Worker Classification – The Battle Continues
The question of whether a worker is an employee or independent contractor for federal income and employment tax purposes is a very complex and subjective question. The stakes of answering the question correctly can be very high. For instance, misclassification of a worker as an independent contractor can subject an employer to liability for federal employment taxes plus penalties and interest, penalties related to failure to withhold state income taxes, failure to pay overtime, failure to provide benefits and the list goes on.
So why do employers risk the threat of worker classification audits? One reason is because it is less expensive to use independent contractors rather than employees. The employer avoids payroll tax compliance issues, employer matching contributions of payroll taxes, federal and state unemployment taxes, having to provide benefits, and possibly having to provide materials or equipment. Another huge reason in the construction industry is that the employer gains the ability to bring in specialized skills on demand instead of full time.
The IRS’ view is that the use of independent contractors has led to a widening “tax gap” in lost revenues from misclassified workers. The Labor Department has recently joined the fray as well, with a July 15, 2015 15-page memo of guidance issued by Administrator David Weil. The memo starts out stating that misclassification of employees as independent contractors is found in an increasing number of workplaces in the United States, mentions the numerous complaints from workers alleging misclassification and touts the Department’s ability to bring successful enforcement actions against employers. The memo goes on to state that “most workers are employees under the FLSA.”
Although the IRS and the DOL have different tests for who is and who is not an employee, the two agencies signed a Memorandum of Understanding in September of 2011 agreeing to work together and share information to reduce the misclassification of employees, to reduce the tax gap and to improve compliance with federal labor laws. It is obvious that the two agencies and employers will be at odds in many classification issues going forward. Although the tax law has not changed related to who is and who is not an employee, it is incumbent on employers to be familiar with both the IRS and the DOL tests and standards for determining worker status and to be prepared for ever increasing enforcement action coming to a workforce near you.
