Contingent worker classification, for tax purposes, continues to be an important topic.The article provides some resources to help understand the factors that make a contingent worker an employee or a 1099 independent contractor.
20 Factor Independent Contractor Test
In order to understand if the contingent workers your company utilizes are classified correctly you may first consult the IRS 20 point test. This test will help to see if the independent contractors you work with meet the criteria needed for classification as independent contractors. In essence though, the more control your company exercises over how, when, where, and by whom work is performed, the more likely the workers are actually employees, not independent contractors.
A downloadable version of the 20 Factor Test can be found here.
46% of Independent Contractors Are Found to be Misclassified
Ultimately, 46% of Independent Contractors reviewed by the IRS are determined to be misclassified and one in three companies fail a worker classification audit. The IRS claims to lose nearly $350 billion a year in unpaid taxes, with $39 billion attributed to underpayments or non-payments by independent workers. Also, if your contractors are re-classified as employees, you have to provide them with the same benefits that you have available to your other employees.
Penalties for Corporations Can Be Severe
Needless to say, the IRS is keen to clamp down on this loss of revenue – last year they hired 4,500 new agents to undertake audits. If your company is found to be in breach of the rules, penalties include back taxes, PLUS interest AND a fine of up to 35% of the total. These penalties can easily stretch into millions of dollars. Defending these cases can take years and also absorb thousands of dollars and a lot of man hours to make the case.
It’s not just smaller companies that have made mistakes, the rules are complex, making big companies equally as fallible as smaller businesses. For example, FedEx was found to owe approximately $319 million in back taxes over worker misclassification issues and Microsoft were famously held responsible for the non-payment of employment taxes by workers inappropriately classified as contractors.
Legal Action
Class action lawsuits by groups of independent contractors requesting employee status are becoming increasingly common. A contractor may successfully sue you for unemployment insurance, disability payments, workers compensation, employee benefits, stock options, profit sharing and retirement benefits by claiming they were effectually employees. Microsoft had to settle for $97 million a few years ago because of benefits denied to contractors who were later classified as employees.
$25 Million Allocated by the Department of Labor to Target Misclassification
The Department of Labor has a $25 million budget for 2011 targeting independent contractor misclassification. The following text (in italics) from the DOL budget outlines the use of these funds and can been seen at there site here.
Employee Misclassification: Individuals wrongly classified as independent contractors are denied access to critical benefits and protections to which they may be entitled as regular employees. Worker misclassification also generates substantial losses to the Treasury and the Social Security, Medicare and Unemployment Insurance Trust Funds. To address this problem, the FY 2011 Budget includes a joint Labor-Treasury initiative to strengthen and coordinate Federal and State efforts to enforce statutory prohibitions, identify, and deter misclassification of employees as independent contractors. The Department of Labor's budget includes $25 million to support this initiative, comprised of:
- Wage and Hour Division. An additional $12 million and 90 FTE are requested to focus on misclassification during targeted WHD investigations.
- Employment and Training Administration. $11.25 million and 2 FTE are requested for competitive grants to States to increase their capacity to focus on misclassification and reward the States that are most successful at detecting and prosecuting employers that fail to pay their fair share of taxes due to misclassification.
- Solicitor of Labor. $1.6 million and 10 FTE are requested to pursue misclassification litigation, including multi-State litigation to coordinate enforcement with States and leverage their groundbreaking work.
- Occupational Safety and Health Administration. $150 thousand is requested to modify training curriculum and investigation guidelines to allow inspectors to identify potential employee misclassification and share information with WHD.
Additional Resources and Readings
Navigating Independent Contractor Compliance
Proposed Changes: 1099 Independent Contractor Classification and Misclassification Penalties
Proposed Changes: 1099 Independent Contractor Classification and Misclassification Penalties
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