Employee misclassification trend prompts IRS and state scrutiny

Temporary and contract workers now make up a significant portion of the labor force. After the economic downturn, working with independent contractors became even more attractive because independent contractors do not require payroll tax and are not subject to California’s wage and hour laws. Independent contractors also cannot file retaliation or discrimination claims against the business that temporarily uses them to complete a business objective or project.

Perhaps that is why the IRS and state agencies are ramping up compliance audits regarding employee misclassification. The IRS estimates that intentional and unintentional employee misclassification results in billions in lost revenue for the IRS every year. In 2013, according to a Fox Business report, the IRS estimates that as many as 30 percent of independent contractors were misclassified.

Unfortunately, however, there is no universal, set definition of when to classify a worker as an independent contractor or as an employee. Instead, employers must establish the classification of workers according to state law and court decisions. Whether an employer is using an employee or independent contractor depends on a variety of circumstances. At the federal level alone there are 20 different factors that go in to determining who qualifies as an independent contractor. These factors include the length of time served in the position, the intent of the parties, and whether the work is part of a business’ ongoing operations.

While the definition of who is an independent contractor can be nebulous, it is still against the law to misclassify workers. Businesses are responsible for tax compliance no matter the sophistication of the law involved.

“Right to control”

Independent contractors are used throughout all industries. However, issues of worker classifications often arise for drivers and construction workers.

As one example, the 9th Circuit Court of Appeals recent issued a decision in Alexander v. FedEx Ground Package Sys., on California’s “right to control” test. This test holds that whether a worker is an employee or independent contractor can depend on whether the worker “has the right to control the manner and means of accomplishing the result desired.” In a significant development, the 9th Circuit Court held in August that FedEx drivers, who had their own vehicles, were nonetheless employees because FedEx controlled the appearance of the trucks and drivers and controlled certain aspects of delivery, including times worked and routes.

State agencies also enforce employee classification

While the courts often issue decisions regarding independent contractor status, numerous state agencies play a role in determining employee classification. These agencies include:

  • The Employment Development Department
  • The Division of Labor Standards Enforcement
  • The Franchise Tax Board, Division of Workers’ Compensation
  • The Contractors State Licensing Board

Each regulatory body focuses on a different aspect or industry regarding independent contractors.

A business and employment law attorney can help

Genuine independent contractors can help businesses meet their goals while saving money. Incorrect classification, however, can cost a business in taxes, penalties, fines and lawsuits. Businesses looking to correctly classify workers according to state law should contact an experienced employment and tax law attorney to discuss their situation, tax and regulatory compliance, and other legal needs.