Independent Contractor Compliance Blog - by Collabrus™

Washington - HR 6111 is currently sitting in the House of Representative’s Ways and Means Committee and the Education and Labor Committee for consideration. It was co-authored and introduced by over two dozen US Representatives on May 21, 2008. This new bill is part of a growing trend by the federal government to stop the improper classification of workers as independent contractors. This latest bill, if passed into law, is intended to make it more difficult to misclassify workers as IC’s and if the worker is misclassified adds severe penalties. Some of the provisions are:

1. Within six months of passing, businesses must give every worker (employee and non-employee) a written notice of their status as an employee or non-employee, plus the following additional information:

• Provide contact information for local enforcement agencies to complain to if they believed they are not properly classified.
• A warning statement that tells the worker they may not receive certain protections and benefits based upon being classified as a non-employee.
• Provide the Department of Labor web site address to obtain more information, which will include instructions and links to initiate an investigation of their status as a worker.

2. Requires businesses to keep additional detailed information about “non-employee” workers, such as hours worked, hourly rates, etc…

3. There is up to a $10,000 penalty for each violation on employers who “repeatedly or willfully” violate the law.

4. The bill also seeks to put pressure on individual states to be more aggressive in seeking out misclassified workers within their own states by adding a new requirement to the Department of Labor’s (DOL) certification for employment tax audits (the type of audits conducted by California’s EDD). The requirement adds a test measure in the DOL’s audit of each state to determine if they are effective in identifying misclassified workers in their state employment tax audit program. If a state is determined not to be effective, the state could lose federal funding for not being in compliance with DOL standards. Currently, this almost never happens.

Why is this bill being proposed?

US Congressman Lynn Woolsey from California, said in a statement, “Employers who misclassify their employees as independent contractors rob workers of needed pay and benefits and cost government at all levels substantial uncollected revenue.”

The lawmakers cited a Coopers & Lybrand study that estimated the federal government lost $34.7 billion in taxes between 1996 and 2004 because of misclassification of workers.

The IRS reports a potentially higher amount of lost revenue from misclassifications. According to recent IRS reports where companies (employers) properly withhold and report wages and payments to individuals there is higher compliance by those individuals. On the other hand, sole proprietor income (basically 1099 Independent Contractors) reported on a Schedule C has a net misreporting percentage of 57 percent. The IRS estimates this one factor alone contributes about $68 billion to the tax gap each year.

Worker misclassification lawsuits are becoming more and more common across the country. The trend began to pick up momentum when Microsoft was sued in the late 1990s by workers classified as IC’s who claimed they were really employees of Microsoft and entitled to benefits, including lucrative employee stock purchase rights. Microsoft ultimately settled for approximately $100 million. In a more recent example, FedEx Ground has been battling legal actions all across the United States over the classification of its drivers as independent contractors. As a result of losing several such battles, they announced effective 2008, they are changing their business model in California for their single route drivers in California. The administrative cost alone of the remodel is reported to be between $30 million and $100 million in the first year.

Microsoft and Fed Ex are just the tip of a very large iceberg. Co-employment and class action law suites involving worker classifications occur everyday all across the country. In addition, there are literally over a hundred thousand government enforcement actions each year, with the accompanying fines, assessments and penalties. All of these battles are resolved without you hearing about them. Why? Because they are settled quietly before getting into court or at the administrative level. Most companies don’t want the negative publicity and are not interested in shouldering the costs to establish precedent law even if they believe they are correct. Even though settling after the fact, is very expensive, it is still more cost effective to settle quietly and move on with their business than to fight in court and air your company’s problems in public. 

What does this bill mean?

The stakes will be raised in the worker classification game. If this bill is passed into law, it will work with other recent initiatives that both the federal and state governments have made to tighten the boundaries around classifying your workers. These initiatives are also, for the first time, making the consequences and costs of being wrong and getting caught more than it is worth to just do it right to begin with. 

When you combine this newest bill with the IRS’ increased focus on closing the “Tax Gap” by going after misclassified consultants and contractors, plus the new Federal-State Partnership Agreement to share employment tax audit information, it is clear the risk is increasing for those who misclassify their workers. Add to this bill’s increased pressure on the states to find more misclassifications or face possible reduction of federal funding for their programs. 

The increased record requirement for businesses using “non employees” will make it easier for government auditors to identify and assess fines and penalties for misclassified workers.

The combined effect means employment tax and labor law enforcement agencies are going to be even more aggressive and will have better tools in the future. The cost of being wrong and being hit with heavy penalties will become much higher.

If this is passed into law, what does this mean to you?

You will be required to give each employee and independent contractor who performs services for you a written notice of their status. If they disagree or have grievances this practically begs them to file a complaint and initiate an investigation or lawsuit against you.

You can expect the number of audits, and the corresponding risk of being selected for an audit, to rise. You can also expect the auditors to be much more interested in finding misclassified workers than they have in the past. The additional $10,000 fine for each repeated or willful violation if you do it wrong is above and beyond the current fines, penalties and interest. 

All of this means an increased risk for any company that is misclassifying its workers. It will be more important than ever to insure you are correctly classifying your contingent and contractor workforce. Being wrong will become very costly. Even if this particular bill is not passed others are on the horizon.