Finance News & Insights

As states share info with DOL, a refresher course on dealing with ICs

Pennsylvania just joined the growing list of states that pledged to work with the Department of Labor (DOL) in preventing employers from misclassifying full-time employees as independent contractors (ICs). Will your state be next?  

The Keystone State recently became the 32nd state to sign a Memorandum of Understanding with the DOL.

The Memorandum – which is part of the DOL’s Misclassification Initiative – allows the agency and participating states to share info and coordinate enforcement efforts with each other. The information sharing, which the DOL has said will “enhance enforcement,” is designed to make it easier for the DOL to prevent employee misclassification.

The independent contractor marketplace has become a powder keg, and employers need to be aware of new tripwires that have been established that could make it blow up in their faces.

Here’s an overview of where the IC situation stands now:

1. Pro-employee legislation, rulings

There are a number of often-cited reasons independent contractors are appealing to employers.

For starters, employers get to benefit from contractors’ work and knowledge without subjecting themselves to added:

  • Social Security and Medicare taxes
  • federal unemployment taxes
  • state unemployment taxes
  • overtime pay obligations, and
  • health insurance and other employer-sponsored benefits costs.

But what flies under the radar is that recent legislation — like the Affordable Care Act’s (ACA) employer mandate — have made using independent contractors in lieu of hiring employees all that much more enticing.

After all, independent contractors aren’t covered by legislation like the ACA employer mandate, FMLAADA and more.

And as new legislation makes employment laws more and more employee-friendly, companies are naturally being pushed to give more consideration to hiring independent contractors — for which much less is required of employers — over regular employees.

So, in essence, many employment law changes designed to aid employees are actually pushing employers into the arms of independent contractors.

2. Increased enforcement of classification rules

The U.S. government has always kept on eye out for employers that misclassify those who should be deemed employees as independent contractors — whether it’s done intentionally (to circumvent tax or employment law obligations) or unintentionally.

The reason is because misclassification results in lost tax revenue, and it denies workers protections under employment laws.

The Obama Administration has made it a point to hunt down employers who misclassify workers — intentionally or not. Since President Obama’s first term, enforcement entities like the DOL, EEOC and IRS have aggressively added auditors and other personnel to weed out employers shirking their required responsibilities by improperly using independent contractors.

In fact, the new Labor Secretary Thomas Perez made it public within days of taking office that he plans to crack down on employers that misclassify workers as independent contractors. He called the practice “workplace fraud.”

Oh and being found guilty of misclassification is expensivevery expensive. First, the IRS will go after guilty employers for their share and employees’ share of back taxes. Then, because the worker should’ve been an employee all along, the DOL will look into whether any FLSA violations occurred, which can trigger civil penalties and back pay responsibilities.

3. Finding a federal standard that applies

OK. So here’s where we’re at so far: Increasingly pro-employee legislative efforts are driving more employers to consider using independent contractors. Meanwhile, the feds are drastically increasing enforcement of worker classification laws, making the improper designation of independent contractors (even if unintentional) a very dangerous proposition.

So all employers have to do to benefit from using independent contractors is find the feds’ classification of an independent contractor and abide by it, right? Not exactly.

The problem is there are two federal tests for determining who’s an independent contractor, and the methodology for determining which test an agency or court is to use is complicated and fuzzy.

Essentially, it comes down to which test is deemed more applicable to the case at hand.

The two tests are:

The good news is the tests are very similar. But they do contain subtle variations, so the best course of action is to make sure your independent contractor classifications can pass both.

4. Complying with state laws

Just because your classification of independent contractors meets the federal standards, that doesn’t mean it’ll hold up to your state standard.

Many states have more stringent guidelines when it comes to who classifies as an independent contractor. In Massachusetts and Illinois, for example, every worker is presumed to be an employee, and the burden falls on employers to prove otherwise.

An employer can be found to have properly classified its workforce under federal laws and still be found guilty of misclassification under some states’ standards.

So always check to make sure your independent contractor arrangements pass your state’s classification tests, too.

5. Compounding penalties

Lately, rulings against employers in classification cases have been all about adding insult to injury.

Say, for example, IRS auditors find your company guilty of intentionally misclassifying an employee as an independent contractor. You’re going to have to pay your share and the employee’s share of back taxes. But the buck won’t stop there.

Chances are the employee will be able to sue you — and win — for back benefits, too. Then, the worker may drag you before the DOL and claim that because you didn’t classify him/her as an employee, he/she’s entitled to overtime pay under the FLSA.

Plus, you could then be charged with civil penalties under the FLSA for things like wage and recordkeeping violations.

Next up, because the feds talk to the states, your state’s DOL will likely audit your classification practices in an attempt to collect back state taxes.

And, as if that wasn’t enough, workers similarly situated to the original misclassified employee may be able to bring a class-action lawsuit against your company for misclassifying them — potentially multiplying your back tax and penalty payouts.

Oh, and you can be held responsible for attorney’s fees as well.

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