ETS Tax Intelligence: Worker Misclassification
The courts and other governmental authorities [including the Internal Revenue Service (“IRS”), the U.S. Department of Labor (“DOL”), and state workforce agencies (“SWAs”)] have addressed the issue of worker misclassification for decades. These government authorities believe that when a worker is considered an employee, and not an independent contractor (“IC”), workforce compliance and the collection of taxes are significantly improved because the employer has the responsibility for adhering to labor laws and properly remitting employment taxes. In an effort to increase compliance, in September of 2011 two independent programs were announced: 1) the DOL and IRS entered into a Memorandum of Understanding (“MOU”); and 2) the IRS created a new voluntary classification settlement program (“VCSP”). Since this time, the DOL has provided funding to SWAs for identification of employers with misclassified workers and entered into MOUs with 20 states (five signed within the past six months) permitting collaboration and the sharing of information. These initiatives have made worker misclassification a key workforce compliance risk area for employers.
Employee Versus Independent Contractor
- Common Law (“20 Factor”) Test: A series of 20 judicially developed factors used federally and by certain SWAs to identify the relationship of the parties and the degree of behavioral and financial control. No single factor is more important than the other; all facts must be considered.
- ABC Test: Three questions used by a majority of SWAs. If the answer to any of the three questions is “no,” the worker may be considered an employee. Many state workforce agencies use a variation of the ABC Test.
Click here for additional information on the 20 Factor Test and the ABC Test.
Consequences of Misclassification
Misclassification can create exposure to both federal and state employment tax risks, in addition to labor law compliance risks. If misclassified workers are identified, the IRS, for federal employment tax purposes, has the ability to offer employers varying levels of relief:
Exposure to state withholding and state unemployment insurance (“SUI”) tax risks are also created when a worker is improperly classified. For example, a worker improperly classified as an IC applying for state unemployment benefits can trigger a SUI worker classification audit. If the SWA determines that an employee has been misclassified, employers become liable for back SUI taxes, including interest and penalties, during the applicable statute of limitations period, and the employer’s SUI tax account will be charged for the unemployment benefits paid to the employee-claimant.
To mitigate the risks associated with misclassification, employers should review current worker classification practices, calculate financial risks, assess exposure to other risks (organizational and reputational), and formulate a plan to mitigate any potential exposure, prospectively or retroactively.
For more information about how Equifax can assist employers with identifying and minimizing risks associated with worker misclassification, please contact Pete Krieshok at (314) 214-7325 or via e-mail at firstname.lastname@example.org. You can also visit our corporate blog at https://insight.equifax.com/ for information on other employment tax matters that might impact your organization.