Employee Misclassification Tops Enforcement List In 2010

Previously published in Holme Roberts & Owen LLP January/February 2010 Employment Law Newsletter.

In 2010, employers can expect an unprecedented increase in enforcement efforts targeting employees misclassified as Form 1099 independent contractors. Attention to this issue has been growing in recent years. However, with state and federal budget deficits now headlining the news, and cash-strapped governments aggressively searching for unrealized tax revenue, the time is right for this nagging issue to become a major headache for employers. The IRS recently announced that in February 2010, it would begin a national audit targeting up to 6,000 employers, with the goal of quantifying the revenue shortfalls created by misclassification of employees. Two-hundred auditors have already begun training to staff this new program. Furthermore, the Department of Labor's Wage and Hour Division and twenty-nine states have signed up to collaborate with the IRS and share the results of their own misclassification-related audits.

In addition to increased tax revenue, state and federal agencies are also seeking significant penalties from employers who have misclassified their workers. On December 10, 2009, the Illinois Department of Labor (IDOL) announced that it had imposed a $328,500 civil penalty against a first-time offender. IDOL assessed penalties of $1,500 per day for 218 days of alleged misclassification and an additional fine of $1,500 for the company's failure to maintain proper records on the misclassified employees. New York also reported recently that it had uncovered 12,300 instances of misclassification in 2009. The fines and penalties imposed on those employers totaled nearly $6 million. With even more enforcement efforts slated for 2010, more such penalties are likely to follow.

Could You Have a Problem?

The starting point for analysis of a worker's classification is the IRS test. The familiar "20-factor test" has been reformulated into an analysis of three characteristics of the relationship between a business and its workers:

behavioral control financial control type of relationship "Behavioral control" relates to the degree of employer control over how the worker performs the work. Factors suggesting employee status include: (1) significant employer instructions regarding how, when, and where to perform the work; (2) evaluation systems that measure how the work was performed rather than merely the end result; and (3) training in how to...