On December 15, 2009, Sen. John Kerry (D-Mass.) introduced a bill in the Senate aimed at reducing the misclassification of workers as independent contractors.  The bill, called the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (S. 2882), is a companion bill to a measure introduced in the House of Representatives last August (H.R. 3408).

Sen. Kerry’s proposed legislation would amend Section 530 of the Revenue Act of 1978, the so-called “safe harbor” provision that gives businesses some flexibility in classifying workers as independent contractors for employment-tax purposes.  Generally, in determining a worker’s status as an employee or an independent contractor for tax purposes, the IRS applies the common-law test for employee status.  The common-law test focuses on twenty factors regarding the relationship between a business and a worker.  Section 530, however, allows businesses to classify workers as independent contractors, regardless of the analysis under the common-law test, unless the business has no “reasonable basis” for such a classification.  Under the safe harbor provision, employers may rely on an industry practice of classifying workers in a particular position as their “reasonable basis” for the classification.  Sen. Kerry’s proposed legislation would substantially reduce the scope of the “safe harbor” provision.

Under the Taxpayer Responsibility, Accountability, and Consistency Act, a business would have a reasonable basis for treating a worker as an independent contractor regardless of the outcome of the common-law test only if the business or its predecessor met a two-factor test as follows.  First, the employer could not have treated any worker holding a substantially similar position as an employee since December 31, 1977, and second, the classification of the worker as an independent contractor must be based in reasonable reliance on either a written determination from the Department of Treasury that the worker (or someone holding a substantially similar position) was not an employee or on an IRS examination of the worker (or someone holding a substantially similar position) that did not conclude the worker was an employee.  To strengthen enforcement efforts regarding the misclassification of workers, the bill would require businesses to issue Form 1099s to every service provider (whether an individual, a partnership, or a corporation) to whom the business pays more than $600 annually and would give workers classified as independent contractors the right to seek a determination of their status for employment-tax purposes from the Secretary of the Treasury.

Senator Kerry’s bill and the companion bill in the House closely resemble bills that were introduced in the last Congress.  In the intervening year since the previous introduction of the legislation, a labor-friendly president who has made clear his intent to enforce the nation’s laws governing the fair payment of wages has entered the White House, and a cash-strapped government is ever more feeling the pinch of lost employment-tax revenue attributable to the classification of workers as independent contractors.  Congress, therefore, has enhanced incentives for pursuing this legislation.

Moreover, in addition to being a tax issue, proper workforce classification is inextricably linked to the lawful payment of wages, including overtime, which remains the primary area of growth in labor and employment litigation.  Misclassification leaves employers liable not only to penalties from the IRS, but also vulnerable to state and federal wage and hour litigation by employees who, because of misclassification as independent contractors, were not provided with statutorily required pay or work breaks.  Accordingly, employers would be well-served to review their system of worker classification.