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Worker Misclassification of Limited Liability Companies and Corporations

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Worker Misclassification of Limited Liability Companies and Corporations

Worker misclassification is the practice of improperly classifying workers as independent contractors, rather than employees. A task force was established by Governor Murphy to investigate worker misclassification.

The Task Force found that employers which misclassifying their employees as independent contractors fail to pay as much as thirty (30%) percent of payroll and related taxes otherwise paid for employees, including under-withholding federal and state income taxes, failure to contribute to federal programs including Social Security and Medicare and State unemployment and disability, workers’ compensation insurance programs.

The Task Force identified several forms of misclassification such as:

  • Employers classifying employees as “independent contractors,” when the workers are not truly running their own businesses; or
  • Employers requiring employees to form a limited liability corporation or franchise company as a condition of getting a job.

A recent decision of the New Jersey Superior Court, Appellate Division, East Bay Drywall LLC v. Dep’t of Labor & Workforce Dev.; Docket No. A-2467-19, considered several forms of potential employee misclassification by a drywall installation contractor which hired installers to perform drywall installation and taping services. Approximately one-half of the installers were properly classified as employees of the contractor. An auditor for the Department of Labor and Workforce Development (DOLWD) found the sixteen installers were improperly classified as independent contractors. Among the installers found by DOLWD to be improperly classified were four individual workers and twelve business entities organized as limited liability companies or corporations.

East Bay challenged the auditor’s findings in the Office of Administrative Law before an administrative law judge (ALJ). The ALJ agreed that three individual installers were misclassified but declined to classify the installers who had formed and operated corporations or limited liability companies as employees. The Commissioner of DOLWD exercised his authority to reverse the ALJ’s decision and reinstate the auditor’s findings. East Bay appealed the ruling of the Commissioner.

The appellate court began its review with a discussion of the rules for governing worker classification under the New Jersey Unemployment Compensation and Temporary Disability Insurance Laws (the “UCL”), including the statutory classification criteria, commonly called the “ABC Test.” The UCL statute is remedial worker protection legislation and historically, has been liberally construed to achieve those purposes.

The ABC Test is a broad test to determine employment status under of a worker the New Jersey Wage & Hour Law, Wage Payment Law, and Unemployment Insurance laws.  A worker is classified as an employee unless the employer can satisfy all three prongs of the ABC Test:

  1. The worker has been and will continue to be free from control or direction of performing such service, but under his or her contract of service; and
  2. The provided service is outside the usual course of business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which   such service is performed; and
  3. The individual is customarily engaged in an independently established trade, occupation, profession, or business.

The Court found all the installers in question satisfied Part A because they were not under East Bay’s control, nor did they take instruction or tools from East Bay to complete the jobs. The Court also found that all the installers at issue satisfied Part B because the work was completed at the customers’ job sites and not East Bay’s place of business. The phrase “places of business” under part B “refers only to those locations where the enterprise has a physical plant or conducts an integral part of its business.

Having found that Parts A and B were satisfied, classification of the installers rested on the satisfaction of Part C which concerns whether the alleged employee is customarily engaged in an independently established trade, occupation, profession, or business.

Regarding three individuals, East Bay was unable prove they operated as a business rather than as a single worker. For instance, one worker worked only for East Bay and another acknowledged to the auditor he did not operate a business.

Three installers each organized as a single member LLC. The Court rejected the Commissioner’s assertion that single-member LLCs are treated as “disregarded’ entities” for the purpose of employment tax liability. N.J.S.A §42:2C-92 treats a single member LLC as a disregarded entity separate from its owner for income tax purposes only. The Court also declined to extend an administrative rule, N.J.A.C. §12:16-11.2, which considers an LLC’s sole member as the employer liable responsible to make UCL contributions, to require an LLC’s sole member to be classified as an employee.

The Court did however uphold the ruling of the Commission that Est Bay failed to prove that  two corporations, for which no annual reports were ever filed, and which have had their charters revoked, were bona fide entities separate for their owners.

Regarding the remaining entities, East Bay showed each of those installers had provided certificates of insurance to East Bay, which is viewed by the Court as being significant, albeit not necessarily dispositive, indicia of their independent business status under the third prong of the ABC Test. The Court discounted the auditor’s finding that none of the remaining entities were in business when the audit was conducted. That finding did not establish the entities were inactive during the audit years and could not support the Commissioner’s disregard of the independent business status of these entities.

The Court was careful to state it was not endorsing the use of sham corporations or LLCs created to evade UCL contributions or avoiding other worker protection legislation. Here, the record did not establish that East Bay illicitly orchestrated with the installers in a coordinated effort to misclassify workers. However, had the Commissioner developed a record that owner and East Bay did not treat the business entity as an independent business or had East Bay required its workers to form a business entity as a condition of getting a job, the court would likely have accorded the DOLWD the high level of deference ordinarily applied in reviewing administrative decisions.

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