Opportunity favors the prepared – and so does the avoidance of tax liability. Worker misclassification audits are on the increase and employers should learn from those who have been through an audit – preparation ought to begin years before you ever get an audit letter. Bad practices and lack of documentation simply cannot be repaired adequately once an audit letter is received.

Audits on the Increase

State agencies, the Department of Labor, the IRS, the Office of Federal Contract Compliance and many other agencies are all planning to increase the audit of employers in search of “misclassified” workers. The Department of Labor has announced a significant budgetary dedication to identifying misclassified workers through all of its umbrella agencies. The formal announcement contains the following quote:

“When workers are misclassified as independent contractors they are deprived of benefits and protections to which they are legally entitled, and law abiding businesses are placed at a disadvantage against employers who violate the law.”

This thinking should concern any organization who engages independent contractors, particularly those who utilize contractors on a regular basis. The quote highlights the philosophical approach of most auditing agencies: specifically, every independent contractor really should be in an employment relationship and the contractor relationship is merely a pretext to avoid taxes.

In a recent case involving the California Employment Development Department (EDD- in California the EDD audits for unemployment insurance as well as for the franchise tax board) a contractor filed an unemployment insurance claim when the contracted work ended, even though the individual had signed an agreement as an independent contractor. Not surprisingly, the EDD found in favor of the worker. The company responded that the claim was improper on the basis of the contractor agreement. The EDD’s representative stated: “We do not believe any reasonable person would leave W-2 income for an independent contractor relationship”. In other words, the engaging entity is presumed guilty until proven innocent. Later in this same case, the worker withdrew his claim for unemployment insurance, undaunted, the EDD decided to pursue the audit.