The Department of Labor (DOL) has signed a memorandum of understanding with the Internal Revenue Service (IRS) to coordinate efforts to address employee misclassification. According to the DOL, the measure is aimed at “improv[ing] departmental efforts to end the business practice of misclassifying employees in order to avoid providing employment protections.” Seven state labor agencies have also signed memoranda of understanding with the DOL, including Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah, and Washington, and four additional state agencies have agreed to sign memoranda of understanding as well, including Hawaii, Illinois, Montana, and New York.

The memoranda of understanding will enable the DOL, the IRS, and signatory states to share information and coordinate law enforcement, which the DOL hopes will ensure better protections for employees and “level the playing field” for law-abiding employers. The memoranda arose as part of the DOL’s Misclassification Initiative, which was created to enforce and deter violations resulting from the misclassification of employees as independent contractors.

The misclassification of an employee as an “independent contractor” exposes employers to significant risks, including liability for unpaid wages, overtime, meal and rest breaks, employee benefits, unemployment contributions, taxes, and penalties.

There has been a pronounced increase in the enforcement of misclassification issues in the past few years, including the allocation of $25 million to the DOL in 2011 to pursue misclassification litigation and provide grants to state agencies for increased enforcement. Additionally, the IRS allocated approximately $6 million to the enforcement of proper classification. State-based enforcement has also been heightened recently, particularly in light of the need for additional tax and unemployment revenue in the current economic climate. The memoranda of understanding signed this week now also mean that employers may simultaneously face scrutiny and enforcement proceeding on multiple fronts.

Employers should be aware of the risks of misclassification and the need to properly classify individuals as either employees or independent contractors, and should seek guidance regarding proper classification.