Hunton Employment & Labor Law Perspectives : Employment Lawyers & Attorneys : Hunton & Williams Law Firm : Labor Law Legislative Updates

Currently, the Internal Revenue Code provides a safeharbor for employers to avoid penalties or at least suffer lighter penalties when they misclassify employees as independent contractors as long as there is a reasonable basis for the classification.  And, given the IRS’s current moratorium on issuing guidance on worker classification issues, employers can almost always provide a rationale for their classification decision because the absence of substantial guidance allows employers to be creative in developing their reasonable basis defense.  According to Senator Kerry’s website, the proposed legislation will reduce the use of the safeharbor by:

• Ending the moratorium on IRS guidance on worker classification issues and requiring the Secretary of Treasury to issue prospective guidance;
• Amending the tax code provisions to clarify that the reduced penalty is not available where employers fail to comply with IRS/Treasury guidance;
• Requiring business owners who use independent contractors to provide each contractor a written statement regarding the contractor’s tax obligations, the labor and employment law protections that do not apply to independent contractors, and the right of the contractor to seek a status determination from the IRS; and
• Requiring the Secretary of Treasury to issue annual reports on worker misclassification.

The White House quickly gave its strong endorsement to the proposed legislation.  According to Vice President Biden, “[S]topping worker misclassification is a priority for the President’s Middle Class Task Force. . . . The legislation is timely, as misclassification is an increasing problem, one that puts employers who properly classify their workers at a disadvantage in the marketplace and costs the government billions of dollars in unpaid taxes.  I urge the Congress to stand up for workers and create a level playing field for law-abiding businesses by supporting this bill.” 

The proposal of The Fair Playing Field Act of 2010, along with the White House’s heightened interest in misclassification issues, underscores the need for employers to closely examine their independent contractor relationships and, to the extent necessary, take corrective action now before they find themselves the subject of a government investigation or a private lawsuit. 

The district court had identified three possible tests: the “common law agency” test (focusing on the hiring party’s right to control the manner and means by which the product is accomplished), the “economic realities” test (a fact-specific inquiry focusing on the economic realities of the situation, as its name suggests), and the “common law hybrid” test (a combination of the other tests, taking multiple factors into account).  The appellate court said that the three tests are functionally equivalent.  Even if their different formulations suggest variations in practical application, the controlling test is the common law test, as pronounced by the Supreme Court in Nationwide Mutual insurance Co. v. Darden.  That test applies “whenever an employment statute defines the term ‘employee’ in the way ERISA does, and the statute in question does not otherwise suggest that the common law test would be inappropriate.”  The Supreme Court identified 12 factors to consider, including whether the hiring party has the right to assign additional projects to the hired party, the extent of the hired party’s discretion over when and how long to work, and the tax treatment of the hired party. 

Applying those factors, both courts found the plaintiff/appellant in this case to be an independent contractor based on the overall picture presented by her situation.  She was free to operate her business as she saw fit, could decide when and where to work (and in fact, paid rent on her own office), was paid on commission only, reported herself as self-employed to the IRS, and sold products other than those offered by the defendant. 

Now that the court has clarified the appropriate standard, hiring parties in the Ninth Circuit should reevaluate their hired parties to ensure they are classified appropriately.