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IRS “Safe Harbor” for misclassified employees?

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Recently the Minnesota Department of Labor and Industry ("DOLI"), the Federal Department of Labor and the IRS entered into an enforcement partnership to pursue companies that misclassify employees as independent contractors. Then, just days later, the IRS announced a new program intended to assist employers to "voluntarily reclassify" independent contractors to employees.

Named the "Fresh Start" program, it is designed to reduce the cost of reclassification and create a specific process for doing so. Any construction contractors that claim to use independent contractors or subcontractors should review this program and their own practices to avoid misclassifying employees as independent contractors. For example, it is very common in the construction industry to misclassify a sales representative as an independent contractor rather than an employee.

These developments from DOLI and the IRS also came only days after the Minnesota Court of Appeals issued an opinion about worker classification for unemployment purposes. Specifically, the Court of Appeals upheld an Administrative Law Judge's reclassification of a transportation driver despite the existence of written independent contractor agreement, holding that the driver was an employee rather than an independent contractor.

The Minnesota Court of Appeals noted the standard five-point test used when distinguishing between an employer and an independent contractor:

  1. The right to control the means and manner of performance;
  2. The mode of payment;
  3. The furnishing of materials or tools;
  4. The control of the premises where the work is done;
  5. The right of the employee to discharge.

In this case, the Court of Appeals found that the driver was an employee because:

  1. The driver worked full time for the provider;
  2. The driver was available for set hours;
  3. The provider instructed and corrected the driver's behavior; and
  4. Either party had the ability to terminate the relationship on short notice.

This reclassification was upheld despite the existence of a written independent contractor agreement specifically disclaiming the driver as an employee and stating he was an independent contractor.

Misclassification of employees as independent contractors is a particularly problematic issue in the construction industry. DOLI, the Minnesota Department of Revenue, and the IRS all very closely scrutinize whether an individual classified as an independent contractor is actually an employee. Individual are deemed employees unless proven otherwise, and the financial ramifications and penalties for misclassification can be severe.

Hellmuth & Johnson handles both construction and employment matters and can assist you in navigating this issue. For more information about employee versus independent contractor classification and subcontractor agreements, please contact Blake Nelson at (952) 746-2131 or bnelson@hjawfirm.com.

More information about the IRS "Fresh Start" Program can be found at http://www.irs.gov/newsroom/article/0,,id=246203,00.html.