Increased Scrutiny for Independent Contractors
Updated: Oct 10, 2017
Independent contractors will be scrutinized even more, by both state and federal regulatory bodies. In a December 31, 2014 Wall Street Journal article, the Department of Labor’s (DOL) chief enforcer identified misclassification of independent contractors as one of its biggest enforcement issues. In addition, over the last several years, the IRS has collected hundreds of millions in back taxes and penalties from employers who improperly classified employees as independent contractors.
Since 2011, the IRS and DOL have had a Memorandum of Understanding (MOU) to "improve coordination on employee misclassification compliance and education" through "enhanced information sharing and other collaboration." The IRS duties under the MOU appear to be directed toward evaluating and following up on employment tax referrals provided by the DOL as the result of the DOL’s investigation into independent contractor issues. We expect the DOL to continue to work with the IRS to identify and remedy employee misclassifications.
Beyond these federal agencies, employers must be aware that state agencies are also increasingly investigating employer use and reliance on independent contracted labor. What is more, employers must be cognizant of the fact that state rules and regulations do not necessarily mirror those of the federal agencies investigating the use of contracted labor. What this means is that while a business may survive an audit by one agency with no adverse determination made, that same business could suffer an adverse determination by another agency (state or federal) that utilizes a different standard for evaluating independent contractor status.
Smart Tip: Be sure you understand what the criteria are for independent contractors. There are three different standards commonly used by the federal courts and agencies to determine independent contractor status:
(1) the IRS 20-factor analysis, for coverage under federal withholding requirements
(2) the "economic reality" test, used to determine compliance with requirements of the Fair Labor Standards Act (FLSA)
(3) the common law "right to control" test, used by many courts to administer discrimination and benefits statutes
One of the key issues common to all of the tests is whether your organization exercises control over how the worker performs the job. In addition, be sure you can support the classification with documentation showing that the worker meets the IRS and other independent contractor criteria. Finally, and this is critical, be aware that state laws affect how one should craft their independent contractor agreement and familiarity with state law requirements as overlaid with the federal requirements is critical if risk is to be mitigated.