Latest News > Federal > State of Maryland Enacts Draconian Sanctions for Worker Misclassification

State of Maryland Enacts Draconian Sanctions for Worker Misclassification

On May 7, 2009, Governor Martin O’Malley (D-Md) signed the Workplace Fraud Act of 2009 (S.B. 909), which will significantly regulatory risks associated with doing business with independent contractors – in some cases, to an intolerable level.  

This law illustrates how extreme some states have become in discouraging firms from doing business with the self-employed.

The law will take effect October 1, 2009, but the effective date is inherently ambiguous, as the bill does not indicate whether it will apply to payments made on or after the effective date, to audits commenced on or after that date or to audits concluded on or after that date. 

The new law expressly targets two industries, namely, construction and landscaping, but its unemployment and workers’ compensation provisions affect all industries. An especially pernicious aspect of the new law is its provisions that appear designed to discourage attorneys or CPAs from advising companies on how to structure independent-contractor relationships, by subjecting such advisors to potential penalties of up to $20,000.

I.             The Targeted Class
The targeted provisions of the new law affect only construction services and landscaping services. These provisions, labeled the Workplace Fraud provisions, prohibit an employer within the targeted industries from misclassifying as an independent contractor an individual to whom the employer pays remuneration.   For this purpose, an employer’s relationship with an individual is presumed to be employment, unless the individual qualifies as an “exempt person” or satisfies Maryland’s “ABC” test. 

The new law acknowledges that an employer can engage another business entity, which may have its own employees, to do the same type of work as the employer and at the same location, without establishing an employment relationship for these purposes.

A.   The “ABC” Test
The “ABC” test for purpose of the Workplace Fraud provisions is satisfied if:

A.   The individual is free from control and direction over its performance both in fact and under the contract;

B.   The individual customarily is engaged in an independent business or occupation of the same nature; and

C.  The work is outside of the usual course of business of the person for whom the work is performed, or performed outside of any place of business of the person for whom the work is performed.

The new law clarifies certain aspects of the “ABC” test for purposes of the Workplace Fraud provisions, but the clarifications do not appear to apply for purposes of Maryland’s “ABC” test that applies for purposes of unemployment.

B.   Exempt Person
To qualify as an “exempt person,” an individual must satisfy the following conjunctive test:

1.   Perform services in a personal capacity with no employees other than specified family members;

2.   Perform services free from direction and control over the means and manner of providing the services, subject only to the service recipient’s right to specify the desired result;

3.   Furnish the tools and equipment necessary to provide the service;

4.   Operate a business that is considered inseparable from the individual for purposes of taxes, profits and liabilities:

a.          in which the individual:

i.     owns all assets and profits of the business; and

ii.    has sole, unlimited personal liability for all debts and liabilities of the business, unless it is organized as a single-owned corporate entity; and


b.         for which:

i.     the individual does not pay taxes for the business separately but reports the business activity on the individual’s personal tax return; and

ii.    if the business is organized as a corporation and the individual otherwise qualifies as an exempt person, the individual files a separate federal information tax return for the entity;

5.   Exercise complete control over the management and operations of the business; and

6.   Exercise the right and opportunity on a continuing basis to perform the services of the business for multiple entities at the individual’s sole choice and discretion.

C.  Investigations and Consequences of Violations
The new law provides the Commissioner of Labor and Industry with broad authority to conduct investigations to determine compliance with the Workplace Fraud provisions. It also provides persons and individuals who submit complaints or statements in connection with such an investigation with sweeping confidentiality protections. 

An employer found to have violated the Workplace Fraud provisions will be subject to the following sanctions:
1.   required to pay restitution to an individual determined to have been misclassified;

2.   required to otherwise comply with all applicable labor laws with respect to the misclassified individuals (for a period limited to twelve months before the date of the citation, unless the violation was deemed to be “knowing”);

3.   not be subject to any civil penalty if the employer timely complies with all applicable labor laws (unless the violation was “knowing”), but employers that fail to timely comply shall be assessed a penalty of up to $1,000 for each misclassified worker for whom the employer is not in compliance;

4.   A knowing violator shall be assessed a civil penalty of up to $5,000 per misclassified worker, and may be required to pay four times the amount of restitution it owes; and

5.   A knowing violator for the second time may be assessed a civil penalty of up to $10,000 per misclassified worker;  for three or more times the civil penalty increases to up to $20,000.

Any penalties imposed under the Workplace Fraud subtitle shall also be in effect against any successor business entity, provided certain requirements are satisfied.
The new law provides that the Commissioner has the burden of proof to show that an employer has knowingly failed to properly classify individuals as employees. It also specifies two ways for an employer to establish strong evidence that it did not knowingly fail to classify an individual as an employee:
1.   the employer, before a complaint was filed against it, or the Commissioner  commences an investigation of it:
      A.         obtained evidence that the individual (i) is an exempt person, or (ii)  as an independent contractor, complies with payroll-tax obligations with respect to all individuals working for the independent contractor, and maintains workers’ compensation insurance, and

      B.         provided to the individual a written notice, to be defined in regulations; or

2.   the employer (i) classifies all workers who perform substantially the same tasks for the employer as independent contractors, (ii) complies with Internal Revenue Service (“IRS”) information reporting requirements with respect to payments made to the individual, and (iii) has received an IRS determination that the individual, or another who performs substantially the same tasks, is an independent contractor.
Special rules concerning employers working on a public contract permit a state agency to immediately withhold payments to an employer upon notification that a citation has been issued for a worker-misclassification violation, which funds will not be released until a final determination is made concerning the citation.

D.  Private Right of Action, Confidentiality and Recordkeeping
The Workplace Fraud subtitle also creates a private right of action to recover “economic damages,” plus attorneys’ fees and costs, for individuals who are misclassified as independent contractors, provided that a final order concerning the misclassification has not already been issued under the Workplace Fraud subtitle.  Plaintiffs may recover up to four times the amount of economic damages in the case of a “knowing” misclassification. 

The subtitle contains sweeping anti-retaliation protections for individuals who file a complaint with the Commission, institute a lawsuit or testify against an employer alleging worker misclassification. The provisions prohibit an employer from discriminating in any manner or taking any adverse action against a covered individual.

The Workplace Fraud subtitle imposes extensive recordkeeping requirements with respect to independent contractors, including a requirement to maintain the method of payment, the amount paid per “pay period,” the hours worked, and evidence that an individual is an exempt individual or an independent contractor.  An employer also is required to provide each independent contractor with a specified disclosure notice.

E.   Prohibition Against Developing or Implementing Avoidance Strategies
The subtitle prohibits an individual from knowingly forming a legal entity, assisting another in doing so, or permitting an individual to use another’s legal entity “for the purpose of facilitating, or evading detection of” a violation of the Workplace Fraud subtitle.

Advisors can be subject to a civil penalty of up to $20,000 for knowingly conspiring with, aiding and abetting, assisting, advising or facilitating an employer with the intent of violating the Workplace Fraud subtitle.  Attorneys and CPAs are excepted from this civil penalty, but will instead be referred to their respective licensing authorities for investigation and possible sanction.  

F.   Prohibition Against Bad-Faith Complaints
A person who makes a groundless or malicious complaint against an employer, in bad faith institutes a legal action under the Workplace Fraud subtitle against an employer, or in bad faith testifies against an employer under the Workplace Fraud subtitle is subject to a penalty of up to $1,000. An employer who must defend against a groundless or malicious complaint may recover attorneys’ fees.

II.            Beyond the Targeted Class
In addition to adding the new Workplace Fraud subtitle, the new law also modifies the Unemployment Insurance and Workers’ Compensation Titles . 

The statutory provision defining “Covered Employment” for these purposes will be changed to presume all employment to be covered employment, and enable an employer to overcome that presumption by establishing an individual as an independent contractor or as otherwise specifically exempted. 

A.   The New Sanctions for Misclassification
An employer – in any industry – that is determined to have misclassified individuals as independent contractors for unemployment-tax purposes, and correspondingly fails to pay the unemployment taxes owed with respect to such individuals, will be assessed interest at 2% per month from the first due date following a notice of the misclassification.  In the case of workers’ compensation, the Commission shall order the employer to secure compensation for the covered employee. 

An employing unit determined to have knowingly misclassified an individual as an independent contractor for purposes of unemployment or workers’ compensation shall be subject to a civil penalty of up to $5,000 per employee, and in the case of unemployment taxes, its unemployment-tax rate, for a two-year period, will be determined at the rate otherwise applicable plus two additional percentage points. 

For an employing unit determined to have knowingly misclassified an individual as an independent contractor a second time, the potential civil penalty increases to $10,000.

For unemployment-tax purposes, the new law provides that an employer can establish strong evidence that it did not knowingly fail to classify an individual as an employee if it can show that it (i) classifies all workers who perform substantially the same tasks for the employer as independent contractors, (ii) complies with IRS information reporting requirements with respect to payments made to the individual, and (iii) has received an IRS determination that the individual, or another who performs substantially the same tasks, is an independent contractor.

B.   Prohibition Against Developing or Implementing Avoidance Strategies
The new law provides that a person who knowingly advises an employing unit or prospective employing unit to take action for the purposes of misclassifying individuals as independent contractors shall be subject to a civil penalty of up to $20,000.  Unlike the Workplace Fraud subtitle, these provisions contain no exception to the monetary penalty for attorneys or CPAs.

C.  Agency Regulations
The new law requires the Secretary to adopt regulations that, among other things, provide guidance on what constitutes a knowing misclassification, and on the application of the “ABC” test to the construction industry, the landscaping industry and the home care services industry, including specific examples.

III.          General Provisions
An employer found to have misclassified individuals as independent contractors can be assessed civil penalties by only one order of a court or administrative unit for the same actions, except that a violator can be required to comply with all applicable state laws.

A state agency that makes a determination of misclassification will be required to notify all other relevant state agencies.  The new law also authorizes state agencies to cooperate and share information concerning suspected worker misclassification.