Today’s article is the third in a four part series addressing the dire consequences of the IRS worker reclassification program.  It is a complicated article because the risks are so great.  Please carefully consider it if it applies to you.

Briefly, the Internal Revenue Service is actively pursuing worker reclassification audits so to change the tax treatment of independent contractors to that of employees. In doing so, it is retroactively subjecting employers to significant federal payroll tax liabilities, including penalties and interest. Further, it is subjecting the employer to numerous other federal and state laws which also can be overwhelmingly expensive and time-consuming.

The IRS has achieved this by developing information sharing programs. It can and does share information with state agencies. Likewise, state agencies can share information with the IRS. The result can be devastating.  For example, the state recently audited a new client to reclassify its Form 1099 independent contract workers as employees. The client foolishly consented because the state tax liability was insignificant. Unfortunately the state shared that information with the IRS and my client was hit with a four million dollar retroactive payroll tax liability.  There was no IRS audit, the IRS simply relied upon the state’s reclassification for its own purposes. And this was just the tax liability!

Today we are going to address the non-tax consequences of the IRS reclassifying independent workers to employee status:

  1. Overtime Pay

Federal law requires additional compensation to workers who work more than 40 hours per week under the Fair Labor Standards Act (“FLSA”). These rules obviously do not apply to contract laborers as we are not their employers. However, if the IRS reclassifies those independent workers to become our employees and coverage under the Fair Labor Standards Act exists, then we can become liable for overtime pay in the event that the employee is not exempt from the overtime provisions of the FLSA. This can be an enormous amount of money.   Also, the regulations of the FLSA were recently amended to raise the salary level requirement for employees to be considered “exempt” from the overtime rules from $455 per work week to $913 per work week.  As a result, effective December 1, 2016, currently exempt employees who earn less than $913 per work week (or $47,476 per year) will no longer be exempt from the overtime rules.  While this rule change will not affect certain classes of exempt employees who do not need to meet the “salary level” requirement, this change in the law is expected to extend overtime entitlement to over 4.2 million workers across the country.


  1. Immigration Law Compliance

Federal law requires that every employer hiring an individual for employment in the United States complete a Form I-9, Employment Eligibility Verification to confirm their identity and authorization to work in the United States. Independent contractors are not required to complete the Form I-9 since they are not considered our employees.  If the IRS reclassifies contract workers to employees, then employers become liable for ensuring completion of the Form I-9 for all reclassified employees.  Failure to timely and properly complete the Form I-9 carries significant federal penalties, including civil fines, debarment from government contracts, and possible criminal penalties (when there is a pattern or practice of violations of the law).


  1. Liability under Anti-Discrimination Laws

If the IRS reclassifies our workers as employees, then we may also become subject to the state and federal anti-discrimination laws.  That’s right folks, if you have more than 15 employees under Texas and federal law (or four employees in New Mexico) then you may become subject to both federal and state laws against sex, disability, religious, national origin, race discrimination and age discrimination.

Of course, we should not be discriminating against anyone.  But that isn’t the issue.  An IRS reclassification may subject you to federal and state scrutiny as to whether or not you may have inadvertently done so. It may also subject you to scrutiny due to completely baseless claims by a former worker seeking unemployment benefits.  Either way, this is an expensive and time-consuming undertaking which involves not just administrative bureaucracy, but can also involve state and federal court litigation which can be very expensive and very time-consuming.

If you have a business that uses independent contractors, you are at risk to salaried government bureaucrats who have publicly announced they intend to exercise their best efforts to reclassify your workers to employees.  The risk here is significant and could implicate further exposure under the various state and federal laws that govern employers. But, this may in large part be avoidable if you will take the time and effort to protect yourself now and are proactive in ensuring that your business is in compliance with these various laws.

I urge you to get a good tax advisor and employment attorney and fix this problem before you are audited.