Independent Contractor Compliance: DOL vs IRS

In the realm of labor and taxation, the classification of workers as either employees or independent contractors holds significant weight. This determination not only affects how individuals are compensated but also impacts various legal and financial obligations for both employers and workers. In the United States, two key governmental entities play pivotal roles in reviewing and enforcing compliance regarding independent contractor classification: the Department of Labor (DOL) and the Internal Revenue Service (IRS). Despite sharing a common goal of ensuring independent contractor (IC) compliance with labor and tax laws, the DOL and IRS approach this issue with distinct perspectives and methodologies. These differences have key implications for staffing agencies and gig platforms, which we will review below. 

Department of Labor (DOL):

The DOL primarily focuses on labor-related matters, including wage and hour standards, workplace safety, and employee benefits. When reviewing independent contractor classification, the DOL emphasizes the economic realities test, which assesses several factors to determine whether an individual is economically dependent on the employer or is in business for themselves. Key factors considered under this test include:

1. Nature of the Work: The DOL examines the extent to which the worker’s services are integral to the employer’s business operations. If the work performed is an essential part of the employer’s core activities, it suggests an employment relationship.
2. Degree of Control: The level of control exerted by the employer over the worker is evaluated. Factors such as setting work hours, providing equipment, and dictating how tasks are performed are scrutinized to assess the degree of independence.
3. Opportunity for Profit or Loss: The DOL looks at whether the worker has the opportunity to make a profit or incur a loss based on their managerial skill and initiative. Independent contractors typically bear the risk of financial gain or loss associated with their work.
4. Investment in Facilities and Equipment: The DOL considers whether the worker has invested in their own tools, equipment, or facilities necessary to perform the job, which is indicative of an independent business operation.
5. Permanency of Relationship: The DOL examines the duration and permanency of the working relationship. A long-term, ongoing arrangement may suggest an employment relationship rather than an independent contractor status.

The DOL enforces compliance through investigations, audits, and enforcement actions. Employers found to have misclassified workers as independent contractors may face penalties, back wages, and other remedies to rectify violations of labor standards.

Internal Revenue Service (IRS):

Contrary to the DOL’s emphasis on labor standards, the IRS primarily focuses on tax-related matters, particularly ensuring proper withholding, reporting, and payment of taxes. The IRS employs the common law control test, which revolves around the degree of control exerted by the employer over the worker’s services. Key factors considered under this test include:

1. Behavioral Control: The IRS assesses whether the employer has the right to control how the worker performs their tasks. Factors such as providing instructions, training, and evaluation criteria are indicative of behavioral control, which is typical in an employer-employee relationship.
2. Financial Control: The IRS examines the extent to which the employer controls the financial aspects of the worker’s job. This includes factors such as reimbursement of expenses, provision of tools and supplies, method of payment, and opportunity for profit or loss.
3. Type of Relationship: The nature of the relationship between the parties is scrutinized to determine whether it resembles that of an employer and employee. Written contracts, provision of employee benefits, and the permanency of the relationship are considered in this assessment.

The IRS enforces compliance through various means, including audits, examinations of tax returns, and the use of Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to seek clarification on worker classification issues.

Implications for Staffing Agencies and Gig Platforms

When thinking about IC compliance, or 1099 vs W2 models, many staffing professionals immediately associate this issue with the IRS. While it is true that the IRS has a position, and can enforce compliance, they typically do not pose as much of a problem as the Department of Labor. Through their new ruling, the DOL has made it clear that it will be enforcing IC compliance more aggressively. Additionally, their role in the US government is to protect employees and ensure they receive all the benefits of employment, if they are entitled to them. This creates a multiplier effect when considering the potential fines and penalties a staffing firm or gig platform could incur if they were to be found violating IC compliance regulations. Fines and penalties are typically added in addition to back pay, OT pay, benefits, and other “wages” the DOL believes a violation firm did not afford to an employee. This can drastically increase costs for those choosing to operate under a 1099 model. 

How to Reduce IC Compliance Risk:

A standard practice for all staffing firms and gig platforms in today’s market is to do everything necessary to reduce IC compliance risk. While there are many methods these firms can consider, the below three are the most common.

• Work with a reputable Staffing Specific Law firm: interpreting the law can be difficult enough for a traditional employer. However, there are certain laws that apply to staffing firms and gig platforms differently. To ensure your organization properly interprets the law, and is protected, agencies should work with a law firm that understands the niche nature of the staffing industry.
• Leverage a Compliance Vendor: Third party compliance vendors have been growing in popularity. These organizations blend a combination of support services with technology in order to allow their staffing firm clients to feel more informed when making compliance decisions. While they do not take on the risk for the firms, they do provide guidance and tools to ensure their clients are on the right path. 
• Partner with an Employer of Record (EOR): Working with an EOR enables staffing firms to mitigate independent contractor compliance risks by ensuring proper employment classification, managing compliance obligations, drafting clear contractual agreements, and transferring certain employment-related risks to the EOR. By leveraging the EOR to legally employ their workers, staffing firms and gig platforms can offload the burden of compliance management, reduce the risk of misclassification, and gain access to a scalable and flexible workforce. EORs specialize in employment compliance, handling payroll taxes, workers’ compensation, and regulatory requirements, thereby providing staffing firms with an all-in-one solution for managing their workforce while allowing them to focus on their core business objectives.

Conclusion:

While both the DOL and IRS share the goal of ensuring compliance with labor and tax laws regarding independent contractor classification, their approaches differ due to their respective areas of focus. The DOL emphasizes labor standards and uses the economic realities test to determine worker classification, while the IRS focuses on tax-related matters and applies the common law control test. Employers and workers alike must understand the criteria used by each agency to assess classification status and ensure compliance with both labor and tax obligations to avoid potential penalties and liabilities. By navigating the nuances of these regulatory frameworks and understanding the distinct perspectives of the DOL and IRS, employers can proactively assess their worker classifications and mitigate the risks associated with misclassification, thereby promoting fair labor practices and tax compliance within their organizations.