Companies that use freelancers, consultants, per diems, long-term temps and
other contingent workers are under assault. The federal government is poised to
take a leading role in cracking down on employers it suspects of misclassifying
employees as independent contractors.
The feds aren’t alone. Labor unions are seeking to organize employees they
claim have been misclassified as independent contractors.
Class-action plaintiffs’ lawyers are seeking out workers who might have been
misclassified and thus been deprived of overtime pay and pension and medical
State regulators are seeking back taxes and premiums for unemployment and
workers’ compensation funds.
Lax Government Enforcement
For years, lax enforcement by federal and state agencies created a comfort
zone in which employers could increase their use of independent contractors. But
beginning in 2007, several states began taking steps to curb what they regarded
as mounting evidence that employers have been misclassifying some workers as
Those state initiatives took the form of legislation that substantially
increased the penalties for employers that misclassify employees. Now employers
face stronger legal requirements for determining who is an independent
By mid-2007, it appeared that the federal government was ready to take firm
legislative and enforcement steps to rein in employee misclassification.
However, IRS initiatives announced in 2007 receded in the face of the financial
crisis in late 2008. So did House and Senate legislation introduced in 2007 and
2008, as Congress turned its attention to health care reform in 2009.
GAO Report on Misclassification
All that appears about to change following the issuance of a comprehensive
report to Congress by the Government Accountability Office (GAO). Released late
in 2009, the report—titled “Employer Misclassification: Improved Coordination,
Outreach and Taxation Could Better Ensure Detection and Prevention”—has prompted
both the Obama administration and Congress to refocus attention on independent
The GAO report (read it at
www.gao.gov/new.items/d09717.pdf) identified 19 potential legislative
and regulatory actions aimed at addressing misclassification. Among the
- enact laws that would make misclassification itself a violation of the
nation’s wage-and-hour laws.
- narrow the so-called “safe harbor” provisions in the federal tax laws.
- enhance IRS compliance programs
- improve coordination and information sharing between federal and state
One of the measures included in President Obama’s FY 2011 federal budget
proposal would authorize $25 million to target misclassification. That would
fund an additional 100 Department of Labor and Treasury Department enforcement
agents. Their job: Track down and penalize employers that misclassify workers.
The IRS announced that in February it would begin an Employment Tax National
Research Project involving line-by-line audits of 6,000 businesses focusing on,
among other things, employee misclassification.
This year, Congress is expected to consider bills that would amend the Fair
Labor Standards Act to make misclassifying an employee a violation of federal
law and limit the “safe harbor” provisions of the tax laws that many businesses
have relied upon to classify groups of workers as independent contractors.
What Should Businesses Do?
For employers that continue to pay their contingent workers on a 1099 basis,
it’s imperative to review whether those workers are properly classified as
independent contractors under the current federal and state legal standards. Do
this in concert with your attorney, so it is covered by attorney-client
This is a highly fact-specific analysis that involves examining numerous
criteria that generally focus on an employer’s control over the manner and means
of performing the services being rendered.
Depending on the results of the legal analysis, employers can choose from a
number of different options:
- restructuring the relationship to enhance compliance with federal and
state tests for independent contractor status.
- reclassifying workers by converting them to employees.
- using employee-leasing firms to employ the workers directly.
The parties’ written agreement is a critical component in determining
independent contractor status. Merely stating that a worker is an independent
contractor is essentially meaningless if the rest of the agreement spells out
work and working conditions that do not reflect a client-contractor
Even worse, some poorly crafted agreements can actually undermine an
independent contractor finding.
In contrast, carefully restructuring the relationship and having your
attorney draft solid contractor agreements can be the difference between a court
or administrative agency upholding a worker’s independent contractor status or
finding that the company is liable for an array of misclassification
Richard Reibstein, Lisa Petkun and Jonathan Clark