Butler Williams & Skilling Blog

Help Is Coming for Improperly Classified Independent Contractors

President-elect Barack Obama and the Democrat majority appear likely to amend federal tax law to prevent companies from benefiting by misclassifying their employees as independent contractors.  The change to the law will eliminate the tax exempt status of many companies who classify workers as independent contractors based on a long standing practice in the industry, which proponents of the change say is a lenient standard that is prone to abuse. Because companies do not pay payroll taxes or incur the costs of employee benefits for independent contractors, as they do for employees, the cost of an employee is significantly higher. A business can save up to 30% on payroll taxes alone simply by designating a worker as an independent contractor.

Under the current tax law, whether a worker is an employee or an independent contractor is determined by examining the level of control that the company exercises over the worker.  The IRS looks to three broad categories to make the determination: (1) Behavioral Control (e.g., Does the company determine what work the worker performs and how the worker performs it?); (2) Financial Control (e.g., How is the worker paid and are expenses reimbursed?); and (3) Type of Relationship (e.g., Is the relationship continuing or limited in time?).  The IRS examines each of these categories to evaluate the nature of the relationship as a whole. Other federal labor and employment laws use similar tests to determine whether a worker is an employee, and thus entitled to the rights these laws provide, such as minimum wages and overtime pay, family and medical leave, and protection against workplace discrimination. Accordingly, workers with the status of employee have significant rights and protections that are not shared by those who are deemed to be independent contractors. Workers who believe they have been misclassified as independent contractors can seek a determination by the IRS as to the proper classification of their work status by filing a Form SS-8. Misclassified workers can often also seek to recover for unpaid employment benefits, overtime compensation, as well as their overpayment of taxes. Combined with the protections afforded to employees by federal employment and labor laws, the reward to a misclassified worker who becomes properly classified as an employee is substantial.

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