March 2010
Employee Misclassification: $25 Million Reasons
Why Your Company May Be At Risk
Thomas P. Krukowski, Esq.
When President Obama revealed his proposed $3.8 trillion budget for fiscal year 2011, it provided $117 billion to the Department of Labor (DOL) for worker protection programs. These funds would enable the agency to hire more than 350 new employees, including 177 investigators and other enforcement staff, of which a good majority will be bilingual.
The Wage and Hour Division would receive $244 million, a $20 million increase over last year’s budget. The Division plans to allocate $25 million to its new “Misclassification Initiative.” The initiative is a joint effort between the DOL and the U.S. Department of the Treasury to eliminate incentives for employers to misclassify employees and to impose sanctions and penalties on employers who do not properly classify workers. Under the initiative, the $25 million would be used to hire and train 90 new investigators to root out instances of employee misclassification, including independent contractors, exempt, executive, administrative, professional and outside sales employees. As well, a key area of enforcement will be on employees who are misclassified as independent contractors and, consequently, deprived of benefits and protections to which they are legally entitled. One of the primary advantages to employers of classifying workers as independent contractors is to save on fringe benefit dollars, including health, dental, short and long-term disability insurance, vacation and sick day accruals, retirement and 401(k) contributions; paying overtime, worker’s compensation and unemployment insurance; and matching social security and Medicare tax payments.
Employee versus Independent Contractor
As a general rule, independent contractors are considered to be self-employed and retain control over their schedule and number of hours worked, jobs accepted, and performance of their job while regular employees have their hours set and work directed and supervised by their employer. Some companies, however, specify the independent contractor's schedule, require purchase of vehicles from the company and prohibit the individual from performing work for other companies. These requirements generally occur in the freight transportation industry.
IRS Criteria
It is not always easy to determine if someone legally is an independent contractor or if they should be classified as an employee. The IRS sets forth three categories of evidence that should be evaluated to determine a worker’s status: financial control, behavioral control, and the relationship between the parties. To assist in making the evaluation, the IRS has established a checklist of 20 factors or elements within these three categories that determine whether an employer has sufficient control to establish an employer-employee relationship. However, a worker does not have to meet all 20 criteria to qualify as either an employee or independent contractor, and no single factor determines a worker's status; rather the individual circumstances of each case determines the classification of a worker as employee or independent contractor. The checklist includes the following 20 factors:
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1. Instructions
2. Training
3. Integration
4. Services Rendered Personally
5. Hiring, Supervising, and Paying Assistants
6. Continuing Relationship
7. Set Hours of Work
8. Full Time Required
9. Doing Work on Employer's Premises
10. Order or Sequence Set
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11. Oral or Written Reports
12. Payment by Hour, Week, Month
13. Payment of Business/Travel Expenses
14. Furnishing of Tools and Materials
15. Significant Investment
16. Realization of Profit or Loss
17. Work for More Than One Firm at a Time
18. Making Service Available to General Public
19. Right to Discharge
20. Right to Terminate
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The Taxpayer Responsibility, Accountability and Consistency Act of 2009 (S.2882 and HR3408)
The DOL’s Misclassification Initiative follows closely on the heels of legislation introduced in the U.S. Senate on December 15, 2009 that would amend the Internal Revenue Code of 1986 to modify the rules relating to the treatment of workers as independent contractors or employees. Introduced by Senator John Kerry, the proposed bill would: (1) require reporting to the Internal Revenue Service (IRS) of payments (including payments of amounts in consideration for property or of gross proceeds) of $600 or more made by or to corporations (other than tax-exempt organizations); (2) set forth safe harbor criteria and rules relating to the treatment of workers as employees or independent contractors; and (3) increase penalties for failure to file correct tax return information or comply with other information reporting requirements.
If passed, the Act would also require the Secretary of the Treasury to issue an annual report on worker misclassification. The report would include: (1) information on the number and type of enforcement actions against, and examinations of, employers who have misclassified workers; (2) relief obtained as a result of such actions against, and examinations of, employers who have misclassified workers; (3) an overall estimate of the number of employers misclassifying workers, the number of workers affected, and the industries involved; (4) the impact of such misclassification on the Federal tax system; and (5) information on the outcomes of the petitions filed under section 3511(e) of the Internal Revenue Code of 1986. The bill was read twice and referred to the Committee on Finance on December 15, 2009.
Enforcement
Under the initiative, in addition to funding for additional enforcement personnel, more money will be made available for competitive grants to states to address this growing problem. As employers try to stay competitive in the current economic conditions, the estimated 30 percent savings in payroll costs is a strong incentive for some employers to intentionally misclassify workers as independent contractors. This approach then often gives those companies an unfair advantage, especially in the construction industry, where contracts usually are awarded to the lowest bidder. Unfortunately, companies that comply with all laws pay the price by having a higher cost of doing business and are often underbid on contracts. Taxpayers are also affected because proper withholding taxes on misclassified employees are not paid, nor are contributions to the Unemployment Insurance Trust Fund. Enforcement efforts will focus on industries where misclassification is most prevalent, such as construction, transportation, communication, and health services. I am confident that employers will see significant enforcement activity as a result of this initiative.
If you have any questions or comments regarding this, or any other employment or labor law matter, contact Krukowski & Costello, S.C.'s educational services department at (414) 988-8400.
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