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Foster Swift Employment, Labor & Benefits Quarterly
Winter 2011
The Internal Revenue Service (IRS) and the Department of Labor (DOL) recently signed a memorandum of understanding, agreeing that they will share information and coordinate law enforcement to end the practice of misclassifying employees as independent contractors. After the DOL shares information with the IRS, the IRS will then pass information along to those state taxing authorities that also have signed onto a memo of understanding as part of the Questionable Employment Tax Practices Initiative (QETPI); Michigan is one of those states that has signed onto the QETPI.
What does all of this mean for employers? The short answer is that it could result in adverse consequences if your workers have been misclassified as independent contractors. The consequences of misclassification can be severe. There are significant civil penalties, as well as interest, taxes, overtime liability, benefits issues – and even exposure to potential criminal charges.
Some commentators will tell you that the "good" news is that the IRS has given employers an opportunity to correct the problem in the form of the Voluntary Classification Settlement Program (VCSP). If an employer applies, meets specified eligibility requirements, and is accepted into the VCSP, the IRS will enter into a "closing agreement" with that employer. The closing agreement allows the employer to pay just 10% of the employment tax liability owed on compensation paid to the workers for the most recent tax year, forgives interest and penalties, and exempts the employer from an audit for employment tax purposes for prior years.
That all sounds enticing … but pause before that sigh of relief. Unfortunately, there are several drawbacks. First, the "forgiveness" does not extend to other state and federal agencies. So, an employer that is granted amnesty under the VCSP still could be flagged and/or penalized for liability for state taxes, unemployment and workers’ compensation taxes, pension plan contributions, and potential exposure to laws such as FMLA. The VCSP also does not shield the employer from wage and benefit claims by the workers. Second, the limitations period on assessment of employment taxes will be extended to six years, rather than three; this is intended to provide an "incentive" for the employer to correctly classify workers on a go-forward basis. Finally, the employer has to apply for the VCSP; the application itself subjects the employer to scrutiny – and what if the employer is not accepted into the program?
So, the first thing to do is review your workforce to determine if you might be vulnerable. Just to keep this challenging, the IRS and the DOL use two different tests for determining employment status, so you should contact your employment attorney for assistance in applying these tests. Also, please take note that the strong inclination of the IRS and the DOL is to find employment status; so any doubt generally should be resolved in favor of classifying the worker an employee. If you find that you are vulnerable on this issue, review the requirements to be accepted into the VCSP, as well as the relative merits and potential disadvantages.
The risk of being tagged for misclassification has never been higher. In addition to the sharing exercise between the agencies, federal funds have been earmarked for investigation into this hot button issue, and the DOL has entered into a venture with the plaintiff’s bar called the "Bridge to Justice." This ironically named program was designed, according to the DOL website, to connect workers with local attorneys who can help them seek redress for suspected violations. In sum, you can’t afford to wait. Engaging in proactive strategies NOW may help avoid the need to scramble for a reactive defense later.
Please contact your Foster Swift employment law professional if you have any questions.