Tax Issues Associated with Misclassification of Persons as Independent Contractors

By George J. Miller

When the Wage and Hour Division of the U.S. Department of Labor or a state department of labor determines that an employer has misclassified employees as independent contractors and has failed to pay them minimum wage or overtime pay required by law, the remedy at the administrative level typically has been for the employer to pay the affected employees back pay sufficient to make up for the lost wages.  Of course, an employer which has misclassified employees in this fashion has not been withholding federal, state, or local income taxes, or FICA, and has not been remitting those taxes (including the employer’s share of FICA) or filing quarterly payroll tax returns with the government regarding the misclassified workers. 

 A lingering, worrisome question in settling such disputes with the Wage and Hour Division or a state department of labor has been whether the employer will be reported to state or federal internal revenue agencies and will be required to pay taxes, penalties, and interest in addition to back pay.  The specter of facing the tax man in such matters became more real yesterday, when U.S. Secretary of Labor Hilda Solis announced that she has signed memoranda of understanding (MOU’s) with the Internal Revenue Service and the state labor commissioners and other state agencies in the states of Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah and Washington, pledging greater cooperation to share information in an effort to protect employees from being improperly classified as independent contractors.  

Look For Increase in Audits For Independent Contractors

By Kim Koratsky

The employee/independent contractor question is often a thorny issue for employers, but in the next year, it could be an even bigger problem.  According to an article in Crain’s Cleveland Business, “[o]ver the past two years, the Wage and Hour Division of the U.S. Department of Labor has hired more than 350 investigators to uncover employment violations, including misclassification, and President Obama has requested $25 million in the fiscal 2011 budget to target the issue further.”  In addition to the government crackdown, class action lawsuits brought against employers accused of misclassifying employees have increased significantly in recent years.

It is much easier to solve these problems with an internal audit than to wait for an official audit by the Department of Labor (DOL).  DOL audits can be devastating to a small business.  The DOL audit process, and appeals if pursued, are long and expensive, even if companies end up not owing back pay, penalties and interest.  While the DOL seems to be looking at all businesses, sectors that are drawing particular scrutiny include trucking, construction, manufacturing, information technology, and home health care.