Relief May Be Available to Companies that Misclassify Workers as Independent Contractors | DCR Workforce Blog

Relief May Be Available to Companies that Misclassify Workers as Independent Contractors

MSP/VMS to the Rescue in Independent Contractor MisclassificationsWe have been following the rulings in various independent contractor misclassification lawsuits. In a number of blogs, we discussed the Voluntary Classification Settlement Program (VCSP), an amnesty program offered by the Federal Government from 2010-2013. In the VCSP program, companies that conducted a self-audit and then voluntarily reclassified workers as employees could limit their liability to 10% of the potential taxes due. In addition, they would avoid interest payments and penalties.

Although never stated, the implication was that companies knowingly misclassified employees as independent contractors. The government was giving these companies an opportunity to “come clean”. Over the past two decades, DCR Workforce has worked with hundreds of companies. In virtually every case, we have found that misclassification is not intentional; regulations are often vague and subject to interpretation. In addition, accepted industry practice sometimes lulls an employer into believing in the legality of such a classification. Examples can be taken from sectors like business services, education, construction, health services and hospitality. Professions such as drivers, farm labor, cleaners and writers are often particularly difficult to property classify. This possibility naturally brings up the question of how employers whose misclassification of workers had little or no fraudulent motive are treated when an audit finds them culpable.
Section 530 of the Revenue Act of 1978 provides some protection for companies that inadvertently misclassify employees as independent contractors. This legislation resulted from the inconsistent rulings handed down by the IRS and other government bodies when auditing companies with workers in similar positions. Section 530 states that, even when the IRS determines that individuals working as independent contractors do not meet standards for that classification, the misclassification may not be punished if the employer can demonstrate the following:

  • All workers in similar positions were treated as independent contractors. The company did not have any W-2 employees performing a substantially similar position.
  • The individuals in question were always treated as independent contractors throughout their working relationships with the company.
  • Treatment of workers performing these services as independent contractors is a standard industry practice.
  • There is a “reasonable basis” for classifying the worker as an independent contractor.
  • The employer must at all times have filed all federal tax returns consistent with their treatment of the workers as independent contractors and not employees. This treatment would include giving the workers Form 1099-MISC as annual wage summaries and not W-2s at any time. Relief is available only for workers for whom the required returns were filed consistently and only for the years they were filed.

While the first three criteria are pretty straightforward, the last two are not. Let’s try to further define what is meant by “reasonable basis”.

Reasonable Basis: for not treating a worker as an employee may be established by:

    • A judicial precedent from a related court case or published ruling by the IRS
    • A prior IRS audit in which similar workers were treated as independent contractors
    • Technical advice from a recognized employment tax authority or subject matter expert

What is meant by “significant segment of the employer’s industry treats similar workers as independent contractors”? A company must be able to demonstrate that a significant percentage of companies in their industry treat similar workers as independent contractors. The government does not quantify “significant percentage” but legal precedents indicate that companies received relief under Section 530 by demonstrating that a number of competitors in their geographic area applied the same standards.

Reporting Consistency: Finally, There are limitations. Section 530 only applies to Federal taxes. It does not address State and local taxes.

Section 530 does not provide relief for all skills. Services provided by technical resources such as engineers, designers, software developers, and drafters are not protected.

Moreover, the safe harbor standards and the reasonable basis offered by Sec 530 are rejected by the Affordable Care Act (ACA) for its pay or play requirements. So, employers who are required to conform to the tenets of the ACA must carefully review their existing classification of employees. They also need to make doubly sure that they will not be held liable for misclassification, or prepare to shoulder the liability.

Some analysts feel that these safe harbor provisions are unnecessary and make it easier for employers to avoid responsibility for misclassifications. Others acknowledge that the imprecise nature of the Independent Contractor qualification tests contributes to the level of misclassification, and that some level of relief is warranted. Please share your views and experiences.

The content on this blog is for informational purposes only and cannot be construed as specific legal advice or as a substitute for competent legal advice. They reflect the opinions of DCR Workforce and may not reflect the opinions of any individual attorney. Do contact an attorney for advice specific to your issue or problem.
Lalita is a people/project manager with extensive experience in operations, HCM and training and development across industries like banking, education, business consulting, BPO and information technology. She believes in a dynamic approach to life and learning as change is the only constant.