The misclassification of employees as independent contractors creates significant risks to employers.  Recently the US Department of Labor and the Internal Revenue Service have significantly increased their enforcement efforts in this area.

The IRS uses guidelines in its determination as to whether an individual is an employee or an independent contractor.  The primary test is whether the company has control over the worker; however, the IRS looks at a number of factors.

In September 2011, the US Department of Labor and the IRS signed a memorandum of understanding in an effort to jointly increase policing of worker misclassification.  The IRS is concerned with lost employment taxes and retirement plan qualification issues.  The Department of Labor’s concerns include the failure of the employer to make required contributions to Social Security.  Pursuant to this memorandum of understanding, the Department of Labor will refer wage and hour investigation information involving IRS employment tax compliance issues to the IRS.  The IRS will, in turn, share employment tax referrals provided by the Department of Labor with state and municipal taxing authorities, that have agreements with the IRS.  The Department of Labor and IRS will also share training materials and meet regularly to discuss ways to improve the partnership between the agencies. 

On September 22, 2011, the IRS launched a voluntary worker classification settlement program.  The program provides taxpayers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past nonemployee treatment.  In order to participate in the program, the taxpayer must meet certain eligibility requirements, apply to participate, and enter into a closing agreement with the IRS.  It is important to note, however, that the closing agreement with the IRS will not cut off any potential liability the employer faces based on employee misclassification with other agencies such as the North Carolina Industrial Commission and the North Carolina Department of Commerce Division of Employment Security. 

The consequences of misclassifying employees are substantial.  The employer could be liable for unpaid payroll taxes, claims based on employees being denied participation in benefit plans, and possible out-of-pocket liability for workplace injuries suffered by the worker due to the absence of coverage under a workers’ compensation insurance policy. 

It is further important to note that only employees are covered under Title VII of the Civil Rights Act of 1964 (Title VII).  The courts have had to decide cases, including those involving physicians, regarding whether or not the plaintiff was an employee or an independent contractor for purposes of determining whether or not the individual could pursue a claim under Title VII.  In the case of Cilecek v. Inova, Dr. Cilecek claimed that he was terminated because of his testimony in a former employee’s sexual harassment suit in violation of Title VII.  The trial court granted judgment in favor of Dr. Cilecek’s employer, and Dr. Cilecek appealed.  In reviewing the matter, the United States Court of Appeals for the Fourth Circuit, the Federal Circuit in which North Carolina is located, considered the following factors in determining whether Dr. Cilecek, who was performing emergency room medical services at a hospital, was an employee or an independent contractor:  (1) the control of when the doctor worked, how many hours he worked, and the administrative details incident to his work; (2) the source of instrumentalities of the doctor’s work; (3) the duration of the relationship between the parties; (4) whether the hiring party had the right to assign additional work to the doctor or to preclude the doctor from working at other facilities or for competitors; (5) the method of payment; (6) the doctor’s role in hiring and paying assistants; (7) whether the work was part of the regular business of the hiring party and how it was customarily discharged; (8) the provision of pension benefits and other employee benefits; (9) the tax treatment of the doctor’s income; and (10) whether the parties believed they had created an employment relationship or an independent contractor relationship.  After reviewing these factors, the Court of Appeals concluded that Dr. Cilecek was an independent contractor. As a result, he was not entitled to pursue his claim under Title VII.

It is critical that every employer, including hospitals and medical practices, carefully scrutinize all its independent contractor arrangements and agreements. It is highly recommended that employers obtain advice of experienced legal counsel in regard to such analysis and the formulation of a course of action in the event of a misclassification.