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Worker Misclassification Amnesty: Olive Branch or a Bear Trap?

On September 21, 2011, the Internal Revenue Service (IRS) extended an olive branch to employers when it announced a new program called the Voluntary Worker Classification Program.  The IRS announcement proclaims “This new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.”

But… wait a moment. 

Way back in February 2010, I advised employers to scrutinize their classifications of workers because of a significant effort being made by the Obama administration to regulate and enforce such classifications.  At the time, the IRS had added 200 IRS investigators to increase business audits.  Additionally, the Department of Labor had budgeted for 250 new wage and hour investigators.  The clear rhetoric from these agencies at the time was that they each were an enforcement body focused on identifying and punishing employers who have misclassified workers.

In April 2010, I discussed then new legislation, entitled the Employee Misclassification Prevention Act (“EMPA”) (H.R. 5107 and S. 3254), which was being proposed by Democrats in both the Senate and House of Representatives aimed at targeting misclassification of workers.  The legislation sought to amend the Fair Labor Standards Act (FLSA) to: (1) significantly increase recordkeeping burdens regarding independent contractor relationships; (2) provide for increase penalties against employers who have misclassified workers; (3) foster the exchange of information among government agencies and departments, directing the DOL to perform targeted audits focusing on employers in industries that frequently misclassify employees and allows the DOL and the IRS to refer incidents of misclassification to each other; and finally, the legislation sought to mandate that the results of state auditing and investigative procedures be reported to the DOL and IRS with respect to indentifying employers that may have excluded employees from unemployment compensation coverage.

Again, in September 2010, more legislation was proposed by the Democratic leadership, and I discussed the The Fair Playing Field Act of 2010 (S. 3786, H. 6128), which sought to address employer misclassification of employees as independent contractors and close a so-called “loophole” under the current tax regime.  This legislation sought to reduce the ability of employers to utilize a safe-harbor provision in the IRS tax code and provide a contractor with documentation responsibility regarding the classification and tax liability.  The Obama administration promptly embraced and promoted the legislation.

Then, in January 2011, the DOL considered proposed regulations 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.

Thus, based on the aforementioned enforcement history by the Obama administration regarding independent contractors, I felt compelled on April 2011 to draft an article to provide some tips regarding the classification of workers as independent contractors.

Now, employers are given an opportunity to voluntarily reclassify independent contractors and minimize the potential tax liability with the IRS.  An enticing olive branch is apparently extended in a purported and uncharacteristic effort to assist employers in correcting classification issues.  However, pardon my skepticism, but the track record of this administration is anything but business friendly.  I recommend employers be VERY CAUTIOUS about the IRS program.  The IRS of today communicates much differently with other agencies within the states and Obama administration.  For example, as recently as September 19, 2011, the IRS entered into an agreement with the DOL and eleven (11) states to share information pertaining to worker misclassification.  I strongly suspect that companies choosing to voluntarily reclassify under the program and take the incentives offered by the IRS will be subject to DOL scrutiny for backwages for the individual workers involved and penalties as well.  The DOL may also assert that the employer deprived employees of required benefits based upon the misclassification.  Moreover, there may potentially be significant liability to the state agencies for circumventing workers’ compensation or unemployment compensation tax liability.

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