Last week, Senator Edward Kennedy’s office issued a press release indicating that he and fellow U.S. Senators, Barack Obama (D-IL), Dick Durbin (D-IL), and Patty Murray (D-WA), had introduced The Independent Contractor Proper Classification Act of 2007 (the “Act”). The purpose of the Act is to protect workers and taxpayers against the misclassification of employees which costs the government billions of dollars and denies workers such benefits as workers’ compensation and overtime pay.

According to the press release, the Act is designed to close a loop in Section 530 of the Revenue Act of 1978 that allows employers to classify workers as “independent contractors” instead of “employees” thereby enabling employers to avoid paying employment taxes and worker’s compensation. According to the senators, employers that follow the rules are forced to pay higher federal and state payroll taxes, putting them at a competitive disadvantage against those employers who misclassify their workers.

The Act will allow the government to collect taxes owed, identify employers in major industries who misclassify their workers, and require greater cooperation between the Internal Revenue Service and Department of Labor in enforcing the law. The Act is supported by, among others, the AFL-CIO, the International Brotherhood of Teamsters, and business associations representing more than 200,000 construction employers.

According to Senator Kennedy, “improperly labeling workers as independent contractors is cheating of the worst kind. Companies resorting to this dishonest practice avoid paying the taxes they owe and deny their employees their legal rights, including the right to a safe workplace, the right to the minimum wage, and the right to overtime pay.”

Misclassification of workers can cause serious problems for employers. Beyond workers’ compensation and overtime pay, should independent contractor(s) later be found to be employees, this finding can cause significant headaches for an employer with a qualified retirement plan. Exclusion of eligible employees from contributions and accruals under a qualified retirement plan will typically require the plan sponsor to make corrective contributions to the plan in order to compensate the employees for the missed deferral opportunity. The calculation method and correction procedure is governed by Revenue Procedure 2006-27. Because the correction process can be complicated and time consuming, all employers are encouraged to review their employee classification procedure.