Ignore worker classification issues at your own peril
July 2008
At Volt Consulting Managed Service Programs, we are staunch proponents of proper worker classification and understand that the cost of failing to comply with federal, state, and local regulations governing contract employees can be painfully high. Unfortunately, many companies mistakenly believe that properly classifying workers is not a big concern because they have so far, avoided the scrutiny of the IRS. In fact, anecdotal evidence suggests that many executives consider worker classification among the least important of business concerns; but just ask the execs from the company in the cautionary tale that follows if they still think this issue is a mere formality.
In a recent, highly publicized case, the IRS challenged a leading services company's classification of many of its workers as independent contractors. For tax year 2002 alone, the IRS has already imposed fines and penalties of $319 million upon the company. In addition to federal investigations, many state taxing authorities have been also challenging the company's independent contractor business model. This company could face significant additional penalties totaling over a billion dollars after the IRS completes its investigation. Facing a potential $1 billion levy in back taxes and penalties payable to both the federal and state government; this organization is certainly learning the hard way.
As the industry relies in ever greater numbers on contractors and contingent workers, the issue of worker classification becomes more and more critical. Industries such as technology, aerospace & defense, and pharmaceuticals - where there is widespread use of contractors, contingents and other non-employee workers - are more frequently subject to misclassification audits by the IRS. Referring to the old adage, "An ounce of prevention is worth a pound of cure," nowhere is this time-honored bit of wisdom more relevant than it is regarding this topic. Keep in mind that it costs comparatively little to make sure that your company has a well-defined set of guidelines in place to arrive at proper classification for each and every worker. The cost to ensure your contingent workforce management systems are configured to support proper classification protocols is insignificant when compared to the cost for failure to do so.
Typically, offending organizations are required to pay the IRS all back taxes owed, with interest. In addition, they are required to pay a penalty of between 12% and 35% of the tax bill. This level of monetary penalty can be many times greater than the amount of savings a company might have expected to attain by endeavoring to use contingent labor in the first place. Further, there can be additional significant legal and accounting expenses involved in mounting a defense against a government audit. And the intangible costs borne by a company for the damage to its ability to compete in the marketplace as precious time, attention and resources are diverted from focusing on their core business to reacting to this unexpected problem, should also be considered. At the end of the day, this kind of problem can pose a truly existential threat to a company. It would be expected that, given the option, most companies would rather not take the chance at all, even if they are of sufficient size to survive the stiff penalties.
Volt Consulting has noticed a recent increase in the number of large companies taking advantage of our worker classification expertise and service offerings which would indicate that the recent high profile IRS investigations have gained the attention of company executives. As an example, one of the world's largest pharmaceutical companies, a Volt Consulting client, is currently engaged in implementing a full-scale worker classification project. Tools have been provided to them which will assist in the development of assessments and processes that will ensure they are properly classifying their workers, thereby mitigating the risks associated with this issue.
Ultimately, the point is that avoiding the aforementioned "unexpected occurrence" doesn't have to be a costly or time consuming process, In fact, the term unexpected occurrence is really a misnomer because the pitfalls of improper worker classification are only unexpected if no efforts are made to prevent improper classification. While the IRS has made some changes to its rules regarding the details of what constitutes a full-time employee versus a contractor, the overall nature of their stance on the subject remains the same. The problem is that just like quicksand, sinkholes, land mines or other unseen dangers lurking just beneath the serene and otherwise unassuming surface of everyday businesses; companies tend not to consider proper classification of their workforce until they are already ensnared or shaken by the danger of improper worker classification.
Sincerely,
Larry D. Kaylor