Correctly Classifying Workers – Employee or Independent Contractor?

The Internal Revenue Service claims that millions of dollars in taxes go uncollected each year due to the mislabeling of workers as independent contractors or non-employees. In response, the Labor Department and the IRS are combining forces to crack down on independent contractor misclassification.

Intensive Investigations

The Labor Department is sharing information concerning businesses that misclassify workers with the IRS, as well as with a number of states that have agreed to work cooperatively with the Labor Department. As part of their efforts, the Labor Department has also hired approximately 300 investigators to explore wage theft grievances.

The IRS has already collected almost $4 million of back wages in 2010, during the first of its three-year plan to audit some 6000 randomly selected, various sized companies. The eventual goal of the plan is to create an employment taxes scoring system.

Protect Your Company and Avoid Back Pay Penalties

Employers who misclassify employees as independent contractors may eventually find themselves paying employment taxes and penalties, in addition to various benefits that the misclassified employee may be eligible for such as pension, health insurance, worker compensation, vacation and sick benefits, unemployment and more.

Employers should therefore be proactive in reclassifying mislabeled workers. One idea, suggested by Elizabeth Milito, senior executive counsel at the National Federation of Independent Business, is to conduct an audit on one’s own company. Business owners should read through the Labor Department’s rules and examine workers’ job descriptions to determine whether classifications are correct.

Worker complaints ought to be investigated promptly. A worker claiming that they are entitled to a particular status or financial benefit should be heeded and employers should be sure to examine the case.

Independent Contractor Eligibility Guidelines

The IRS provides clear eligibility parameters for determining independent contractor status. One must consider all information that helps determine the degree of control and independence maintained by the worker in relation to the company.

Here are some pertinent questions an employer may want to answer for each worker in question: Does the company control how the worker performs their work? How is the worker paid and who pays for expenses and supplies? What type of relationship exists between the employer and worker? Is there a written contract and are there employee benefits? Is the work performed by the worker essential for the business? Is the worker employed on a short- or long-term basis?

The answers to questions of this sort will guide employers in their determination of each worker’s classification. The IRS created a concrete tool to assist employers with this task called the 20 Factor Test. Bear in mind that a worker does not require all 20 factors in order to be considered either an employee or an independent contractor.

In short, to prevent future aggravation and financial penalties, be proactive, investigate complaints promptly, carefully check each worker’s status and reclassify as necessary.