On September 19, 2011, Secretary of Labor Hilda L. Solis signed a memorandum of understanding (“MOU”) between the Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) meant to improve departmental efforts to identify and prevent misclassification of employees as independent contractors.  The labor agencies of seven states (Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah, and Washington) entered into similar memorandums of understanding with the DOL.  It appears that several other states (including Hawaii, Illinois, Montana, and New York) will follow shortly.  

Independent contractors are not subject to the minimum wage and overtime provisions of the Fair Labor Standards Act, nor are they generally eligible for unemployment benefits, workers’ compensation benefits, or employer contributions to social security.  Moreover, employers do not pay employment taxes for independent contractors, who are considered self-employed.  Accordingly, the government is seeking both to vindicate employee rights and preserve tax revenues with this joint venture between the DOL and IRS.

The MOUs arose out of the DOL’s broader Misclassification Initiative, which was launched as part of Vice President Biden’s Middle Class Task Force.  Through the MOUs, the DOL hopes to “share information and coordinate law enforcement with the IRS and participating states in order to level the playing field for law-abiding employers and ensure that employees receive the protections to which they are entitled under federal and state law.”

The DOL’s use of the term “law-abiding employers” suggests a “white hat/black hat” scenario in which employers who misclassify employees are bad actors who do so intentionally.  As a practical matter, this frequently is not the case.  Determining whether an individual may properly be characterized as an independent contractor often is a close issue involving a number of factors, such as job duties, degree of control over work performed, nature and extent of supervision, degree of skill required to perform job duties, ownership of tools or other implements of the trade, and other similar factors.  Nor is it a static determination, given that the facts and circumstances of an individual’s work environment are subject to change over time.  

Employers who use independent contractors in any capacity should perform a classification audit to ensure compliance with the FLSA, federal tax code, and relevant state laws, as the DOL and IRS are certain to aggressively investigate and prosecute violations in coming months, even those made in good faith.  

Significantly, on September 21, 2011, the IRS implemented the Voluntary Classification Settlement Program (“VCSP”), which provides partial relief from past federal payroll taxes on employees improperly classified as independent contractors.  Under this program, eligible employers agree to prospectively treat affected independent contractors as employees in future tax periods.  In exchange, the employer: (1) will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year; (2) will not be liable for any interest and penalties on the amount; and (3) will not be subject to an employment tax audit with respect to the worker classification of the workers for prior years.  While the employer will not be subject to liability for employment taxes for periods prior to the voluntary reclassification, the employer must agree to an extension of the statute of limitations from three to six years for the first three years following the reclassification.   Additional details on eligibility requirements, application procedures, and other details concerning the VCSP can be found at the following link:  http://www.irs.gov/businesses/small/article/0,,id=246013,00.html.

Employers should bear in mind that the VCSP does not provide amnesty for violation of other federal laws, so employers may expose themselves to scrutiny from the DOL should they choose to participate.  Accordingly, employers may wish to consult legal counsel before making a decision concerning participation in the VCSP.