By: Dan Cohen – 3/17/15
I was delighted to learn the other day that one of my clients received a clean bill of health from the IRS concerning its treatment of certain individuals as independent contractors rather than employees. The groundwork for this result was laid well in advance of the IRS audit and involved a detailed review of the operation and duties of the individuals and the adoption of an independent contractor agreement. This document was front and center of the IRS audit, and I like to think that it was influential.
Don’t get me wrong though: merely calling an employee an independent contractor in a contract will not protect your business from an adverse determination by the IRS, the Department of Labor (“DOL”), state agencies or class action attorneys. Yes, all are stakeholders in cases of employee misclassification. Several years ago, the U.S. Government Accountability Office estimated that employee misclassification costs the federal government in excess of $2.72 Billion in lost tax revenues. This cost may actually exceed $3 Billion today. State unemployment insurance tax losses are in the hundreds of millions. Beyond that, misclassified workers often are not paid minimum wages or overtime pay, and do not typically participate in employer-based health and pension plans.
Under the Obama Administration, the IRS and DOL have signed a Memorandum of Understanding enabling the two agencies to work together and share information to reduce misclassification cases. The DOL has collected tens of millions from employers in misclassification investigations since hiring 300 additional investigators to combat the problem. Michigan is one of nearly 20 states that have created inter-agency tasks forces to strengthen enforcement mechanisms. Of course, class action litigation has resulted in several high profile misclassification findings, like the exotic dancer case in 2012.
Workers are misclassified, often by mistake, but sometimes by design. For some professions, the line between employee and independent contractor is blurred and employers make the decision that an independent contractor designation is proper. Clearly, there are huge cost savings for employers who classify their employees as independent contractors. And, most of the legislation designed to protect employees (e.g. Title VII, NLRA, the Elliott-Larson Civil Rights Act) do not apply. It is for this reason that misclassification cases are so widespread.
However, unless you can pass the IRS right to control test and the economic realities test employed by the DOL and State of Michigan (among other states), the reward may not be worth the risk. Even though the temptation may still exist, make it a point to review the two tests which can be found at “Independent Contractor (Self-Employed) or Employee?” Internal Revenue Service, October 2, 2014. http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee as well as FACT SHEET 13: Am I an Employee?: Employment Relationship Under the Fair Labor Standards Act (FLSA).” Department of Labor, Wage and Hour Division, May 2014. http://www.dol.gov/whd/regs/compliance/whdfs13.htm. If you still believe the worker(s) are truly independent contractors, you should memorialize the terms and conditions of the relationship in an independent contractor agreement, establishing the workers independence, non-exclusivity, right to refuse assignments and the like.