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 Real Workplace Issues |
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Welcome to the latest
installment
of "Real Workplace Issues," a newsletter dedicated to
providing our clients and friends with practical,
everyday employment law and HR
information. In late December of 2007, the
Internal Revenue Service (IRS) fined the Federal
Express
company $319 million for misclassifying 15,000 of its
drivers as "independent contractors." While this is an
extreme example of the potential penalties which can
result from misclassifying individuals as independent
contractors, the basic problem of misclassification is
nevertheless prevalent in the modern workplace. The IRS reportedly found
this problem so
common that it created a new Form 8919 (to be used
beginning for the 2007 tax year) for individuals
misclassified as independent contractors by their
employers. Likewise, a recent study conducted by the
School of
Industrial Labor Relations at Cornell University
estimates that approximately 10 percent of individuals
reviewed from audits conducted by the Department of
Labor were misclassified, and that this number
increased to 15% in the construction
industry. This edition of Real
Workplace Issues will review
the benefits of retaining independent contractors, the
risks associated with misclassifying employees as
independent contractors, and the steps you can take
to avoid such misclassifications.
The most obvious benefit of
retaining independent contractors as opposed to
hiring a new employee is that, with independent
contractors, employers are able to avoid payments
associated with Federal Insurance Contribution Act
(FICA) tax, Federal Unemployment Tax Act (FUTA)
excise tax, state unemployment and workers'
compensation insurance, employee-like expenses
(such as travel and entertainment) and employee
benefit plans (including sick leave, vacation, and
health insurance). In addition, employers reduce their
costs associated with supervising and managing
employees.
In addition to basic monetary
benefits, the ability to hire independent contractors
allows employers to swiftly react to changes in
business needs and the demands of the
marketplace. In addition, independent contractors
usually possess some type of specialized
knowledge and expertise.
With all of these benefits, it is easy
to see why many employers go out of their way to
classify individuals as independent contractors. It is
important to note, however, that what matters is not so
much whether the parties believe an independent
contractor relationship exists, but whether the
individual is considered an independent contractor
under the various tests defined under state/federal
law and government enforcement agencies.
While the number of factors
change depending upon the test applied, all tests
used by federal and state authorities focus on the
alleged employer's right to control the individual in the
performance of the task(s) or job(s) for which he/she
is retained.
The federal Fair Labor Standards
Act (FLSA) establishes minimum wage, overtime pay,
recordkeeping, and child labor standards affecting full-
time and part-time workers in the private sector and in
Federal, State, and local governments. Many of the
standards established by the FLSA apply only to
employees (as opposed to independent contractors).
The U.S. Department of Labor (citing the view of
the U.S. Supreme Court) has stated that there is no
single rule or test for determining whether an
individual is an independent contractor or an
employee for purposes of the FLSA. Instead, it is
the "total activity or situation" which controls.
Among the factors considered significant are:
The IRS is the
government agency
responsible for determining whether an individual is
an employee or independent contractor for the
purposes of federal employment taxes. The IRS
formerly utilized a "20 Factor Test," but simplified the
rules in 2006 and now focuses on three specific
areas:
Although
government agencies (such as the IRS and U.S.
Department of Labor) and courts look beyond the
agreements in determining whether an individual is
an employee or an independent contractor, a well
drafted agreement is vital to defending your
independent contractor classifications.
A well drafted
independent contractor agreement defines the
relationship between the alleged employer and
consultant as that of a "business to business"
relationship, as opposed to that of an "employee and
employer." This agreement should set forth the
specific services to be performed (including fee and
term) and reinforce the independent relationship
between you and the individual.
The main risk associated with
misclassifying individuals is that a governmental
agency will take action and determine that your
independent contractor is really an employee.
The IRS frequently audits
companies which retain large numbers of
independent contractors. In addition, an "individual
non-employee taxpayer" who reports more than
$10,000 in earned income from a single source or
who earns the majority of his/her income from a
single source may attract the attention of the IRS.
An individual's claim against a
denial of benefits often triggers investigations and
audits by state workers' compensation and
unemployment authorities. Likewise, an individual's
claim for wages and/or overtime under the FLSA could
result in the federal Department of Labor uncovering
misclassifications.
Misclassifying employees as
independent contractors
can result in investigations and audits by
these governmental agencies, which may
subject your business to:
Employers must be very careful
when retaining independent contractors. While there
are numerous advantages to using independent
contractors, the risks associated with
misclassification are substantial and should be taken
seriously.
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