Employers that have disguised employees as independent contractors to save on wages and benefits could get slaughtered by monetary penalties as the government seeks to close tax loopholes.
In its proposed 2011 budget, The White House has proposed funneling $25 million into a “Misclassification Initiative” to help the Labor Department’s Wage and Hour Division combat the practice of employee misclassification as “independent contractors." In addition, Sen. John Kerry (D-MA) introduced a bill in December to close a tax loophole that he claims has facilitated the practice.
“By and large, most workers are properly classified as employees by most employers,” says James Coleman, partner in the Fairfax, Va., office of national employment and labor law firm Constangy, Brooks & Smith. “Moreover, there are many different legitimate independent contractor classifications. However, many lawmakers at both the federal and state level are concerned that some employers may be overreaching in attempting to classify individuals who should be employees, as independent contractors.
“One motivation for using the independent contractor classification is that it saves an employer money on employment taxes, employee fringe benefits, insurance premiums, and administrative costs. Of course, if taxes are being saved by employers, that means that tax revenues are being reduced at both the federal and state levels, and this provides the motivation for lawmakers to attempt to tighten up statutes to make it more difficult for employers to use the independent contractor classification, and more costly if they attempt to do so, and get it wrong."
Currently, determining whether an individual is an employee or independent contractor is defined under Fair Labor Standards Act, whose protections for workers can also be triggered by definitions under the Internal Revenue Code, and most other federal employment laws, as well as most state tax and employment statutes, which all similarly address the issue, though with some discrepancies, of when an employer-employee relationship arises.
Under these various federal and state statutes, penalties can be severe and can include back wages and back overtime, back taxes for failure to withhold income and employment taxes, liquidated damages and significant penalties under the Internal Revenue Code.
“Some of the criteria that are out there are how much direction an employer gives the particular individual, whether the employer is concerned with how the job is done versus the overall outcome of it,” Coleman explains. “[In other words,] if the employer is dictating how the job is to be done, when the job is to be done, where the job is to be done and getting down to that level of detail, those are all factors that tend to weigh on the side of an employer-employee relationship. If [companies] have people defined as independent contractors who are doing largely identical work to those classified as employees [over the long term] that should be a red flag.”
In an effort to regain what they see as lost taxes, legislators are taking a hard line on the issue. It’s important to know the definitions of an employee-employer relationship under all codes and statutes and to adhere to them strictly, especially if the money comes pouring in to tease out these relationships from those with an independent contractor. “Now would be the time to double check [interdependent contractor] qualifications,” advises Coleman.
