Department of Labor Issues Guidance on Worker Misclassification
In its guidance the DOL stated that a worker’s status can affect workplace protections such as minimum wage, overtime compensation, unemployment insurance, and workers compensation. It can also determine whether your company should be issuing and filing Form 1099-MISC with the Internal Revenue Service (“IRS”) and appropriate state governments. Form 1099-MISC reports sources of income earned other than wages, salaries, and tips. It is used to report self-employment earnings in the case of independent contractors.
IRS THREE-FACTOR TEST
The classification of a worker is important for compliance with federal and state tax laws as well as wage and hour rules under the FLSA. The IRS generally uses the following three factors (which replaced the original 20-factor test used by the IRS to determine a worker’s status) to determine whether a worker is an employee or an independent contractor: behavioral control, financial control, and type of relationship between the parties.
In determining behavioral control the IRS looks to the degree of control the employer exerts over the worker that would indicate the worker is conducting his or her own business, which would classify them as an independent contractor. The IRS addresses the question; “Does the employer control or have the right to control what the worker does and how it is done?”
The key factor used in financial control is the worker’s own investment in the services provided. When the worker’s investment is relatively minor compared to that of the employer, it is likely that the worker is economically dependent on the employer and would likely be considered an employee from an IRS rules and regulations perspective. In addition, the worker’s opportunity for profit and loss is also considered. If workers do not have the potential to experience a loss, they would likely be considered an employee. The ability of the worker to provide services for other employers, which would be an indicator of and independent contractor, is another factor that is considered. For this test the IRS addresses the following question; “Are the business aspects of the worker’s job controlled by the payer?”
In determining the type of relationship of the parties, key factors include the intent of the worker and employer, benefits, integration, and termination of the relationship. The length of the relationship may also be considered. An indefinite relationship may suggest the worker is an employee. The IRS addresses this issue by asking the following questions; “Are there written contracts or employee type benefits? Will the relationship continue and is the work performed a key aspect of the business?”
AI 2015-1
AI 2015-1 does not change the law with respect to worker classification. It clarifies current rules and regulations and places more significance on whether or not a worker is economically dependent on the employer as opposed to the behavioral control factor. AI 2015-1 provides that “a multi-factor “economic realities” test should be used to determine whether a worker is an employee or independent contractor under the FLSA.” AI 2015-1 looks to this “economic realities” test as opposed to the “control test” in determining the extent a worker is economically dependent on an employer.
Under this “economic realities” test, as outlined in AI 2015-1, the DOL looks to the following factors to determine a worker’s status:
- Is the work performed by the worker an integral part of the employer’s business?
- Do the managerial skills of the worker affect their opportunity for profit or loss?
- How does the worker’s investment compare to the employer’s investment?
- Does the work performed by the worker require special skills and initiative?
- Is the relationship between the worker and employer permanent or indefinite?
What is the nature and degree of the employer’s control over the worker?
Please note that the definition of an employee under the guidance and the FLSA is broader than that under common law standards.
OTHER AREAS OF INTEREST
In evaluating whether a worker is an employee or an independent contractor all relevant factors presented above need to be considered and evaluated. Worker classification determinations should be made for each scenario on a facts and circumstances basis. As outlined above, the DOL is taking a more expansive view of the definition of employment. Employers should review their classification of workers to ensure they are in compliance with the FLSA. The DOL and IRS have said that they are working together to reduce worker misclassification and improve compliance by employers.
The misclassification of a worker by an employer can have a significant financial impact on the employer. Specifically, when it comes to payroll taxes, if an employer misclassifies a worker as an independent contractor, although relief may be available under Section 530 (see IRS Publication 1976, Section 530 Employment Tax Relief Requirements), the IRS will assess payroll taxes on the amount of the misclassification as well as penalties and interest associated with failure to withhold and pay these payroll taxes. Worker misclassification can also affect excise taxes associated with the Affordable Care Act.
The IRS has instituted a Voluntary Classification Settlement Program that provides taxpayers an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. In addition, workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.
CONCLUSION
Although voluntary disclosure and relief programs are available, taxpayers should carefully consider AI 2015-1 and current IRS rules and regulations so as to avoid any unnecessary negative impact regarding worker misclassification.
The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.
