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EMPLOYEE CLASSIFICATION Watch out — Oklahoma follows IRS' lead

Oklahoma Employment Law Letter - March 1, 2010

By Charles S. Plumb

Oklahoma employers increasingly hire and classify workers as “independent contractors,” particularly during slow economic times. When business slows, employees are laid off; sometimes they’re hired back as independent contractors, even though they’re performing the same or similar tasks they performed before the reduction in force. Read on to learn why that could be a bigger problem than ever.

Pros and cons
By classifying individuals as independent contractors rather than employees, companies try to gain operational and economic advantages. Using independent contractors is a way for some employers to “test the waters” before committing to full-blown employment relationships, especially if there are doubts about the business or workload. Independent contractors also allow companies to enjoy cost savings because they rarely receive health insurance, 401(k) coverage, or other benefits that cost the employer money.

Employers don’t pay overtime to independent contractors, nor do they include them in their premiums for workers’ compensation insurance coverage or unemployment benefit payments to the Oklahoma Employment Security Commission. In addition, employers aren’t required to withhold federal or state taxes and other amounts (such as social security or Medicare) from independent contractors’ pay.

As we noted in our February 2008 issue, employers may misclassify individuals as independent contractors when, under unemployment law, they’re actually employees. If federal or state agencies find out about a misclassification, an employer can find itself paying a lot of money in back taxes, benefits, and other costs (see “Death and taxes: IRS investigation ends with $319 million bill for FedEx,” pg. 4). Recent activity in Washington, D.C., and Oklahoma City indicates that Oklahoma employers can expect more governmental scrutiny. Thus, you should review your workers’ status to ensure you’re not incorrectly classifying employees as independent contractors.

The IRS’ intention

The IRS recently announced that over the next three years, it will randomly audit thousands of businesses throughout the country, with particular emphasis on whether employers have misclassified employees as independent contractors in order to evade federal tax obligations. The IRS hasn’t conducted an audit with this sort of focus for more than 20 years. The initiative is part of the agency’s effort to identify categories representing the largest portion of uncollected taxes.

Oklahoma considers piling on
Not to be outdone, on January 13, 2010, Oklahoma Senator Andrew Rice introduced Senate Bill (SB) 1384, aimed at identifying Oklahoma employers that have misclassified individuals as independent contractors rather than employees and underpaid state taxes and workers’ comp and unemployment benefits premiums.

The bill directs the Oklahoma Tax Commission, the Oklahoma Workers’ Compensation Court, and the Oklahoma Employment Security Commission to create a database of employers, employees, and independent contractors that can be accessed by any one of the agencies. They are also directed to “share information and coordinate investigation and enforcement efforts for the purpose of detecting those employers who intentionally misclassify individuals as independent contractors other than employees.” SB 1384 contemplates the agencies sharing information and coordinating enforcement efforts to identify and confront employers that have misclassified individuals as independent contractors. On February 10, the bill was referred to the Senate Business and Labor Committee.

What does it all mean?
It’s too early to tell the scope of the IRS’ upcoming audits or where SB 1384 is headed. It’s safe to assume that in the current economic and political climate, companies classifying workers as independent contractors are more likely than ever to be reviewed by federal and/or state agencies. Now is the time to look at your use of independent contractors to make sure you’re in compliance with applicable tax, benefits, and employment laws.