The Internal Revenue Service (IRS) cares about misclassification of employees as independent contractors and the Department of Labor (DOL) cares, too. These two agencies launched a massive “Misclassification Initiative” which created 100 new auditor jobs.

The U.S. Government Accountability Office estimated employer misclassification resulted in $2.72 billion in lost government revenue in 2006. The majority of the loss was attributed to failure to pay income tax, and the balance was failure to pay Social Security, Medicare and unemployment taxes.

The IRS estimates 80% of workers classified as independent contractors should be classified as employees. A Fact Sheet published by the Department for Professional Employees stated companies that misclassify their workers can lower their labor cost by 40 percent creating an unfair advantage. Employers can save an average of $3,710 per employee earning $43,007 annually, according to a report of the Treasury Inspector General for Tax Administration.

In addition to the financial loss to the government and advantage of the employer, in most cases it is the worker who is losing. Typically workers who are misclassified as independent contractors have lower incomes, less economic security, and are not protected by the Fair Labor Standards Act (FLSA), Family Medical Leave Act or employer sponsored benefits.

Like misclassifying an employee as salaried and exempt from FLSA overtime regulations, the title doesn’t matter; nor does signing an agreement or labeling employees as partners or members of a LLC. Employees are not permitted to waive their employee status.

The DOL published an Administrator’s Interpretation applying the FLSA’s “Suffer or Permit to Work” standard to identify misclassified employees. Suffer or permit to work means any person allowed to act directly or indirectly in the interest of an employer may be considered an employee. Using the “suffer or permit” concept broadens the interpretation of who is an employee.

Historically, the phrase “suffer or permit” was used to regulate child labor. Businesses were using middlemen to illegally hire and supervise children. The term was used to combat the employers who stated they were unaware children were in their employ.

This report states that someone who is economically dependent on an employer and acting in the employer’s interest is suffered or permitted to work by the employer. The Supreme Court and Circuit Courts of Appeals developed an “economic realities’ test to determine whether a worker is an employee or an independent contractor. Each of the six factors should be analyzed and considered in totality to determine whether economic dependence exists. No single factor is more important than another.

If the worker is economically dependent on the employer, then the worker is an employee. An independent contractor is in business for him or herself and economically independent from the employer.

What all employers should do:

Assess your relationship with your independent contractors using the Economics Realities Test:

• Is the work an integral part of the employer’s business?
• Does the managerial skill of the worker impact the worker’s profit and loss?
• Is the worker making a significant financial investment to be in business?
• Does the worker’s skills demonstrate independent business judgment?
• Is the relationship permanent or indefinite?
• What is the nature and degree of control over the worker?

Each response should be analyzed to conclude whether the worker is economically dependent on the employer or an independent business.