The Government’s Misclassification Initiative: Why Use of Independent Contractors Is A Target

Written exclusively for Hartford Help

ICon Professional Services, a leader in 1099 contractor compliance and payroll and benefits administration, released a report earlier this year exposing a significant gap between executives’ perceptions and reality about misclassification risk.

The survey methodology used a sampling of senior executives to provide insight on their worker misclassification experiences. Respondents came from a range of industries including energy, government, health care, and technology. Employers with fewer than 100 workers using only a few independent contractors a year were polled, as well as employers with more than 5,000 workers using hundreds of independent contractors.

According to ICon’s report:

  • Eighty-four percent of respondents plan to maintain or increase their investment in independent contractors in 2015.
  • Half of respondents use up to 20 independent contractors per year. Thirty percent use up to 100 independent contractors per year and, 15 percent   utilize more than 500 contractors per year.
  • Thirty-seven percent retain their relationship with contractors for up to a year. Twenty-eight percent maintain relationships for up to three years.
  • Nearly seven-in-ten respondents use independent contractors because of their unique specialist skills.
  • The report also reveals that 77 percent of respondents think their total financial risk exposure to failing a worker misclassification audit is below $100,000. In reality, for 100 independent contractors paid an average $100K annually, an employer’s financial risk could exceed $4,500,000. Only 57 percent of respondents have “great confidence” in knowing the exact number of independent contractors they are currently using.According to Dana Shaw, COO at Icon,

The majority of Fortune 2000 employers are either ignoring or seriously underestimating the reach of the government mandates and therefore financial risk to which they are exposing themselves. With the contingent labor market on the rise, business leaders can’t afford to ignore the importance of properly classifying their employees.
Ann Warren for ClearEdge Marketing, “Companies Largely Unaware of Financial Risk of Independent Contractor Misclassification, Reveals ICon Survey Report,” (Oct. 6, 2014).

Commentary and Checklist

The Internal Revenue Service (IRS) estimated that 3.4 million employees were misclassified as independent contractors back in 2011. The IRS estimated an annual revenue loss of $3.4 billion because of the misclassifications.

Independent contractors reduce labor costs because employers do not have to pay their unemployment taxes, workers’ compensation, overtime, health care, and other benefits. As revealed in the survey, many employers take advantage of specialized skills. Some employers use independent contractors to keep the number of employees down, which allows them to avoid regulations that apply to larger employers.

To crack down on misclassification, the U.S. Department of Labor (DOL) announced the Misclassification Initiative and teamed up with the IRS and state governments to rectify the problem. To fund the Initiative, the government issued $14 million to combat misclassification, including $10 million in grants to states to identify misclassification and recover unpaid taxes, and $4 million for DOL investigators. In 2012, the DOL’s Wage and Hour Division requested an additional $3.8 million and 35 full-time employees for increased enforcement related specifically to misclassifications.

Federal and state governments continue to focus time and money on detection and deterrence of misclassified workers.

In the event your organization is audited, the DOL will closely examine the relationship between the organization and your independent contractors. “Independent” is the key word in determining whether your relationships pass muster. True independence depends largely on how much the employer controls the contractor’s activities.

The Supreme Court has held that employee status is not determined by the timing or mode of pay. According to the DOL, “independent contractor agreements” also are not determinative, and neither is the fact that the individual is incorporated or licensed as a separate business entity.

There is no single rule or test for determining whether a person is an employee or independent contractor under the Fair Labor Standards Act and tests vary from state to state.

Here are some considerations for employers trying to keep their contractors independent:

  • Independent contractors should furnish their own equipment.
  • Consider the permanency or length of the independent contractor relationship. Longer relationships will draw more scrutiny.
  • Make sure no one in your organization exercises specific direction and control over the contractor’s employees.
  • Although labels are not determinative, contractors should have their own workers’ compensation insurance and be licensed and incorporated.
  • Similarly, even though “independent contractor agreements” are not decisive by themselves, have one anyway. Make certain that the workers are employees of the contractor and that the contractor is responsible for hiring, firing, payroll, paying workers’ compensation premiums, and managing workers.
  • Make sure contractors exercise managerial skills that influence their profits and losses.
  • Make sure independent contractors maintain their own initiative and judgment in open market competition. The contractor should have other clients and contracts.
  • Employers should consult with legal counsel and tax professionals before deciding an individual is an independent contractor.



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