Misclassifying workers as LLC “members” leads to costly settlements

The desire to avoid payroll taxes and other employee-related costs by misclassifying workers (as, for example, “independent contractors”) is nothing new. But a relatively recent scheme made the headlines in April when 16 Arizona companies and individuals agreed to pay $700,000 in back wages, employment taxes and penalties to resolve misclassification of more than 1,000 employees as “member/owners” of LLCs that were fronting for various construction companies.

In announcing the settlement on April 2, the U.S. Department of Labor stated that the construction workers were “building houses in Utah and Arizona as employees one day and then the next day were performing the same work on the same job sites for the same companies,” but without minimum wage, overtime, workers compensation, unemployment insurance, and other workplace protections.

The Labor Department’s five-year investigation began in southern Utah and then moved to Arizona after Utah passed a law that required LLCs to provide workers’ compensation and unemployment insurance to their members.

The settlement requires the defendants to:

• pay $600,000 in back wages and liquidated damages to employees in Utah and Arizona and an additional $100,000 in civil penalties;

• stop using limited liability companies to avoid Fair Labor Standards Act compliance;

• treat themselves as “employers” and their current and future workers as “employees” under the FLSA;

• comply with the FLSA’s minimum wage, overtime, recordkeeping, and anti-retaliation provisions;

• pay all applicable federal, state and local taxes; and

• work with the department to identify those workers who were harmed by their misclassification scheme and determine proper individual payment of back wages.
  

In a separate related investigation, last year the government obtained a consent judgment against a Phoenix drywall contractor that was allegedly a major client of the Arizona defendants in this case. That contractor was required to stop using the Arizona defendants’ unlawful LLC business model and to pay $600,000 in back wages, liquidated damages and civil money penalties.

Lesson for Contractors. While it is easy to differ with the federal government on many issues, there is little disputing that, as a Labor Department spokesperson noted, “the resolution of this case should send a strong message to any other employers, in any industry, contemplating such a scheme."

Nearly every company that has ever found itself in the Labor Department’s cross-hairs can readily attest that there is very little chance of emerging unscathed. In most cases, whatever financial savings a company achieves in the short term will pale in comparison to the devastating financial costs of fighting a misclassification scheme and, at some point, being forced to pay the piper.