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Targeting Misclassification

When the Obama administration took control in 2008, lost revenue was a major focus behind a myriad of legislation seeking to crack down on employee misclassification and discourage employers engaging in employee misclassification. The Government Accountability Office estimated that in 2006 employee misclassification cost the federal government $2.72 billion in tax revenue from Social Security, unemployment, and income taxes.

Last session, the Congressional Committee on Health, Education, Labor and Pensions considered federal legislation designed to make misclassification of independent contractors an “independent” violation of federal law. Under the current Fair Labor Standards Act, misclassification alone does not subject an employer to liability. Rather, the employee has to show not only that he/she was misclassified, but that he/she actually worked overtime or was paid less than minimum wage. The legislation, called the Employee Misclassification Prevention Act (EMPA) (H.R.5107), would change this by imposing hefty penalties ($1,100 for each initial misclassification; $5,000 for each persistent or willful violation) on employers for simply misclassifying, regardless of overtime or minimum wage.

Significantly, EMPA would also:

  1. Establish civil monetary penalties for employer recordkeeping violations;
  2. Create a legal presumption that if an employer fails to keep accurate records, the individual is an employee; and
  3. Notify workers of their right to proper classification under federal law.

Many expect EMPA to be reintroduced in the new congressional session.  However, EMPA is not the only piece of legislation on the horizon. New legislation authored by Sen. John Kerry, D-Mass., and Rep. Jim McDermott, D-Wash., called The Fair Playing Field Act of 2010 (S.3786), was introduced in both the U.S. House of Representatives and the U.S. Senate in September 2010.

The Fair Playing Field Act aims to close a perceived tax “loophole” for misclassification. Under current law, a safe harbor allows companies to treat a worker as an independent contractor for employment tax purposes unless the company has no reasonable basis for such classification or fails to meet certain requirements under a common law test. The Fair Playing Field Act would amend portions of the tax code providing reduced penalties for failure to deduct and withhold income taxes and the employee’s share of Federal Insurance Contributions Act (FICA) taxes. Companies who hire independent contractors on a regular basis will have to provide a written statement to each independent contractor that informs them of the federal tax obligations of independent contractors, the labor and employment law practices that do not cover independent contractors, and the right of every independent contractor to
request a status determination from the IRS.

The impact of the November 2010 elections and the Republican take-over of the House of Representatives concerning the passage of this legislation remain unclear. Both pieces of legislation were sponsored exclusively by Democrats, and will likely meet resistance from a Republican-controlled House. However, the issue of misclassification has not been a straight partisan issue, and the proposed legislation would generate much needed revenue for the federal government. Moreover, the Republican take-over of the House does not alter the Department of Labor’s (DOL) initiative and the initiatives of other federal agencies regarding
misclassification.

The DOL is considering a proposed regulation that would require an employer, before classifying a worker as an independent contractor, to perform a written analysis of the reasons for that classification, to be disclosed to the worker. The employer then would have to retain records of its written analysis and make it available in the event of an audit. The DOL and Internal Revenue Service (IRS) are already working together and with states to increase enforcement of independent contractor classifications, particularly in the following industries: construction, janitorial work, hotel/motel services, food services and home health care. There also is a joint initiative between the DOL, IRS and 39 states to share information to target employer audits for unemployment insurance and misclassification purposes.

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