Businesses that utilize independent contractors should be ready for increased scrutiny. As part of President Obama’s federal budget for the upcoming fiscal year, $25 million was requested by the Department of Labor (DOL) to enforce wage and hour laws and pursue employers who misclassify employees as independent contractors. Another $12 million and 90 new investigators were requested by the Wage and Hour Division to expand its efforts to ensure workers are in compliance with the law.

The "Misclassification Initiative" also supports new targeted efforts to recoup unpaid payroll taxes due to misclassification through state audits of problem industries supported by federal audits. These industries include: construction, manufacturing, restaurants and home health care. Additionally, the initiative includes a $10.9 million pilot program that would reward the states that are the most successful or improved at detecting and prosecuting employers that fail to pay the appropriate taxes due to worker misclassification.

In addition to the DOL, the Internal Revenue Service (IRS) will be scrutinizing independent contractor arrangements. As part of a National Research Project on employment taxes, the IRS is due to audit 6,000 randomly selected companies over the next three years. The audit will focus on, among other things, worker classification.

Given the potential liability for penalties, taxes and interest, businesses must pay close attention to this issue. Employers should engage in proactive self-audits, reviewing, among other things, their payroll records and IRS Form 1099s to identify those they have been paying as independent contractors and assess whether these individuals meet the requirements established by federal and state law.