous legal tests to determine if an employee is an independent contractor, including the ‘economic realities’ test, the common law test, and the common law of agency test. All of the tests consider different factors to determine whether an employee qualifies as an independent contractor, but generally, all of these tests consider the employee’s ability to procure outside employment and the degree of control the employer has over the employee’s services, hours and manner of employment.

In New Jersey, the courts apply the “ABC” test, where an employee is not considered an independent contractor unless the following three factors are satisfied: (a) The employee must be free from the employer’s control in performing her work functions; (b) the employee’s service must be outside of the usual course of business of the employer, performed outside of the employer’s places of business; and (c) the employee must have another, regular job, trade or business. See N.J.S.A. 43:21-19(i)(6)(A)-(C).

As stated above, certain employees may prefer to be classified as independent contractors, which can be less expensive for both employees and employers. However, erroneously classifying an employee as an independent contractor can have grave consequences in the event of a lawsuit, later, or a Department of Labor investigation. In the event of a lawsuit, attorneys’ fees and other damages, including liability for unpaid payroll taxes, unpaid overtime, and minimum wage compensation can be awarded to the employee – even if that employee requested to be classified as an independent contractor.

If your business or franchise currently employs 1099 employees, it is critical to conduct regular audits to ensure those employees meet the applicable tests in your state. If the audit uncovers misclassified employees, you must immediately switch these employees to “W2” employees, to limit your liability. Even if your audit does not uncover misclassified 1099 employees, the safest bet, in most instances, is to classify all employees as “W2” employees, and to require employees to record their own hours, in writing, and thereafter to be paid via a payroll service.

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