Federal and state governmental agencies have announced crackdowns on independent contractor misclassifications. For example, President Obama�s fiscal year 2011 budget sets aside $25 million for the Dept. of Labor and the Dept. of Treasury to investigate worker misclassifications.

Also, the Internal Revenue Service has reported that the federal government loses billions of tax dollars due to misclassifications and the ultimate goal of the program is to recoup up to $7 billion in unpaid employment taxes over the next 10 years.

In addition to protecting the interests of workers who are misclassified, this loss of revenue has contributed to federal and state deficits and is a major reason for the increased government scrutiny on worker classifications.

In an effort to better identify misclassifications, the IRS and the various states engage in information sharing agreements, e.g., sharing of W2, 1099-MISC filings, audit reports, etc. In addition, the IRS has entered into agreements with 48 states to combat abusive tax avoidance schemes. The IRS has also instituted a National Research Program aimed at tax compliance in the employment arena with one area of focus being worker classification. Under this program, the IRS will audit 6,000 employers over a three-year period.

Jennifer Neumann
Scott Callen

The increased focus extends beyond the federal level. Several states have created task forces designed to ferret out misclassifications. In fact, there have been increased efforts by southeastern state agencies to investigate, audit and assess substantial fines related to independent contractor misclassifications. These task forces often involve an interagency approach to misclassification issues and indicate an increased willingness to cooperate and a higher level of focus on misclassification issues.

Basic Primer While classifying workers as independent contractors can result in substantial savings for an employer, the potential penalties for misclassifying a worker as an independent contractor can be significant. There are various legal standards, but the key factor in determining proper worker classification is the right to control the worker.

For an employee, an employer generally has the right to control both what the employee will do and how it will be done. However, no one factor alone usually proves or disproves a proper independent contractor classification. Companies must evaluate federal and state laws to properly classify a worker as an independent contractor and legal guidance is strongly recommended, but the examples below provide a basic primer on independent contractor classification.

Independent contractors are usually hired to perform a discrete project during a set period of time with a starting and ending date. A painting contractor, for example, is hired to complete one discrete project, i.e., to paint a specific room a specific color by a certain date. Unlike most employment relationships, independent contractors are not typically hired to continuously perform services for an indefinite period of time.

Independent contractors have significant freedom or �control� to determine what materials and equipment are used during the project, and the methods and techniques to achieve the final work product. To illustrate, a painting contractor is not typically instructed on the paint brushes to use, what wall to paint first, or the painting techniques or methods. Conversely, in many employment relationships, employees are required to adhere to company policies, protocols, procedures, methods or manuals as to how to achieve the final work product.

Independent contractors usually supply their own materials, pay for many, if not, all of their own expenses, and are not typically trained by the company. Painting contractors, for example, supply the ladders and paint brushes to complete the project, pay for phone service and do not typically charge for travel expenses to go to the paint store. Employees, on the other hand, are usually provided company materials or equipment to complete their job.

�?Independent contractors have freedom to work for other customers or employers during and after the project. Alternatively, employees usually work for one employer and may have restrictions on their employment opportunities with other companies during and after the employment relationship.

Independent contractors usually have a formal agreement in place describing the independent contractor relationship, setting a price/fee for the final product, and the terms of the project. Beware, however, as a contract stating that a worker is an independent contractor will not, alone, establish independent contractor status. Alternatively, employees oftentimes are employed �at-will� and are governed by company policies and procedures setting forth the terms and conditions of employment.

Make sure to review your company�s policies, practices, and agreements regarding this issue because many building/construction firms inadvertently misclassify employees as independent contractors. And as stated above, the overseeing federal and/or state agencies will more likely catch mistakes.

Scott Callen and Jennifer Neumann are both senior counsel from Foley & Lardner LLP’s national Labor & Employment Practice. Callen can be reached at scallen@foley.com and Neumann at jneumann@fole.com.