Independent Contract / Employee Classification Issues

Avoiding Improper Worker Classification (Employee/Independent Contractor)

As I've noted in passing to many of our business clients, including those who are currently dealing with painful audits from federal or state agencies regarding worker classification issues, our law firm has experienced a significant increase in audits conducted by the Utah Department of Workforce Services, the Wage and Hour Division of the U.S. Department of Labor, the Utah State Tax Commission and the Internal Revenue Service. 

As noted in an earlier blog post, the IRS and DOL have entered into an agreement to improve their efforts to end employee misclassification. These agencies are now sharing information and coordinating enforcement with state agencies.  The IRS also launched the Voluntary Classification Settlement Program (VCSP), which encourages employers to voluntarily reclassify independent contractors as employees.  For more details about VCSP, please look here http://www.irs.gov/businesses/small/article/0,,id=246013,00.html. 

In light of these developments, I thought now would be a good time to go over some basic strategies to avoid misclassification issues.  So, what can employers do to avoid misclassification issues? Well, understand that there a number of different tests applied by different agencies to determine the classification of employees is a start. For example, the Department of Workforce Services uses its own test for purposes of unemployment insurance.  The Department of Labor uses a very broad test for determining if a person is an employee for purposes of the Fair Labor Standards Act (FLSA) and certain other laws. In addition, the Equal Employment Opportunity Commission (EEOC) uses yet another test to determine employee status for discrimination purposes under Title VII of the Civil Rights Act of 1964 and certain other discrimination laws. The IRS also has its own twenty factor test. Generally, however, here's what you need to know to avoid improper classification:

            1.         The more control your business has over the method and manner in which the individual performs his work, the more likely he is an employee. In other words, do you have the right to direct and control how the individual performs his work?  Things to think about include, for example, the extent of training provided to an individual, whether or not you require the individual to perform tasks in a certain way, and whether you evaluate the manner in which tasks are performed. You also want to look at where you require the individual to work, and when you require the individual to work.  Employees typically work exclusively for an employer, under set hours with set compensation.

            2.         You also want to look at financial control.  Or, in other words, does the individual have the freedom to provide work for other businesses in the same profession? Is the individual in business for himself, and does he have the risk of generating a profit or loss for himself?  Independent contracts are typically hired for a specific task, perform work for other companies like yours, determine their rates and use their own facilities, equipment and standards. You hire them to achieve a result. How they do it and whether they make money is up to them.

If you have independent contractors, consider examining your classifications.  You will want to look at each position that you have classified as a contractor, and examine their duties and functions in light of the above requirements.  You may want to start by looking at the test used by the IRS.  Remember also, that the VCSP is available to employers who want to voluntarily change the classification of their workers from independent contractors to employees. In some situations, this can be a very attractive way of dealing with misclassification issues.  The VCSP is available to employers who want to voluntarily change the classification of their workers form independent contractors to employees.  To be eligible, the employer must have treated workers in the past as independent contractors, filed all required 1099 forms for the workers for the prior three years, and not be under an audit by the IRS, DOL or a state agency concerning the classification of workers.  If the requirements are met, eligible employees can obtain relief from federal payroll taxes (10% of the tax liability that may have been due must be paid, no interest and penalties are assessed on that amount, and the employer will not be audited for the years in question).  Note, however, that the IRS classification program applies to federal employment taxes only. Employers that misclassify employees as independent contractors may have other obligations under other laws, including FLSA, unemployment, workers' compensation, and state wage payment statutes.

If you have questions about improper classification, is probably advisable to contact an attorney. The number of wage and hour claims, and audits by state and federal agencies, has increased significantly. Understand that you have options, but it's important to act quickly.

In my next post, we will talk about other misclassification issues under the Fair Labor Standards Act (FLSA).