Labor: Ring in the New Year with an employee classification audit

Appropriately classifying workers can prevent your company from being negatively affected by a federal action

In addition to auditing compensation practices to ensure that there are no gender-based compensation discrepancies in the workplace, companies can continue their efforts to kick-start 2012 by making sure that their workers are not improperly classified as independent contractors rather than employees.

Appropriately classifying workers can prevent your company from being negatively affected by a federal action. Why does it matter that workers are classified as independent contractors rather than employees? Generally, independent contractors are not entitled to benefits, nor are they protected by various state and federal laws that are designed to protect employees in the workplace. Equally important from the government’s perspective, there is a substantial loss of tax payments when workers are misclassified as independent contractors rather than employees, as neither state or federal taxes are deducted by companies from an independent contractor’s compensation.

As part of the Department of Labor’s (DOL) Misclassification Initiative, Secretary of Labor Hilda Solis announced in September 2011 a major step forward with the signing of a Memorandum of Understanding between the DOL and the Internal Revenue Service (IRS). Under this agreement, the agencies will work together and share information to reduce the incidence of misclassification of employees to help reduce the tax gap and improve compliance with federal labor laws. For fiscal year 2012, the DOL’s budget includes $46 million to combat worker misclassification by partnering with other agencies to fund state grants that will address the issue.

For companies that utilize independent contractors, don’t wait for the DOL, IRS or another state and/or federal agencies to question the classification of your independent contractors. Instead, be proactive and audit your decisions to classify those in your workplace deemed independent contractors.

The following should be reviewed as part of an internal audit to ensure that independent contractors are properly classified:

  • The company should not control or have the right to control when, where or how an independent contractor does his or her job. The more control the company exercises over an independent contractor, the more likely the independent contractor will be considered an employee.
  • How long the independent contractor has worked at the company: the longer the assignment, the more likely the independent contractor will be considered an employee
  • If the independent contractor is working 40-hour weeks, the more likely the independent contractor will be considered an employee
  • If the independent contractor is paid in the same manner as employees [i.e. hourly, weekly or monthly], the more likely the independent contractor will be considered an employee
  • If the company pays the business or travel expenses of the independent contractor, the more likely the independent contractor will be considered an employee
  • If the independent contractor does his or her work using company tools, materials or supplies, the more likely the independent contractor will be considered an employee
  • If the company has the unilateral right to terminate the independent contractor, the more likely the independent contractor will be considered an employee

Once the audit has accurately identified those that are, and should be, properly classified as independent contractors rather than employees, the company should first make sure that its management team understands the difference between the company’s employees and independent contractors so that the independent contractors are not managed or treated as employees. Finally, the company should memorialize its independent contractor relationships through independent contractor agreements with each of its independent contractors.

With these small steps as part of an employee classification audit, your company can be better prepared for what lies ahead in 2012.

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R. Anthony Prather

R. Anthony Prather is a partner in the Indianapolis office of Barnes & Thornburg LLP and a member of the firm's national Labor and Employment...

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