Filed under: IC Compliance | Tags: IC Diagnostics, Independent contractor misclassification, misclassification liability
The last four years started out with expectations that the federal government would enact legislation to curtail misclassification of employees as independent contractors (ICs). Yet, not a single bill was enacted despite strong support by President Obama for Congressional action in the area of IC misclassification. Federal regulators, though, were undaunted by the legislative gridlock, as both the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) implemented initiatives seeking to address IC misclassification.
What will the legislative landscape look like over the next four years?
Legislative action is expected in the area of IC misclassification if, as most Americans hope, Congress begins to operate on a bipartisan basis to address matters affecting the nation’s tax revenues. Curtailing IC misclassification arose as a federal priority in large measure because it deprives the federal treasury of billions of dollars of tax revenues. An oft-quoted 2006 Report from the Government Accountability Office (GAO) estimates that this type of misclassification resulted in an estimated $2.62 billion tax loss annually. Yet, instead of focusing on the need to raise tax revenues and reduce our increasing “tax gap,” bills were introduced in Congress repeatedly that infused politics into IC misclassification. Because raising tax revenues is likely to be a priority for many in Congress, regardless of party affiliation, IC misclassification legislation will most likely become the subject of several bills in the coming year, but whether one or more of these bills becomes law depends on the level of cooperation that will be exhibited by Congressional leaders.
As readers of this blog will recall from past blog posts, Democrats introduced two bills in particular over the past four years that did not enjoy bipartisan support. The first was the Employee Misclassification Prevention Act (EMPA), first introduced in 2008, then re-introduced in 2010 and again in 2011. This bill did not directly address the tax gap; instead, it focused on the labor and employment aspects of IC misclassification. EMPA not only would have made IC misclassification a federal labor offense under the Fair Labor Standards Act (FLSA), but also it would have imposed an array of increased penalties on businesses that misclassified employees and subjected businesses to new notice and paperwork obligations, even those that did not even use ICs. Thus, this bill was destined for defeat in Congress, as it was the antithesis of a bipartisan legislative endeavor. Indeed, EMPA was regarded by U.S. businesses and Republicans in Congress as akin to “throwing the baby out with the bathwater.”
What would a bipartisan labor bill do – and not do?
It would retain IC misclassification as a federal labor offense but would eliminate any additional notice and paperwork provisions, which typically create partisan disputes, and do away with the treble damages provision in the 2010 and 2011 EMPA bills. Currently, the FLSA imposes liquidated damages that would double any lost wages resulting from a “willful” violation of that law. A bipartisan bill would likewise limit damages to double (not treble) any actual losses for “willful” misclassifications. Because the test for determining whether workers are independent contractors or employees is so ill-defined, varies from law to law, and is often confusing to both employers and workers, a bipartisan EMPA bill would more likely be enacted if it would limit violations to willful misclassification of employees as ICs. This is precisely the legislative compromise that was enacted in California when that state’s legislature passed the Independent Contractor Willful Misclassification Law, where violations are limited to “avoiding employee status for an individual by voluntarily and knowingly misclassifying [an] individual as an independent contractor.”
What would a bipartisan tax bill do – and not do?
The other bill that was introduced in Congress during the President’s first term was the “Fair Playing Field Act.” That bill, first introduced in 2010 and then again in 2012, would have addressed a portion of the tax gap by prospectively eliminating so-called “safe harbor” in the federal tax laws relied upon by some businesses that for years may have consistently misclassified employees as independent contractors. It would also have required the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. Although this bill did not contain provisions that, on their face, would likely have been objectionable to Congressional Republicans, it was merely referred as a matter of course to the House Ways and Means Committee and was thereafter ignored – perhaps because of the bill’s title and the fact 2012 was an election year and misclassification of ICs had already been turned into a political issue.
A bill repealing the safe harbor provision in the federal employment tax laws would more likely be regarded as bipartisan if the bill did not bear a name that was not as politically charged as the “Fair Playing Field Act” and if a member of the current Cabinet was not issuing regulations or prospective guidance on the status of individuals for employment tax purposes. The legislation could simply utilize the definitions of “employee” and “independent contractor” in court cases and Revenue Rulings that are based on the common law definition of those terms. While there may be less certainty about who is and who is not an independent contractor, there are few positions whose status should automatically be treated as either “employee” or “independent contractor.” Court decisions and administrative rulings make it clear that the determination of independent contractor vs. employee status is very fact dependent and may vary from one instance to another where the facts are different – even when the titles or positions are alike or similar. Indeed, many individuals treated as ICs but who have been re-characterized by the courts and the IRS as employees can legitimately be re-classified as ICs if one or more key indicia of direction and control had been adjusted by the parties in the past or if such adjustments are made going forward.
What regulatory initiatives are we likely to see in the next four years?
As reported in earlier blog posts, the President has included funds in his most recent budget for the DOL to “detect and deter” companies from misclassifying employees as independent contractors. President Obama committed $14 million in 2013 for misclassification prevention, including $10 million for grants to States to identify misclassification and recover unpaid taxes, and $4 million for personnel at the Labor Department to investigate misclassification.
The DOL has engaged in a variety of enforcement efforts, which we can expect to continue in the next four years.
- First, the DOL has begun to share information with the IRS about suspected misclassification
- Second, the DOL has entered into information sharing agreements and coordinated enforcement agreements with state workplace agencies in 13 states.
- Third, the DOL has sought to focus its enforcement activities in industries where misclassification is regarded as prevalent.
- Fourth, the DOL announced in 2010 that it would propose new “Right to Know” rules updating the recordkeeping regulations of the FLSA to presumably protect workers’ entitlement to wages that they have earned and bring greater transparency and openness to the workplace. The proposed rule would require employers to conduct classification analyses of their workers and notify workers of their status (either as an employee or independent contractor) and whether that person is entitled to the protections of the FLSA. To date, these proposed regulations have yet to be issued.
We fully expect that the first three initiatives will continue with renewed vigor in the next four years and that more states will sign agreements with the DOL to share information about suspected IC misclassification. This will enable states to piggyback on the federal initiatives and the DOL to re-double state enforcement actions.
The IRS has also been active in regulatory enforcement matters in the past few years. In September 2011 the IRS instituted a voluntary classification settlement program in the form of reduced payments for those businesses that are willing to acknowledge they have misclassified employees as ICs, and it also signed an agreement with the DOL to coordinate federal enforcement actions against companies that are believed to have misclassified employees as ICs.
Federal regulatory action to curtail IC misclassification is likely to increase substantially in the next four years. The President has made misclassification of ICs a priority each time he has announced a budget, and the opportunity to turn this issue into a bipartisan initiative to address the tax gap is likely to be viewed by the Administration as one way to reduce the deficit. IC misclassification has been and will also remain a principal focus of the IRS Commissioner and the Secretary of Labor. The DOL is expected to finally seek to implement its “Right to Know” misclassification rules through proposed regulations, which have been the subject of over two years of work to date. It is reasonable to assume that they will be issued in 2013.
These types of federal initiatives will likely increase public awareness of this issue, thereby causing more workers to question if they have been misclassified and are owed moneys – whether as a result of overtime hours worked, employee benefits they have not been offered, and/or lack of coverage for unemployment and workers compensation. Such workers may seek relief through the DOL, or through class action lawyers, or by simply filing a Form SS-8 with the IRS. That form, entitled “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” may only take a worker under an hour to complete but can affect not only the specific worker but all other similarly situated workers classified as ICs by a business – if the classification is subject to scrutiny.
While this blog post is limited to federal misclassification initiatives, many states have cracked down on IC misclassification, and more are expected to join in if they have yet to do so or if they wish to stiffen their laws against misclassifying employees as ICs. In 2012, eight states passed substantive legislation to curtail misclassification – both states that had already enacted legislation to curtail IC misclassification and states that had not previously enacted legislation in this area. Now, close to half of all states have enacted IC misclassification laws since 2008.
Businesses that rely on ICs as one of their key sources of manpower or to supplement their existing workforce can take steps to minimize exposure to misclassification liability by ensuring that their relationships with such workers are properly structured, documented, and implemented.
Those companies that have yet to be targeted by federal or state regulators or class action lawyers may wish to consider a form of IC Diagnostics™ to avoid or minimize such exposure. This starts with an analysis of all applicable federal and state IC tests and an examination of each of the dozens of factors found by the courts and administrative agencies to be relevant to a determination of IC status. Some businesses may need little if any restructuring to their IC relationships, while others can benefit from more substantial changes to enhance the likelihood of a successful defense to any challenge to their use of ICs.
Documentation of the IC relationship can be critical under most laws governing the status of workers – and many IC agreements either have not been updated or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status, is typically an essential aspect of IC Diagnostics™.
Some companies risk exposure to IC misclassification liability simply because their use of manuals, guidelines, policies, or procedures are either drafted in a manner inconsistent with the structural framework of the IC relationship or were drafted in a noncompliant manner with applicable IC laws. These are documents that are oftentimes ignored, but not by the regulators or class action lawyers.
Your comments are invited.