by Vaughn Burkholder and Tara Eberline
What do the U.S. Department of Labor (DOL), the Internal Revenue Service (IRS), and Congress have in common? Sound like a setup for a bad joke? The punch line is that each of those federal entities has announced its intention to focus on employers’ misclassification of employees as independent contractors. Because of the increased scrutiny on worker misclassification, employers must be extra vigilant to make sure their workers are properly classified.
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DOL: ‘We Can Help’
Workers who are classified as independent contractors aren’t entitled to the Fair Labor Standards Act’s (FLSA) minimum wage and overtime protections or protections offered by other federal laws. Thus, employees who are wrongly classified as independent contractors do not receive legal protections to which they are entitled.
As a result, the DOL initiated “We Can Help,” a new campaign that encourages workers to seek assistance from the department if they believe they aren’t being properly paid or have been misclassified. The DOL intends to further focus on correcting worker classification issues in 2011 by adding 90 new enforcement personnel and $12 million to the Wage and Hour Division’s (WHD) budget.
IRS: even more ‘help’
The IRS is similarly planning to focus on worker misclassification issues this year. Businesses do not pay social security, Medicaid, unemployment, or other payroll taxes on independent contractors, so they may be tempted to misclassify workers to avoid paying those taxes. To correct the problem of misclassification (and collect the associated tax dollars), the IRS announced that it is adding 100 new enforcement agents and allocating $25 million to investigating misclassification of employees as independent contractors.
The IRS will target 6,000 companies over the next three years for comprehensive tax examinations, including a focus on misclassified workers. Additionally, an IRS audit may result in penalties and payment of back pay and taxes for workers who were previously misclassified. The U.S. Treasury Department estimates that the crackdown on misclassification will increase Treasury receipts by $7 billion over the next 10 years.
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State and federal legislators
In addition to the initiatives at the DOL and the IRS, members of Congress and the Kansas Legislature have proposed new laws related to worker classification. Last September, the Fair Playing Field Act of 2010 was introduced in both the U.S. House and Senate. The bill would amend Section 530 of the Revenue Act of 1978, which currently provides a safe harbor for employers to treat workers as independent contractors for tax purposes if the company has a reasonable basis for doing so and has consistently reported the workers’ income on Form 1099s. The legislation, if passed, would eliminate that safe harbor and potentially expose companies to greater penalties for worker misclassification, including good-faith mistakes.
Another proposed federal bill is the Employee Misclassification Prevention Act, which focuses on worker classification for purposes of compliance with the FLSA. The measure was introduced in April 2010 and would create a new FLSA violation:
- misclassification of an employee as an independent contractor. The Act would also:
- impose notice and record-keeping requirements on businesses with independent contractors;
- impose fines on businesses for each employee misclassification;
- expand the FLSA’s antiretaliation provisions to cover independent contractors; and
- award triple damages for violations of minimum wage or overtime laws for employees who are wrongfully classified.
The proposed Fair Playing Field Act and the Employee Misclassification Prevention Act are both intended to correct abuse of the “independent contractor” label. However, the bills contain different tests for determining who is an independent contractor and who is an employee, which may lead to even more confusion surrounding the issue. Neither Act became law last year, but one or both of them may be reintroduced during this session of Congress, and President Barack Obama has expressed his endorsement of both.
The Kansas Legislature has introduced legislation similar to the Fair Playing Field Act. However, the state measure would apply a third test for determining a worker’s status. That bill was passed by the Kansas House in February 2011 and is currently being considered by the Kansas Senate. Finally, the Kansas Senate is also considering a new bill that would give the Kansas Attorney General the power to investigate and seek an injunction prohibiting employers from misclassifying employees.
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Are your workers classified correctly?
If your company is treating any of its workers as independent contractors, you should conduct a careful legal review to make sure they are not actually employees under applicable laws. (Even if you and a worker have an agreement stating that he is an independent contractor, government agencies and courts will ignore it and determine employee status based on the actual nature of the relationship.)
Make any necessary changes now, before the IRS or the DOL targets you for an audit — and before the penalties for misclassification get more severe. Remember: They may be from the government, and they may be “here to help,” but you’ll be better off if you get some help now from your own lawyer.
Vaughn Burkholder is a partner with Foulston Siefkin LLP. He can be reached at (913) 253-2133. Tara Eberline is an associate with Foulston Siefkin LLP. She can be reached at (913) 253-2136.