Independent Contractor Compliance Blog

Last time I introduced the First Layer of the infamous Layered Defense Strategy Argument-”I won’t get audited.” This time let’s talk about the next level of this infamous strategy.

The Second Layer:

You are sitting in your conference room, discussing the use of IC consultants and temporary help, and how beneficial this strategy is to your company. Someone mentions they aren’t sure if the temporary workers should be handled as employees or ICs. Your attorney says something to the effect, “I’m not concerned. Even if we are selected for an audit we’ll put up a vigorous defense and probably knock most of it out at the audit level. For any portions we are assessed, we’ll appeal and prevail in the informal hearing or in court.” Everybody gives a sigh of relief and it’s decided to move on, because there’s no issue with the proper classification of your contingent workers.

We’ll convince the auditor we did it right and there will be no tax assessment.

Fact:  At least 70% (this is a conservative estimate) of all companies that are audited receive a tax assessment for misclassified workers, including back payroll taxes, income tax withholding with penalties and interest. There are some reports that the IRS’ statistics are even higher, approaching 90% of employment tax audits finding misclassified workers.*

*Government agencies don’t like to publicize these statistics. However, the numbers cited in this article are as valid as any you will find, even from “inside sources.”

Why do so many audits result in finding misclassified workers?

The reason the number is so high is because tax agencies rarely select a company for an employment tax audit unless they suspect there are misclassification errors. This means the auditor shows up the first day with the pre-conceived idea that your business has done something wrong. Of course, no government agency will officially tell you this, but it’s the way tax auditors think…

They think this way because tax agencies follow a detailed filtering process to identify companies that appear to have misclassification issues. Because of this selection process an auditor, who has been on the job for several years, forms the attitude that most cases will result in finding misclassified workers. It becomes the auditor’s reality-his expectation if you will…

This expectation becomes a self-fulfilling prophecy. Auditors are persistent; they will keep looking until they find The Error. Their supervisors, who also share this reality, will begin to suspect the auditor isn’t properly doing his/her job if they don’t maintain that +70% statistic. This combination of case pre-selection and auditor-attitude almost guarantees finding misclassifications.

OK-So we’ll win at the hearing.

Another fact: The EDD and the IRS both experience an 85-90% win ratio at their tax hearings and trials. Actually, as you enter the civil courts-Superior Court; Appellant Court; Supreme Court, etc, the win ratio for the government goes up, that’s because the government won’t appeal a worker misclassification decision to that level unless the issue is real important to the government (i.e. issues where the government wants to establish a precedent and they believe they will win).  

If this is one of those situations, the government will put their “A Team” on the case. 

Keep in mind here that the government attorneys are specialists. That means they eat, breathe, sleep and…(whatever) these issues every day, year-after-year. They have almost unlimited resources for research and time. They have case law and arguments that’s been used successfully in the past on the same issues. In many cases they have argued the same issues in front of the same judge before. They know what to expect. They know what will win and what will not. They don’t normally go to court on cases their experience tells them they will lose. With all that going for them they should win 100% of the time!

My attorney tells me he wins over 80% of his cases.

Private attorneys who claim to win 80% of the time in court, on misclassification issues against the government, are either the rarest of exceptions or may be counting “Settlements” as a win.  

“Settlements” is a different subject. They are a negotiated conclusion to avoid going to trial. The government still wins those cases because one of the hard-wired rules for most settled cases involving worker classification is that the government cannot compromise the status, or the rights, of a worker. Therefore, the worker is held to be an employee and the government still gets most of the money.

Your IC witness may not be there for you.

Another significant contributor to the government’s success in appeals is the witnesses (your former IC’s) are many times testifying against you. They made a claim for unemployment insurance benefits, or were injured on the job requiring medical care, or filed a civil suit for employee benefits, or for wrongful termination-all things employees may do but are denied to IC’s. They are sitting in the witness chair telling the judge they took the job as an IC because you told them they were an IC…

So before you polish your sword, put on your armor and prepare for battle in court, consider very carefully if you are one of the 10-15% who will beat the government. 

Don’t forget the cost of going to court.

You should also balance the cost too. It takes many hours to prepare and put on a case involving misclassification of workers. Attorneys typically bill these cases by the hour-not on contingency.  Your in-house attorney knew that…

So again, it comes down to do it right in the beginning and avoid this hardship altogether.

What’s next?

OK, we’ll just invest the money now and pay up then. We’ll still be ahead, because a $1 invested today will be worth $1.25 in three years, so we can pocket the 25 cents.