A new bill introduced in the US House of Representatives seeks to penalize employers who misclassify employees as independent contractors in an effort to increase government regulation of worker classification. Called the Employee Misclassification Prevention Act, the law would crack down on employers seeking to avoid paying minimum wage and overtime pay. In addition to its effect on compensation, misclassification allows employers to avoid providing employees other rights and benefits, including worker’s compensation coverage, family and medical leave and the right to unionize. Finally, by classifying employees as independent contractors, employers are able to avoid paying payroll taxes. 

Under the proposed law, employers would be required to maintain records on their classification system and to inform employees of their status and their right to challenge it. Employers would then be audited by state unemployment insurance agents and the US Department of Labor. Violators would be subject to a maximum fine of $10,000 per repeated or willful violation. It is estimated that the federal government has lost tens of billions of dollars in unpaid taxes in the last several years due to misclassification.  According to the bill’s supporters, millions of workers miss out on deserved compensation benefits, and dishonest employers gain a distinct advantage over their competitors. 

Who Qualifies as an Independent Contractor?

According to the IRS, the general rule is that an individual is an independent contractor if the employer or person for whom the services are performed has “the right to control or direct only the result of the work and not the means and methods of accomplishing the result.” Facts that go toward determining classification fall into three categories: behavioral (taking into account instructions about how, when and where to work), financial (taking into account worker investment and opportunities to take a profit or loss or to work for others) and type of relationship (taking into account permanency and the existence of a written contract). 

How Should Employers Make and Reevaluate Classifications?

The IRS acknowledges that there is no determinative factor and advises employers to look at the entire relationship when making a classification. In doing so, employers should consider the extent of the right to direct and control the worker. They should also document each factor used to make the determination. Having a reasonable basis for the misclassification may relieve an employer from penalty under current law. It is crucial to classify carefully – employee classification issues will be the basis for 30 percent of all IRS audits this year.

A second proposed bill, the Taxpayer Responsibility, Accountability and Consistency Act, would replace the reasonable basis exception currently in place with a clear definition of independent contractor. Until such a definition is adopted, the most important thing an employer can to do to avoid paying a penalty for misclassification is to file a Form 1099 reporting the income of any workers classified as independent contractors. Doing so drastically reduces the maximum amount of damages that the IRS can exact. 

It should be noted that under DOL and EEO law courts may adopt different variations of the test for contractor status than those used by IRS.

If you are interested in learning more about the Employee Misclassification Prevention Act, please contact Darrell S. Gay or any member of Arent Fox's Labor and Employment Practice in New York, Los Angeles or Washington, DC.

Darrell S. Gay
darrell.gay@arentfox.com
212.457.5465