What do the Department of Labor, the Internal Revenue Service, and Congress have in common? Fair wages—the DOL ensures that workers receive the proper wages, while the IRS and Congress do their best to send those dollars right back to Washington. Sound like the set-up for a bad joke? The punch line is that each of these federal entities has announced its intention to focus on employers' misclassification of employees as independent contractors in the upcoming year. Because of this increased focus on worker misclassification, small employers must be extra-vigilant in 2011 to make sure their workers are properly classified.

The Department of Labor: "We Can Help"

Workers classified as independent contractors are not entitled to Fair Labor Standards Act protections regarding minimum wage and overtime or to other federal employment law benefits, so small employees that are wrongly classified as independent contractors do not receive legal protections to which they are entitled. The DOL has consequently initiated "We Can Help," a new campaign that encourages workers to seek assistance from the DOL if they believe they are not being properly paid or are misclassified. The DOL intends to further focus on correcting worker-classification issues in 2011 by adding 90 new enforcement personnel and an additional $12 million to the Wage and Hour Division's budget.

The Internal Revenue Service: Even More "Help"

The IRS is similarly planning to focus on worker-classification issues this year. Employers do not pay social security, Medicaid, unemployment, or other payroll taxes on independent contractors, so employers may be tempted to misclassify workers to avoid paying those taxes. To correct those misclassifications (and collect the associated tax dollars), the IRS announced that it is adding 100 new enforcement agents and allocating $25 million to investigating misclassification of employees as independent contractors. The IRS will target 6,000 companies over the next three years for comprehensive tax examinations, including a focus on misclassified workers. IRS audits may also impose penalties and require payment of back pay and taxes for workers previously misclassified. The Treasury Department estimates that the crack down on misclassification will increase Treasury receipts by $7 billion over the next ten years.

Congress: Proposed Legislation Affects Even Small Employers

In addition to the initiatives at the DOL and IRS, members of Congress have proposed new legislation related to worker classification. Last September, the Fair Playing Field Act of 2010 was introduced in both the House and Senate. That bill would amend Section 530 of the Revenue Act of 1978, which currently provides a safe harbor for employers to treat workers as independent contractors for tax purposes if the company has a reasonable basis for treating them as independent contractors and has consistently reported their income on Form 1099s. Such legislation, if passed, would eliminate that safe harbor and potentially expose companies to greater penalties for worker misclassification, even good faith mistakes.

Another proposed bill is the Employee Misclassification Prevention Act, which focuses on worker classification for purposes of compliance with the Fair Labor Standards Act. That Act was introduced in April 2010 and would create a new FLSA violation: misclassification of an employee as an independent contractor. The Act would also:

  • impose notice and record-keeping requirements on businesses with independent contractors,
  • impose fines on businesses for each employee misclassification,
  • expand FLSA's anti-retaliation provisions to cover independent contractors, and
  • award triple damages for violations of minimum wage or overtime laws for employees wrongfully classified.

Although the proposed Fair Playing Field Act and the Employee Misclassification Prevention Act are both intended to correct perceived abuse of the independent contractor label, the acts contain different tests for determining who is an independent contractor and who is an employee, which may lead to even more confusion surrounding the issue.

Are your Workers Classified Correctly?

Companies of all sizes – but perhaps small companies even more – should work with an employment lawyer to do an internal audit to ensure that their workers are properly classified, and correct any errors now, before the IRS or DOL targets them for an audit, and before the penalties for misclassification get more severe. Remember: They may be from the government, and they may be here to help, but you are going to be better off if you get some help from an experienced employment lawyer first.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.