Classifying individuals as independent contractors or employees has always been tricky. The desire to reduce employment expenses led some employers to utilize more independent contractors rather than hiring additional employees. Now, the Obama administration has stepped in to curb what it believes to be an abuse of employers classifying workers as independent contractors rather than employees.

While the scope of the problem is hard to quantify, the U.S. Department of Labor estimates 30 percent of employers misclassify workers. President Obama's Fiscal Year 2011 budget (released on February 1, 2010) sets aside money to establish a proposal jointly administered by the Departments of Labor and Treasury to crack down on employers misclassifying individuals as employees rather than independent contractors. The goal is to recoup up to $7 billion in unpaid employment taxes over the next 10 years. The specific enforcement efforts include allocating $25 million to hire 100 more enforcement personnel. The IRS also plans to increase its audits of companies to ensure compliance with the law. Likewise, many states also have increased enforcement efforts by imposing penalties for misclassifying workers.

What should an employer do? The general rule is to determine whether the independent contractor is truly independent or doing work for an employer that would be normally be done by an employee. Key characteristics of an independent contractor include:

  • Working for more than one company
  • Bearing the risk of loss for work performed
  • Being able to determine the manner and method in which work is to be performed
  • Being responsible for providing the tools and equipment necessary to perform the job

The list is not exhaustive. Perhaps the best way to approach the issue is for employers to ask three simple questions: First, is the work the independent contractor is performing something I routinely or regularly need in my business? Second, if I did not utilize an independent contractor to do the work, would I have to hire an employee to do it? Third, if challenged, what rationale can I give for utilizing an independent contractor rather than an employee other than the cost was lower (presumably because employment taxes or benefits were not being paid)?

We do not want to suggest it is inappropriate to use independent contractors. However, given the increased budget to search out and enforce violations, now is a good time to take a look at your use of independent contractors to ensure those individuals are properly classified.