By Sylvia Hsieh
Dolan Media Newswires
In an effort to fend off an official investigation of its books, a major tobacco company hired a law firm to audit the classification of 5,000 workers.
“The audit was to find out what kind of exposure they had,” said Kristin R. Erenburg, an attorney with Walter Haverfield in Cleveland who was hired by the company.
The company decided to investigate itself rather than wait for a knock on the door from the Internal Revenue Service, the Department of Labor, state agencies or a class-action plaintiffs’ lawyer.
Employers are facing pressure on all fronts over their practice, either chosen or inadvertent, of misclassifying workers as independent contractors instead of full-time, benefit-earning employees.
GJ Stillson MacDonnell, an employment tax attorney at Littler Mendelson in San Francisco, said corporations are not the only targets of worker classification audits. Partnerships, LLCs, mom-and-pop operations, nonprofit organizations, religious groups and even government agencies have been audited.
Since 2011, 14 states have signed agreements with federal agencies to share information about employers suspected of misclassifying workers. And class actions brought by workers who say they wrongly were classified remain at the top of the list when it comes to hot litigation trends.
A DOL spokesperson said misclassification is popping up in industries that traditionally have not had such problems.
For example, the DOL collected back wages and liquidated damages for dozens of restaurant workers in Boston who improperly were categorized as independent contractors of a staffing agency rather than direct employees of the restaurant.
While there is no law that makes misclassification illegal, the denial of wages, overtime and other benefits, such as unemployment, often triggers an investigation into whether a worker was categorized properly.
By classifying workers as independent contractors, small employers can stay small for purposes of some federal laws that set 50 employees as the threshold number for making benefits mandatory.
“It costs more money,” said Kraig J. Marton, an attorney at Jaburg & Wilk in Phoenix who has represented businesses and employees. “It’s purely a matter of economics and ease.”
Others say competition fuels misclassification.
“The big problem is that for many businesses, because all their competitors treat workers as independent contractors, it’s very difficult as a business matter to convert them to employees,” said Dennis N. Brager, a tax attorney at the Brager Tax Law Group in Los Angeles.
The majority of IRS audits come from tips from state agencies when a worker applies for benefits.
“When someone files an unemployment claim who is not engaged as an employee,” MacDonnell said, “it opens the door to an audit, not just of that one person, but of the entire organization.”
An audit under the Internal Revenue Code seeks payment of all taxes owed, plus penalties and interest, while other statutes, such as the Fair Labor Standards Act, impose treble damages in addition to back wages and overtime.
Even though rules that distinguish an employee from an independent contractor are not black and white and depend on how the individual is treated by an employer, MacDonnell recommended employers “take a step back and consider the consequences” when deciding how to classify an individual.
Preempting an audit
The IRS has launched a voluntary compliance program that lets employers self-report, reclassify their employees and pay a fraction of what they owe in back taxes.
“The IRS is making a genuine effort to use a carrot to convert people and cut a really good deal,” Brager said, noting that employers who voluntarily reclassify pay no more than 10 percent of federal payroll taxes owed.
The IRS announced in February that it was expanding a “low cost” voluntary compliance option to more employers by loosening eligibility requirements until June 20.
However, despite the incentives, not many companies are taking the bait.
“I’m not seeing a stampede of companies voluntarily coming forward,” Brager said.
However, some employers, mostly larger ones, are asking lawyers to perform independent audits.
Ultimately, the tobacco company Erenburg represented discovered it had misclassified some independent contractors. It then reclassified them as employees.
The company then made sure those employees signed waivers of their right to sue for wage and hour violations in exchange for their new classifications.
Even though an internal audit would not prevent government agencies from looking into an employer’s books as far back as 10 years, she said, it could strengthen a company’s position in a real audit.
“If they can right the ship in time,” Erenburg said, “it looks good that [they] had reclassified some employees … if an agency does come knocking on the door.”