Friday, February 19, 2010

Employees or Independent Contractors: Traps and Pitfalls to Avoid

The economic downturn has not just hurt individuals, it has also left the Federal government and state governments with huge tax shortfalls.

As a means of closing this tax gap, the IRS is beginning to seriously scrutinizing working relationships — especially the employee/independent contractor designation. Facing record budget deficits, many federal and state officials are starting to aggressively pursue companies that misclassify employees as independent contractors.

The cornerstone of this new effort is President Obama’s 2010 budget which calculates that the federal crackdown will yield at least $7 billion in lost revenue over 10 years. The Obama administration plans to hire 100 more enforcement personnel and the I.R.S. has already begun auditing 6,000 companies to see whether they are in compliance with the law. Many states across the country have also have started to step up enforcement efforts, often in the form of stricter penalties for misclassifying workers.

The problem – in order to cut costs a numerous companies have chosen to wrongly classify regular employees as independent contractors. Companies that intentionally misclassify employees as independent contractors avoid paying Social Security, Medicare, and unemployment insurance taxes for those workers. And in this tough job market, workers are slow to rock the boat and challenge the misclassification.

This is not a small or random problem – many companies are intentionally passing employees off as independent contractors. The Department of Labor estimates that up to 30% of companies misclassify employees. And according to a New York Times article Ohio’s attorney general estimates that his state has 92,500 misclassified workers, potentially costing the state $35 million a year in unemployment insurance taxes, $103 million in workers’ compensation premiums and $223 million in income tax revenue. And last April, California Attorney General Jerry Brown won a $13 million judgment against companies that had misclassified 300 janitors, cheating the state out of payroll taxes.

At a time when companies are struggling, many in the business community are a little baffled by the increased federal and state scrutiny. In the aforementioned New York Times article, Randel K. Johnson questions whether the goal of raising a legitimate rationale for reclassifying workers. Johnson is the Senior Vice President with the United States Chamber of Commerce.

As Johnson also aptly points out, the laws are unclear in this area, and many employers are simply confused by the gray area that the law presents. And I would have to agree. Just listen to a tax attorney run through all the different factors and guidelines (that come from numerous sources) used to distinguish between an employee and independent contractor – your head starts to spin after a while.

Very generally stated – workers are generally considered employees when someone else controls how and when they perform their work. In contrast, independent contractors are generally in business for themselves, obtain customers on their own and control how they perform services. Among some of the most often misclassified workers are high-tech engineers, truck drivers, home health aides, and construction workers.

Companies are also able to circumvent many laws – minimum wage, overtime and antidiscrimination – by passing off regular workers as contractors allows. For example, independent contractors do not receive unemployment insurance if they are laid off or workers’ compensation if they get injured. And independent contractors rarely receive health insurance or other fringe benefits regular employees such as retirement benefits.

If you are an employment attorney or represent business, please join tax attorneys Stuart Hurwitz and Michael Sanders for Employees or Independent Contractors: Traps and Pitfalls to Avoid as they discuss the traps and pitfalls that your clients must avoid when making this difficult decision, and the consequences they face if they make the wrong choice. The course covers the IRS three point test, provides case examples, analyzes case law and details the consequences of misclassification.

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