intense global competition. 1 Independent contractors, also called - PDF document

N OTE Balancing the ERISA Seesaw: A Targeted Approach to Remedying the Problem of Worker Misclassification in the Employee Benefits Context Tracy Snow * I NTRODUCTION Employees cost a lot. Consider the following scenario: Two com- panies, Letter of the Law Ltd. (“Letter of the Law”), and Cutting Cor- ners Co. (“Cutting Corners”), want to increase the size of their workforce to satisfy escalating production demands. To add extra em- ployees, each company must absorb the costs of paying state and fed- eral employment taxes and providing pension and welfare benefits to these workers. Neither company can meet these expenses and remain in business. Instead of throwing in the towel, both employers hire in- dependent contractors, a decision that allows them to avoid the costs of payroll taxes and employee benefits. Like Letter of the Law and Cutting Corners, many companies are increasingly using independent contractors to reduce costs in an envi- ronment characterized by unexpected fluctuations in the market and * J.D., May 2011, The George Washington University Law School; B.A., 2005, The Col- lege of William and Mary. I owe countless thanks to Kimberly Sikora Panza, Allison Owen, and Michael Viglione for their invaluable support and insight throughout this process. I also thank Alex Hastings, Chris Dawson, Johanna Hariharan, and Richard Crudo for their careful editing. June 2011 Vol. 79 No. 4 1237

1238 THE GEORGE WASHINGTON LAW REVIEW [Vol. 79:1237 intense global competition. 1 Independent contractors, also called “freelancers,” are self-employed individuals who render services di- rectly to companies outside the scope of the traditional employment relationship. 2 Courts and agencies use various common law tests to distinguish independent contractors from employees. The widely used control test, for example, gauges the amount of control exerted by the hiring party over “the manner and means by which the [work] product is accomplished.” 3 To abide by the control test, Letter of the Law and Cutting Cor- ners must relinquish a significant amount of control over their work- ers before classifying them as independent contractors. Suppose the following occurs: Letter of the Law allows its workers to set their hours and work from home. Cutting Corners, however, labels its workers as independent contractors, yet intentionally retains the same level of control it exercises over its common law employees. Now suppose that the Internal Revenue Service (“IRS”) audits the companies and, using its own version of the control test, concludes that the companies misclassified their workers. 4 Misclassification oc- curs when a worker labeled as an independent contractor actually meets the control test definition of an employee. 5 The IRS could have reached its conclusion for any number of reasons; perhaps it deter- mined that Letter of the Law retained the right to control its workers (even though it did not exercise such control) and thus misclassified them. 6 1 See Orly Lobel, The Slipperiness of Stability: Contracting for Flexible and Triangular Employment Relationships in the New Economy , 10 T EX . W ESLEYAN L. R EV . 109, 112, 115 (2003); Katherine V.W. Stone, Legal Protections for Atypical Employees: Employment Law for Workers Without Workplaces and Employees Without Employers , 27 B ERKELEY J. E MP . & L AB . L. 251, 253–54 (2006). 2 J AYNE E. Z ANGLEIN & S USAN J. S TABILE , ERISA L ITIGATION 1404 (3d ed. 2008). 3 Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323 (1992) (quoting Cmty. for Crea- tive Non-Violence v. Reid, 490 U.S. 730, 751 (1989)). Besides the control test, courts have also used the economic reality test, which regards employees as “those who as a matter of economic reality are dependent upon the business to which they render service.” Bartels v. Birmingham, 332 U.S. 126, 130 (1947). For a comprehensive history of both tests, see Richard R. Carlson, Why the Law Still Can’t Tell an Employee When It Sees One and How It Ought to Stop Trying , 22 B ERKELEY J. E MP . & L AB . L. 295, 304–34 (2001). 4 See Rev. Rul. 87-41, 1987-1 C.B. 296, 296–99 (outlining twenty-factor control test used by IRS to classify employees); see also I NTERNAL R EVENUE S ERV ., D EP ’ T OF THE T REASURY , I NDEPENDENT C ONTRACTOR OR E MPLOYEE ?: T RAINING M ATERIALS 2-3 to -4 (1996) [hereinaf- ter IRS, T RAINING M ATERIALS ]. 5 See U.S. G OV ’ T A CCOUNTABILITY O FFICE , GAO-09-717, E MPLOYEE M ISCLASSIFICA- TION : I MPROVED C OORDINATION , O UTREACH , AND T ARGETING C OULD B ETTER E NSURE D E- TECTION AND P REVENTION 3–4 (2009). 6 See Gierek v. Comm’r, 66 T.C.M. (CCH) 1866, 1868–69 (1993) (stating that a worker

2011] BALANCING THE ERISA SEESAW 1239 Although both Letter of the Law and Cutting Corners misclassi- fied their workers, their behavior vastly differed: the former mistak- enly interpreted the common law standard, while the latter knowingly disregarded the test’s requirements. A host of federal and state laws recognize the distinction between the behavior of these companies. Under federal law, for example, the IRS may assess tax liabilities stemming from misclassification. 7 A federal safe harbor provision, however, relieves employers like Letter of the Law, which, among other things, had a good faith basis for its mistaken classification. 8 Re- cently enacted state laws, such as Maryland’s Workplace Fraud Act, 9 impose harsher penalties on employers who knowingly misclassified their workers than on employers who misclassified without the requi- site intent. 10 Pursuant to these standards, Letter of the Law would potentially avoid liability, while Cutting Corners would face severe penalties. Under the Employment Retirement Income Security Act of 1974 (“ERISA”), 11 the federal law that regulates employer-sponsored wel- may be considered an employee if the business had a right to control the worker, even if it did not actually control the worker). 7 An employer who misclassified a worker could be required to pay a portion of the taxes it should have withheld from the worker’s paycheck, I.R.C. § 3509(a) (2006), and additional penalties for the failure to file a tax return, id. § 6651(a)(1)–(3). 8 The safe harbor provision, section 530 of the Revenue Act of 1978, allows employers to escape federal employment tax liability if three requirements are met: reporting consistency, substantive consistency, and a reasonable basis for the classification. See Revenue Act of 1978, Pub. L. No. 95-600, § 530, 92 Stat. 2763, 2885–86 (amended 1979, 1980, 1982, 1986, 1996, 2006, 2008). Section 530 is technically not part of the Internal Revenue Code, although its text is included in the notes accompanying I.R.C. § 3401(a) (West 2006). IRS, T RAINING M ATERIALS , supra note 4, at 1–3. 9 Workplace Fraud Act, M D . C ODE A NN ., L AB . & E MPL . §§ 3-901 to -920 (LexisNexis Supp. 2010). 10 Compare id. § 3-909 (requiring employers who knowingly misclassified their workers to pay an automatic civil penalty and restitution to employees “up to three times the amount” to which they are entitled), and id. § 3-911 (providing a private right of action where employees can obtain triple damages from employers who knowingly misclassified them), with id. § 3-908 (al- lowing employers who misclassified their workers, but did not do so knowingly, to escape civil penalties by timely complying with state labor laws). Kansas and New Mexico have also enacted misclassification statutes that differentiate employers based on their behavior. See K AN . S TAT . A NN . § 44-766(a) (Supp. 2009) (“No person shall knowingly and intentionally misclassify an em- ployee as an independent contractor . . . .”); N.M. S TAT . A NN . § 60-13-3.1(C) (Supp. 2010) (spec- ifying that a person who “intentionally and willfully” misclassifies an employee as an independent contractor is guilty of a misdemeanor). 11 Employee Retirement Income Security Act (ERISA) of 1974, Pub. L. No. 93-406, 88 Stat. 829 (codified as amended at 29 U.S.C. §§ 1001–1461 (2006) and in scattered sections of the Internal Revenue Code). Most practitioners refer to ERISA’s original section numbers. Ac- cordingly, this Note will cite to the original section number, followed by a parallel citation to the United States Code section number.