Five Tips to Avoiding the “Misclassification Crisis”

Posted on April 10, 2007

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On March 27, 2007, at an U.S. House of Representatives Subcommittee on Workplace Protections hearing in Washington D.C., Congress and the U.S. Department of Labor were called upon to address the "unchecked and growing practice" of misclassifying employees as independent contractors.

At the hearing, John Flynn, president of the International Union of Bricklayers & Allied Craftsworkers, said the practice is on the rise and called it a "work misclassification crisis".  To support his claim, Flynn pointed to the findings of a December 6, 2006 University of Missouri-Kansas City study saying that misclassification rose from 5.5% of workers in 2001 to 8.5% in 2005 (a 55% increase in the misclassification rate).

Catherine Ruckelhaus, litigation director of the National Employment Law Project, testified that independent contractor misclassification "occurs with an alarming frequency" in construction, day labor, janitorial and building services, home health care, child care, agriculture, poultry and meat processing, high tech, delivery, trucking, home-based work and the public sectors.

With this issue being raised before Congress and pressure being put on DOL to overhaul its enforcement, it is important for employers to know the difference between and independent contractor and an employee and to make sure that each worker is appropriately classified.  Such classification has implications beyond proper payment under the Fair Labor Standards Act (FLSA).  Whether a worker is an employee or an independent contractor has implications under workers’ compensation laws, federal and state civil rights laws, the National Labor Relations Act, the Occupational Safety & Health Act, the Americans with Disabilities Act, the Family & Medical Leave Act, and state income and unemployment tax measures.

The following five tips should aid employers in the proper classification of workers:

  1. Review the status of all of your workforce:  Undertake an examination of the current classification of all of your workers.
  2. Determine the functions of each worker’s job:  For those currently classified as "employees," is there a job description?  How does the job description compare to the actual jobs performed?  For those currently classified as "independent contractors," is there a written contract including a scope of work provision?
  3. Take the "Control Test":  The main factor a business must use in determining how to classify its workers is the degree of control the business has over its workers.  The more control, the more likely the worker is an employee.  Historically, the Internal Revenue Service (IRS) has used a 20 Common Law Factor Test to determine the status of workers.  However, the IRS recently changed its approach to worker classification.  The more relevant of the 20 Factors were grouped into three categories:  Behavioral Control (instruction and training); Financial Control (significant investment, unreimbursed expenses, services available to the relevant market, method of payment, and opportunity for profit/loss); and Relationship of the Parties (intent of the parties/written contract, employee benefits, discharge/termination, and regular business activity).  For more information on the IRS’ factors, click here (see Section 2) and here.
  4. Review classifications in light of applicable employment laws:  While the IRS factors are applicable specifically for a determination of classification under the tax law, the factors are also generally helpful in making a classification determination in most laws.  However, be aware of the federal, state and local laws that impact your workforce and classify the worker accordingly.
  5. If a worker is misclassified, take action to remedy immediately:  If a worker is incorrectly classified, the business could be subject to penalties and fines.  Therefore, it is important to correct any misclassifications immediately in order to minimize any legal risks.  IRS Headliner 152, IRS Offers Tips on How to Correct Misclassification of Employees, contains information about correcting worker classification.  If the misclassification resulted in a worker being paid less than he/she would have been paid as an "employee" (e.g., minimum wage and/or overtime), it is recommended to consult with legal counsel since "settlements" under the FLSA must be court or DOL approved.

Additional information about worker classification may be found in the following resources:

Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding

Publication 15, Circular E, Employer’s Tax Guide

Publication 15-A, Employer’s Supplemental Tax Guide

Publication 1779, Independent Contractor or Employee brochure

Publication 1976, Independent Contractor or Employee?  Section 530 Employment Tax Relief Requirements

N. DeWayne Pope, DeWayne Pope LLC

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