Employee classification: Could your best worker be putting you at risk?

Here on The Seamless Workforce there have been a number of discussions about employee classification and the risks associated with noncompliance. Several of you might say this is an IRS-related effort, and the chances of being audited for labor classification are as likely as me being personally audited by the IRS. While this may be true, I would caution that the odds are starting to stack against you.

With government agency coffers running on empty as a result of the current economic bailout, government has two, well, three options to recoup funds:

1. Print money. Though we have seen it happen recently, we are confident that it won't happen again anytime soon.
2. Increase taxes. While this will likely happen to some degree, there would need to be an exorbitant increase to make a difference. And that would be political suicide for either party.
3. Exercise law and code enforcement. Since the laws and codes are already in place, as well as the resources to enforce them, this seems to be the most sensible option. The IRS has told us it's coming, it's just a matter of executing.

And executing it they are. We already introduced you to FedEx's classification woes, and, as if things couldn't get worse for the company, now New Jersey, New York and Montana plan to sue FedEx Ground, claiming the unit's classification of workers as independent contractors rather than employees violates state labor laws. What does this prove? If you're a national company, you better have all your ducks in a row regarding employee classification because if one state finds grounds to sue, all the other states you operate in are going to follow suit.

Remember my earlier comment about the chances of being audited? Consider this: How many individuals, time and resources would have to be invested in order to collect the same fees that auditing a single Fortune 500 company found to be in violation could provide? The truth is, the government knows where to find money; companies have much deeper pockets than individual taxpayers.

A recent Washington National Tax Services (WNTS) report highlights a new IRS compliance program focused on worker classification. The report states that this will be "the most comprehensive IRS examination of employment tax compliance undertaken since 1984." The new program, scheduled to begin later this year, may increase tax exposure for businesses that rely heavily on independent contractors, of which the U.S. government estimates there are as many as 10 million in the workforce.

The potential exposure and risk associated with this include:

• Steep increases in penalties
• More stringent reporting and monitoring requirements by business to government
• More independent contractors suing for employee benefits

So how can you mitigate these risks? Consider these three proactive steps:

1. Evaluation/qualification: Perform internal audits of your organization's entire workforce to accurately identify the number of independent contractors and the level of risk exposure due to misclassifcation. Outside organizations also provide this evaluation as a service.
2. Payrolling through a third party: Transitioning misclassified employees to your own W-2 employees is an option. However, this approach poses its own risks. The "reshuffling" of workers could most definitely draw the IRS's attention to the matter, and it could look to recoup back taxes. In addition, not only is the IRS due entitlements with the transition, but workers reclassified from independent contractor to employee status have the right to claim substantial benefits, such as health benefits and matching contributions to 401(k) or other savings plans. One method for alleviating this risk is to transition the misclassified employees to a managed service provider who then becomes the employer of record.
3. Pre-evaluation: Incorporating a comprehensive classification screening process during candidate evaluation and selection to define workforce categorization is the most proactive way to avoid both the risk and the cost.

Remember what Benjamin Franklin said? "The only things certain in life are death and taxes." We know we can't cheat death, and now it seems the government is making it increasingly harder for organizations to avoid some additional taxes as well.