DOL, IRS, And 11 States Enter Agreement To Work Together Against Misclassification

On September 19, 2011, the United States Department of Labor (DOL) and Internal Revenue Service (IRS) signed a memorandum of understanding to improve the agencies' coordination of efforts to combat employee misclassification, recoup wrongfully withheld payroll taxes, identify workers entitled to overtime, and better improve compliance and education. Seven states have signed a similar memorandum with DOL and IRS. The signatory states are Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah and Washington. Four states – Hawaii, Illinois, Montana, and New York – are expected to sign similar agreements in the very near future. This most recent development in interagency cooperation highlights that businesses that utilize independent contractors (e.g., consultants, freelancers) should be prepared for increased scrutiny.

Under the new agreements, a state will now share information with the DOL that a business failed to remit unemployment insurance or workers' compensation premiums, which might well lead the DOL to audit that employer for possible federal wage-hour violations. The IRS, in turn, also would receive information about the violation, which would give that agency the opportunity to seek unpaid taxes and associated penalties. Thus, an employer risks being hit three times, instead of just once, for the same, possibly inadvertent, violation.

With increased scrutiny paid to worker misclassification, employers subject to the Family and Medical Leave Act should keep in mind that their health insurers or third-party administrators also may be tempted to designate temporary workers who have been engaged for many months or even years as covered "employees" under the FMLA regulations pursuant to 29 C.F.R. § 825.106. While we are by no means suggesting an uptick in such activity, there have been some reported decisions on these issues and, consequently, employers should not be shocked if this should arise.

Motivation To Misclassify

Many employers have long appreciated the advantages of "alternative" work arrangements with independent contractors, contingent workers, consultants, "freelancers", and temporary staff because these arrangements often produce cost savings and increased flexibility. The temptation to classify a worker as an independent contractor can be great, considering that employers do not pay unemployment insurance taxes, workers' compensation premiums, or the employer's portion of Social Security and Medicare taxes for independent contractors. Also, such workers generally are not eligible for fringe benefits such as insurance and...