Employee Misclassification in Healthcare: Penalties and Risks

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Written by Aldo Zilli, Esq. Senior Manager, B2B Content, IntelyCare
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Healthcare facilities and their resource managers face a number of staffing challenges on any given day — from confirming that shifts are staffed at the right ratios to ensuring that the right type of staff are in place to address the dynamic needs of patients or facility residents.

One way that facilities have been able to meet those needs in an efficient and flexible manner has been to utilize a staffing strategy that includes full-time and contract staff, with contractors serving as short-term support without the long-term commitment. There are important distinctions between these types of workers, and if the distinctions are not recognized, an employer could face significant legal exposure from the risk of employee misclassification.

Here’s an overview explaining the misclassification of employees as independent contractors, how it can apply in the healthcare setting, and how facilities can minimize their risks and avoid possible penalties.

What Is Employee Misclassification?

Employee misclassification occurs when a company hires a worker as an independent contractor, but the worker behaves — and is treated — more like an employee than a contractor. Companies might hire an independent contractor instead of a worker classified as an employee based on the apparent cost savings, but they assume significant legal and financial risk if they misclassify workers.

This is because employees have certain rights under federal employment laws as well as state laws. For example, under the Fair Labor Standards Act (FLSA), many employees are entitled to minimum wage protections, overtime pay, and basic recordkeeping per pay period. These rights and employer responsibilities (which also include payment of Social Security and Medicare taxes) don’t apply to workers who are independent contractors, making them an appealing option for industries that need a flexible workforce.

Whether a worker has been improperly classified as an independent contractor instead of an employee — and who makes that determination — can vary depending on the nature of the misclassification and its impact. Here are a few examples of governmental entities that can make a determination of misclassification and the various tests they use.

Internal Revenue Service

The IRS is concerned about misclassification because employers are generally required to withhold and pay income taxes, Social Security, and Medicare for employees, but not for independent contractors. When a violation is identified, the IRS penalties for misclassification of independent contractors would include, among other things, efforts to recover back taxes owed by an employer.

To determine the appropriate worker classification, the IRS looks to common law rules involving the degree of control and independence of the worker. Specifically, it looks at the level of control that an employer has in what the worker does (behavioral), the business aspects of the worker’s job (financial), and the stated relationship between the employer and the worker (type of relationship).

U.S. Department of Labor

The U.S. Department of Labor (DOL), through its Wage and Hour Division, conducts employee misclassification investigations with a focus on whether employers are avoiding labor laws — and skirting employee rights — by designating workers as contractors instead of employees. The DOL can initiate a workplace audit of a business for any reason, but they are often triggered by a worker complaint or by the fact that the business’ geographic region or industry has a history of misclassification issues.

The DOL has traditionally used a “totality of the circumstances” test to determine whether a worker has been misclassified, with the ultimate focus on the work relationship. Is the worker economically dependent on the employer for work (employee) or in business for themselves (independent contractor)? Under the totality of the circumstances test, the DOL considers multiple factors, such as the:

  • Degree of control that the employer has over the worker
  • Opportunity for profit or loss
  • Worker’s level of investment in equipment and facilities
  • Permanency of the relationship
  • Level of skill and initiative of the worker
  • Degree to which the work is an integral part of the employer’s business


The court system can also be involved in determining whether a misclassification exists, but only on the filing of a complaint by a worker alleging damages or when a governmental agency seeks to enforce the law by filing suit. Based on Supreme Court precedent, courts generally use the “element of control [as] the principal guidepost” in determining whether an employee has been improperly classified as an independent contractor, but courts still use a multi-factor test, like the one used by the DOL.

State Agencies

States also have laws against the misclassification of employees. While there are exceptions and variations, many jurisdictions use the “ABC Test,” under which a worker is presumed to be an employee unless each of the following three criteria are met:

  1. They are free from the hiring entity’s control and direction while performing their service.
  2. They are performing a service that’s outside the hiring entity’s usual course of business.
  3. They are engaged in an independently established trade or business that involves services that are similar in nature to those they are performing for the hiring entity.

This is a stricter test that leans heavily toward an employee designation. There are states that use the ABC Test, but with exceptions for certain industries. California, for example, uses the stricter ABC Test for most industries, but then uses a less stringent test for certain professional occupations like attorneys or architects, or for construction subcontractors.

Other states have specifically targeted misclassification in the healthcare field. For example, in 2022, Illinois updated its laws requiring nursing care facilities to deem any nurse contractors as employees when operating within their facilities. In updating its laws, the state recognized that nurse professionals in a facility require supervision and control in order to safely and effectively carry out their responsibilities, and to comply with their licensing requirements. However this supervision and control isn’t consistent with an independent contractor status, especially considering the legal tests discussed above.

What Are the Risks of Employee Misclassification in Healthcare?

At first glance, the healthcare setting is an ideal environment to bring in temporary contractors, especially when a facility needs to surge staff to deal with a sudden influx of patients. With all the hazards of short staffing, having a standby pool of healthcare workers is essential.

However, misclassification carries weightier risks in the healthcare setting. Consider what a true independent contractor status — where a worker has full autonomy to perform their services without any direction or control — means in a healthcare setting and the consequential risks that follow. Here are just a few examples:

  • Nursing professionals who aren’t bound by a set shift or break schedule can lead to patient abandonment, especially when no nursing handoff is performed.
  • Nursing professionals who aren’t required to abide by the control imposed by a facility’s policies or standards of care could perform their services in an inconsistent, and perhaps negligent, manner.
  • LPNs or CNAs who must operate under the supervision of an RN could instead be operating autonomously in violation of their authorized scope of practice.

To better illustrate the distinction, when you hire an independent contractor to paint your facility, you don’t tell them which brushes to use. However, when you hire a nurse contractor to care for your patients, you do want to direct how they care for their patients to ensure that they abide by facility policies and are adequately reporting to a supervisory chain.

What Are Some Employee Misclassification Penalties?

Needless to say, there is significant risk of legal and financial exposure when you classify workers improperly. When a patient, or even a staff member, incurs an injury as a result of workers operating without needed oversight in a healthcare facility, a plaintiff’s attorney could hone in on the lack of supervisory control as evidence to show a breach of the basic duty of care.

Facilities can also face legal exposure resulting from increased interest in misclassification by agencies. For example, the DOL has increased its misclassification enforcement efforts in the healthcare space and has noted a wide range of violations by staffing agencies and facilities. Often these “1099 misclassification lawsuits” have resulted in costly multimillion dollar settlements covering back wages, unpaid employment taxes, overtime, and other employee benefits that should have been provided. Willful violations are also subjected to separate fines and penalties. Some states, like Massachusetts, even impose treble (triple) damages for any lost wages or benefits.

The penalties that a healthcare facility can face create a catch-22 dilemma — supervise and risk the danger of a misclassification determination, or don’t supervise and risk the danger of accidents, injuries, and possible lawsuits for negligence or malpractice.

Ways to Avoid Employee Misclassification

Despite the apparent financial incentives to hire independent contractors at your healthcare facility, the risks associated with misclassifying employees as ICs should give you pause. In addition to the fines, settlements, and other financial sanctions you could face by misclassifying your staff, you also have to consider the legal fees, audit costs, and the potential hit to your facility’s reputation.

So, what are some ways to avoid employee misclassification? Awareness of the distinction between 1099 workers and W2 employees is an important first step, but here are a few other steps you can take to minimize your misclassification risks.

1. Ensure Staffing Agencies Properly Train and Support Staff

Employment law can be intimidating, especially when you look at how federal and state laws overlap with regard to worker classification. Learn the basics of what defines an employee under federal law and the laws of your state and look out for red flags in your hiring practices. Don’t assume the staffing agency has this covered, and remember that your facility can face legal exposure for noncompliance with these requirements.

2. Clarify the Roles and Responsibilities of ICs

If you’re planning to simply fill staffing holes with 1099 contractors, without considering how their classification affects their role, then you may be opening yourself up to legal problems. States differ in how the roles of nursing professionals working as independent contractors are defined, but they generally are not subject to direct management as are employees. Be sure to have very clear guidance in place for if, when, and how your facility uses independent contractors.

3. Work With a Trusted W2 Staffing Partner

Utilizing a staffing partner who hires their nurse professionals as W2 employees means that healthcare facilities can still fill shifts with temporary support staff, but these workers will already have a designated employer to support, train, and help supervise their work. Unlike a staffing partner, typical staffing agencies are less invested in the ongoing, long-term needs of your facility and are more geared toward providing short-term fixes.

Surveys show that nurses place a very high value on professional development, which they might not necessarily receive through a traditional staffing agency. Also, nurses hired as W2 employees likely have access to healthcare, paid vacation, sick time, and other key benefits, making it less likely that you would face a misclassification action requiring you to provide them with such benefits.

Want to Reduce the Risks of Employee Misclassification at Your Facility?

The risks and penalties of misclassifying employees, even if by mistake, make your job that much more challenging. But there’s good news. As a true staffing partner, IntelyCare can offer the benefit of a talented pool of support staff when you need them, but with the added protection that only a W2 employer can provide. Find out more about the wide range of safe staffing solutions we offer.

Legal Disclaimer: This article contains general legal information, but it is not intended to constitute professional legal advice for any particular situation and should not be relied on as professional legal advice. Any references to the law may not be current as laws regularly change through updates in legislation, regulation, and case law at the federal and state level. Nothing in this article should be interpreted as creating an attorney-client relationship. If you have legal questions, you should seek the advice of an attorney licensed to practice in your jurisdiction.