Skip to Main Content

Keeping you informed

DOL and IRS Focusing on Independent Contractor Misclassification

    Client Alerts
  • July 23, 2010

Last week, FedEx agreed to settle a Massachusetts lawsuit challenging the company's classification of certain of its delivery drivers as independent contractors. This case is one of a growing number of legal challenges to businesses' use of independent contractor labor. These suits claim that under statute or common law, the workers in question are actually employees, and are entitled to the legal protections extended to employees.

The federal Department of Labor has been particularly aggressive about challenging companys' classification of workers as independent contractors, especially in the context of overtime and minimum wage claims. In addition, the IRS is sanctioning companies for failure to withhold income and payroll taxes from amounts paid to persons classified as independent contractors.

The legal distinction between an employee and independent contractor is based on a case-by-case assessment of the individuals in question. The IRS has published a "20 Questions" test that it uses to determine whether the person in question is a true independent contractor. The key factors used in making this determination include the degree to which the worker has discretion over the means and methods used to perform the work. Is the work closely supervised? Does the worker set his/her schedule? Does the worker perform services for multiple companies?

While no one factor is determinative, the agency reviewing this question will look to determine whether the work being performed is similar to that done by actual employees of the company. Businesses have an especially difficult time defending independent contractor classification for a former employee who terminated from employment, but continues to perform the same or similar services as a contractor. The worker's preferences, and any written agreement between the company and contractor are largely irrelevant to the classification question.

In addition to the wage payment and tax issues, misclassification of independent contractors can result in a variety of claims against the business, including failure to provide Workers' Compensation and unemployment benefits, and claims of entitlement to employee benefits, such as medical insurance, 401(k) participation and stock options or other employee equity incentives. Any company using independent contractors should thoroughly analyze and document their grounds for concluding that this classification is legally appropriate and defensible.