The worker misclassification issue is complex, not only for employers, but for the government departments that should participate together in the reclassification programs. Currently, the IRS sponsors a voluntary program, the Voluntary Classification Settlement Program (VCSP), to resolve worker classification issues for tax purposes without admitting any wrongdoing. However, this program does not solve the issue with the other federal government or state departments. The result is that resolving the reclassification with the IRS signals the Department of Labor and state tax and labor departments that they need to look into the employer’s compliance.
The problem starts because employers have an incentive to classify workers as independent contractors – employers are not responsible for paying their portion of the employment taxes or paying the unemployment insurance.
Worker classification has been an issue highlighted and scrutinized by the IRS for several years now, with the recent Uber driver decision in California illustrating the IRS’s and court’s use of a defined criteria to classify workers, set out in the IRS Fact Sheet FS-2015-21 (August 2015).
The IRS looks at the amount of control and type of control the employer exerts over the worker. There are generally three criteria the IRS applies to the facts to determine the degree of control and independence:
- Behavioral: Does the business owner control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the business owner? (including things like how the worker is paid, whether expenses are reimbursed, who provides tools and supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits such as a pension plan, insurance or vacation pay? Will the relationship continue and is the work performed a key aspect of the business?
The lack of a comprehensive program among government agencies means that employers that want to correct their errors may have trouble doing so with the different agencies. Furthermore, the IRS’s VCSP requires an employer treat its workers consistently, meaning that an employer who starts treating new workers as employees, while it continues to treat current workers as independent contractors, are disqualified from participating in the VCSP.
The Department of Labor receives the bulk of complaints from workers, but the Department has not yet issued any guidance about how it will coordinate its program with the VCSP. Currently the Department of Labor uses a different test from the IRS:
- The extent to which the work performed is an integral part of the employer’s business. If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer and less likely that the worker is in business for himself or herself. For example, work is integral to the employer’s business if it is a part of its production process or if it is a service that the employer is in business to provide.
- Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Managerial skill may be indicated by the hiring and supervision of workers or by investment in equipment. Analysis of this factor should focus on whether the worker exercises managerial skills and, if so, whether those skills affect that worker’s opportunity for both profit and loss.
- The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment (and bear some risk for a loss) in order for there to be an indication that he/she is an independent contractor in business for himself or herself. A worker’s investment in tools and equipment to perform the work does not necessarily indicate independent contractor status, because such tools and equipment may simply be required to perform the work for the employer. If a worker’s business investment compares favorably enough to the employer’s that they appear to be sharing risk of loss, this factor indicates that the worker may be an independent contractor.
- The worker’s skill and initiative. Both employees and independent contractors may be skilled workers. To indicate possible independent contractor status, the worker’s skills should demonstrate that he or she exercises independent business judgment. Further, the fact that a worker is in open market competition with others would suggest independent contractor status. For example, specialized skills possessed by carpenters, construction workers, and electricians are not themselves indicative of independent contractor status; rather, it is whether these workers take initiative to operate as independent businesses, as opposed to being economically dependent, that suggests independent contractor status.
- The permanency of the worker’s relationship with the employer. Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee, as opposed to an independent contractor. However, a worker’s lack of a permanent relationship with the employer does not necessarily suggest independent contractor status because the impermanent relationship may be due to industry-specific factors, or the fact that an employer routinely uses staffing agencies.
- The nature and degree of control by the employer. Analysis of this factor includes who sets pay amounts and work hours and who determines how the work is performed, as well as whether the worker is free to work for others and hire helpers. An independent contractor generally works free from control by the employer (or anyone else, including the employer’s clients). This is a complex factor that warrants careful review because both employees and independent contractors can have work situations that include minimal control by the employer. However, this factor does not hold any greater weight than the other factors. For example, a worker’s control of his or her own work hours is not necessarily indicative of independent contractor status; instead, the worker must control meaningful aspects of the working relationship. Further, the mere fact that a worker works from home or offsite is not indicative of independent contractor status because the employer may exercise substantial control over the working relationship even if it exercises less day-to-day control over the employee’s work at the remote worksite.
While the tests sound similar, they can result in a different worker classification by the Department of Labor and the IRS. Until the Department of Labor and the IRS can agree, or Congress acts to create a consistent criteria, employers will have to carefully navigate the different criteria to bring themselves into compliance with each agency.
For further information, please feel free to contact me about the criteria used.