Tuesday, September 27, 2011

If It's Too Good to Be True…

It's probably not smart. This is especially the case when it's the government that comes knocking on the door with a "good deal". In this case, the offer is especially troubling because it's coming from the IRS, an agency which rarely offers a good deal to anybody.

Those of you wedded to the idea of using independent contractors in lieu of employees, pay attention. That goes for those of you just using independent contractors, too. What's happening right now in Washington with respect to this issue is a one-two punch involving the Department of Labor and the IRS. If this diabolical combination doesn't get your attention, nothing will.

DOL recently announced that it was going to start paying a lot more attention to companies making use of independent contractors. There are any number of advantages for a company to use independent contractors, rather than employees, in its day-to-day operations. For one thing, the employer is not responsible for wage tax withholdings, unemployment insurance payments, workers compensation insurance, and a host of other expenses that are required when someone is formally part of the company workforce. In addition, virtually all employment laws apply only to "employees"; independent contractors typically can't make employment-related claims against the company using their services. Given the lack of protection provided to most independent contractors, and more importantly the lack of tax revenue that results from the use of independent contractors, state and federal tax and employment agencies have long focused on ferreting out improper contractor classifications.

The Department of Labor emphasis involves a teaming approach between the federal and state employment agencies to ensure that companies are not calling people independent contractors who are really employees. This classification issue is a complex factual analysis involving as many as 20 separate factors, and varies from state to state. Generally speaking, however, the key factor is who is controlling the work. If the individual worker is in control of how the job is performed, and is not integrated any more than necessary into the company structure, there's a good argument that she is a contractor and not an employee. Moreover, companies employing independent contractors must observe a variety of tax niceties, such as the use of an IRS Form 1099 for payment records. DOL and the IRS are going to be looking very carefully at those niceties, and how work is controlled.

At roughly the same time, the IRS announced a "voluntary settlement program" designed to encourage companies making use of workers in a questionable independent contractor status to reclassify these workers as employees. In exchange for the voluntary acknowledgment by the employer that its contractors are actually employees, the IRS will forgo a multiyear assessment of employment taxes and penalties, and instead use a single year assessment with reduced rates. The employer must agree to treat all of these reclassified contractors as employees from that point forward, of course.

Here's where it gets really troubling, from my perspective. The IRS Announcement says nothing about the limitation of state tax liability, or any other employment law . In other words, an employer that agrees to reclassify its employees under this program might be able to limit its federal tax liability to a single year, but is not protected from its individual state tax agencies coming in and assessing multiyear tax liability reaching back however far the state law allows. This would include unemployment insurance contribution taxes (and the associated penalties), workers compensation insurance contributions (and the associated penalties), and whatever other contributions based on employee status the host state happens to require. Even more troubling is the fact that this reclassification does not waive any liability under the Fair Labor Standards Act, Title VII, the Family and Medical Leave Act or any federal or state EEO laws.

Conceivably, an employer that reclassified an employee under the IRS program could find itself suddenly being sued for failure to pay overtime wages over the last two years (typically not an arrangement found in independent contractor agreements), or for failure to reinstate what it thought was a contractor following an FMLA qualifying absence six months ago, or for the toleration of a hostile work environment, or for an Equal Pay Act violation, or what have you. It's perfectly possible that an employer that reclassified its employees under this IRS provision would the next day find itself facing an audit by federal and state Department of Labor personnel, who have been tipped off by the IRS filing.

So before you jump at this "get out of jail almost free" offer from the feds, look at the affected workforce carefully. You might find yourself in trouble far more costly than any potential savings under this initiative.

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