Wage and Hour Guidance: IRS and Department of Labor Focus on Worker Misclassification

Employers should be aware of two recent announcements from the U.S. Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) regarding the misclassification of workers as independent contractors or non-employees. First, the DOL on September 19, 2011 signed a memorandum of understanding with the IRS that is designed to improve the DOL’s efforts to curtail employee misclassification by employers by sharing information with both the IRS and participating states. Second, the IRS announced on September 21, 2011 the launch of a new program, the Voluntary Classification Settlement Program (“VCSP”), that will enable employers to resolve prior misclassification of employees as independent contractors. The VCSP significantly limits past taxes for misclassified workers if an employer comes forward voluntarily in an attempt to comply with the tax laws.

Department of Labor Enforcement Efforts

The DOL’s memorandum of understanding (“MOU”) with the IRS “enables the DOL to share information and coordinate law enforcement with the IRS and participating states in order to level the playing field for law-abiding employers and ensure that employees receive the protections to which they are entitled under federal and state law.” Among others, signatory states to the MOU include New York, Connecticut, Massachusetts and Maryland.

The MOU goes on to note that “[b]usiness models that attempt to change, obscure or eliminate the employment relationship are not inherently illegal, unless they are used to evade compliance with federal labor laws — for example, if an employee is misclassified as an independent contractor and subsequently denied rights and benefits to which he or she is entitled under the law.”

Voluntary Classification Settlement Program

Under the VCSP, employers will have the opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past non-employee treatment. At its core, the VCSP is “designed to increase tax compliance and reduce the burden on employers by providing greater certainty for employers, workers and the government.” The VCSP is open to employers who have erroneously treated workers as non-employees or independent contractors and who meet the following criteria:

  • Consistently have treated the workers in the past as non-employees;
  • Have filed all required Forms 1099 for the workers for the previous three years;
  • Not currently under audit by the IRS, the DOL or a state agency concerning the classification of these workers.

Qualifying employers will:

  1. pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year;
  2. will not be liable for any interest and penalties on the liability; and
  3. not be subject to an employment tax audit with respect to the worker classification of the workers for prior years.

The VCSP provides employers an extraordinary opportunity to avoid the tax risks associated with misclassification of their workers. Employers should be cautioned, however, that the VCSP does not grant them total immunity. The previously misclassified workers may have claims for benefits and wages under either local, state and/or federal wage and hour laws.

Employee vs. Independent Contractor

As illustrated by the DOL’s MOU and the VCSP, worker misclassification is a serious issue. A recent study conducted by the Government Accountability Office estimated that the IRS is losing billions of dollars on worker misclassification, and a DOL study indicates that up to 30% of employers misclassify their workers.

The classification of a worker as either an “employee” or an “independent contractor” has significant implications for the employer’s payment of payroll taxes and workers’ compensation, unemployment and disability insurance, as well as compliance with minimum wage, overtime and other wage and hour laws.

Of course, determining whether a worker should properly be classified as an independent contractor or employee is no simple task. The Gibbons Employment & Labor Law Department can help you avoid misclassification issues, mitigate risks associated with same, and ensure compliance with applicable tax and employment laws. Please feel free to contact our attorneys for assistance.

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