Temporary Worker Misclassification Crackdown Spreads Across the U.S: Feds Announce Misclassification Alliance

Government agencies have aggressively cracked down on worker misclassification in recent months; but took it an extra step further last week when they announced that the U.S. Department of Labor has entered into an agreement with the IRS and other agencies to crack down on employers that misclassify workers as independent contractors when they should be classified as employees.

The signatory states are Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah, and Washington with other states expected to follow suit. Numerous other states, including Pennsylvania and Wisconsin, have already passed worker misclassification laws that impose severe penalties on employers who misclassify their employees in an attempt to recover billions in lost revenue.

If a worker is an employee, the employer must pay the necessary federal and state unemployment taxes AND its share of Social Security and Medicare taxes, in addition to the withholdings of the employee's share of Social Security, Medicare and Income Taxes. The employer must also incur costs related to pensions, health insurance, vacation pay, sick pay, and workers' compensation insurance. In addition to all this, employers face federal and state regulations regarding working conditions and overtime.

With all of these burdensome obligations to handle, no wonder employers try to take a shortcut by classifying temps as independent contractors. However, with the likelihood of getting caught on the rise, the financial implications of incorrectly classifying workers could be financially crippling. 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 owed. 

If you utilize or supply temporary workers on a 1099 basis, it’s worth talking to a company like Emergent (855 250 5000) who are able to handle employer obligations including payrolling, tax withholding, workers’ comp and risk management on your behalf.     

Unfortunately, the economic downturn has increased pressure on staffing firms and their clients to classifying temporary or contract workers as independent contractors to lower their costs and/or provide a better rate to their clients. Staffing firms tempted to do so are well-advised to first make sure they are complying with federal and state law as well as the IRS 20 Factor test. The majority of workers assigned through a staffing arrangement perform their work under the supervision and control of either the staffing firm or the client, and the assignment usually takes place at the client’s offices –a good indicator that the worker should be classified as an employee rather than a contractor.

Worker misclassification also can lead to other serious issues such as work authorization, overtime pay, benefits eligibility, workers' compensation insurance, state unemployment insurance taxes, and violation of state worker misclassification laws. The entire process can be costly and extremely onerous for businesses. To be safe rather than sorry, contact Emergent today on 855 250 5000 or info@emergent.com.

For additional information on proper classification of workers, see the new 12th edition of the ASA book Employment Law for Staffing Professionals.

1099s and Independent Contractors: What You Need to Know

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.

In addition, the budget proposes legislation to ensure the proper classification of employees by: (1) shifting the burden of proof to employers to demonstrate that their employees are classified correctly, (2) closing the loophole created by Section 530 of the Revenue Act of 1978, and (3) making misclassification a violation of the Fair Labor Standards Act, with appropriate penalties.


Additional Resources and Readings

Navigating Independent Contractor Compliance
Proposed Changes: 1099 Independent Contractor Classification and Misclassification Penalties

Independent Contractors Or 1099 Employees - The Risks