CLASSIFYING WORKERS AS INDEPENDENT CONTRACTORS? BE CAREFUL. 

Your "head count" number is 20, but you could use one more worker. Rather than hire a new employee—and exceed your "head count" limit—you engage an independent contractor.

 

Under a separation agreement a terminated employee will continue to provide services as an independent contractor. 

Engaging a worker to provide services as an independent contractor in these types of situations—and others—may put your business at risk.

Internal Revenue Service Audits

Over the next three years, the Internal Revenue Service (IRS) will audit approximately 6,000 randomly selected businesses to determine if they have misclassified workers as independent contractors. The cost of an unfavorable IRS audit may be increased employment and income taxes, penalties and interest.

Department of Labor

The Department of Labor (DOL) is also becoming more active in ensuring workers are properly classified. An employee may be entitled to the federal minimum wage and overtime and have rights under the Family Medical Leave Act and anti-discrimination laws. One DOL focus is businesses that classify students as unpaid interns. Among other rules, the DOL’s position is that a for-profit employer cannot receive any immediate advantage from the intern’s activities. This makes it very difficult for any internship with a for-profit employer to satisfy the DOL test.

Pending Federal Legislation

Pending legislation would make it more difficult to classify independent contractors, make it easier for federal agencies to monitor an independent contractor relationship and increase penalties for businesses that misclassify workers. Two bills would revise employment tax laws to restrict independent contractor classifications, require the IRS to issue annual reports on worker misclassification and increase penalties for employers failing to comply with information reporting and payee statement requirements.

In addition, the Employee Misclassification Prevention Act would amend the Fair Labor Standards Act (FLSA) to require businesses to maintain more detailed recordkeeping of independent contractors and provide special notices to each new employee and independent contractor. It would also make it unlawful to improperly classify an employee as an independent contractor and to discriminate against or discharge a worker who opposes a company’s practice—or file a complaint—with regard to the worker’s classification. The Act would also increase liquidated damages, impose civil penalties, mandate states audits to identify employers that misclassify workers have the DOL monitor such state efforts, and allow the DOL and IRS to refer misclassifications to one another.

State Efforts

Many states are also involved in worker classification issues and may not necessarily follow the IRS test or the DOL test. In Massachusetts, for example, there is a presumption that every worker is an employee and unless the business satisfies a very stringent three-prong test to establish an independent contractor relationship, it faces significant penalties for improperly classifying a worker as an independent contractor. On July 15, 2010, the Massachusetts Attorney General’s office announced a $3 million settlement with FedEx Ground to settle claims that the company misclassified its drivers as independent contractors. The settlement covers the Commonwealth’s claims for payroll taxes, worker’s compensation and unemployment assistance and also provides payments to 13 drivers named in the Attorney General’s action. The settlement does not cover claims of other FedEx Ground drivers with respect to their pending lawsuit against the company.

Costs of Non-Compliance

Failing to properly classify a worker as an employee can be costly. Noncompliance may result in coordinated investigations by various federal and state agencies and lawsuits by workers. An unfavorable determination may subject the employer to back state and federal taxes, penalties and interest, back wages and overtime, unemployment and workers compensation claims, employee benefit plan claims and litigation by workers. And as the FedEx Ground agreement shows, even when a business denies improper classification, a settlement with federal or state regulators or litigants can still be expensive

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This alert is a copyrighted publication produced by Oppenheimer Wolff & Donnelly LLP. The information contained in this alert is of a general nature and is subject to change. Readers should not act without further inquiry and/or consultation with legal counsel.