In September, the Department of Labor (DOL) and the Internal Revenue Service (IRS) signed a memorandum of understanding (MOU) addressing the business practice of misclassifying employees as independent contractors to avoid providing employment benefits and protections. Eleven states have also signed or agreed to MOUs: Connecticut, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, Missouri, Montana, New York, Utah, and Washington. From the DOL news release:

The memorandums of understanding will enable the U.S. Department of Labor to share information and coordinate law enforcement with the IRS and participating states in order to level the playing field for law-abiding employers and ensure that employees receive the protections to which they are entitled under federal and state law.

“We’re here today to sign a series of agreements that together send a coordinated message: We’re standing united to end the practice of misclassifying employees,” said Secretary Solis. “We are taking important steps toward making sure that the American dream is still available for all employees and responsible employers alike.”

“This agreement takes the partnership between the IRS and Department of Labor to a new level,” said IRS Commissioner Doug Shulman. “In this new phase of our relationship, we will work together more efficiently to address worker misclassification issues, and better serve the needs of small businesses and employees.”

Business models that attempt to change, obscure or eliminate the employment relationship are not inherently illegal, unless they are used to evade compliance with federal labor laws — for example, if an employee is misclassified as an independent contractor and subsequently denied rights and benefits to which he or she is entitled under the law. In addition, misclassification can create economic pressure for law-abiding business owners.

The MOUs are the result of a General Accounting Office report estimating that employee misclassifications cost the federal government $2.72 billion in 2006. The GAO noted that the DOL, the IRS, and state agencies traditionally have not shared information on misclassification, but the MOUs will change these practices.

In the November Labor Letter from Fisher & Phillips LLP, John McLachlan presented a cogent analysis of a hypothetical situation to help employers properly classify workers as employees or independent contractors. And Alfred Robinson Jr. of the InsideCounsel blog offers this advice to employers in light of the initiative to correct misclassification:

1. Audit the company’s classification of independent contractors to assess whether any should be treated as employees. Be aware that the test of whether a worker is an employee rather than an independent contractor derives from the broad “joint employer” rules under the FLSA. Those rules look at the economic realities test to determine whether a person is “suffer[ed] or permit[ted] to work” and acts “directly or indirectly” on behalf of an employer’s interests. To complicate the area, the standards for the IRS and under various state laws are not necessarily the same and often differ.
2. Review written agreements with independent contractors to document the job or tasks for a contractor to perform, identify expected results, provide contractor’s with the discretion to perform their work, etc. If an employer does not have a written agreement, he or she should consider instituting them.
3. Monitor the manner in which the employer treats his or her employees versus independent contractors to maintain distinctions and to avoid over-utilization of independent contractors.
4. Review relationships an employer may have if he or she uses “temporary” employees from a staffing company or leases employees from a professional employer organization (PEO) to assess any joint employment risks.
5. To the extent that an employer seeks to reclassify independent contractors as employees and participate in the IRS’ [Voluntary Classification Settlement Program], evaluate the hours worked and compensation paid to these workers as independent contractors to quantify potential back wage exposure under the FLSA before participating.
6. Verify whether any state law might apply. For example, California recently enacted a comprehensive independent contractor statute including civil as well as criminal penalties.

For the statutes and annotations you need to get a handle on federal employment law, pick up your copies of O’Connor’s Federal Employment Codes Plus (2011-2012) today. The new edition will be available in a few months.

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