Recently, the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) renewed a memorandum of understanding (MOU) combining agency resources and efforts to prevent employee misclassification. In brief, the bi-agency effort adds a streamlined process for joint referrals and more close-knit coordination. The MOU allows the agencies to more effectively pursue employers that misclassify workers as independent contractors, denying them their full wages, benefits, and legal protections. Earlier this month, the DOL recovered $503,000 from a staffing agency to settle an independent contractor misclassification case.

MOU to Prevent Employee Misclassification

The renewed MOU to prevent employee misclassification will help the DOL’s Wage and Hour Division (WHD) share information and work seamlessly with the IRS to bolster enforcement of federal and state employment laws. Under the MOU, when WHD investigators discover that an employer is misclassifying employees as independent contractors, the two agencies are obliged to use their enforcement resources and data jointly. Such data sharing helps prevent employee misclassification and reduce the tax gap while improving compliance with federal labor laws. Joint duties and responsibilities under the MOU include:

  • Sharing data that may raise employment tax compliance issues related to misclassification;
  • Exchanging investigative leads or complaints of Fair Labor Standards Act (FLSA) violations;
  • Joint training materials and opportunities;
  • Coordinated outreach activities relating to preventing employee misclassification; and
  • Providing annual reports summarizing the results achieved by using WHD investigative data to pursue misclassification-related employment tax violations.

Misclassification and Proposed Independent Contractor Rule

The FLSA provides a minimum wage and overtime protections for virtually all U.S. workers. The critical wage and hour standards the FLSA sets make it one of the most crucial employment laws all businesses need to know. Under the FLSA, private sector and government employers must pay at least the federal minimum wage of $7.25 an hour and an overtime pay rate of one and one-half the regular pay rate during hours worked over 40 a week. However, some employers illegally and inaccurately treat their workers as independent contractors to avoid paying required overtime, as well as other benefits and protections promised to workers covered by the FLSA.

In 2022, the DOL published its proposed independent contractor rule for determining employee versus independent contractor status to prevent employee misclassification. The proposed rule looks at the totality of the circumstances surrounding a particular worker when determining whether they are really an independent contractor. In detail, the proposed independent contractor rule applies a six-factor economic reality test that examines the following areas:

    1. the extent to which the performed work is integral to the employer’s business;
    2. a worker’s level of investment in facilities and equipment;
    3. the nature and degree of control in the working relationship;
    4. a possible contractor’s opportunity for profit or loss;
    5. the amount of foresight and initiative judgment the worker needs to be successful; and
    6. how permanent or temporary the work relationship is.

Employer Takeaways

All employers are obligated under the IRS tax code, the FLSA, and various federal and state labor laws to ensure that workers are properly classified as either “employees” or “independent contractors.” After all, misclassifying employees as independent contractors or violating the legal rights of an independent contractor by treating them like an employee can result in lawsuits, tax penalties, and other monetary penalties. Alternatively, preventing employee misclassification protects workers’ rights under wage and hour law. Therefore, employers will want to apply the DOL’s aforementioned six-factor economic reality test, as well as other factors like workload control and what party provides materials, when determining employee classification.