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Legal Updates

An IRS Wake-Up Call: Natural Disasters Prompt Government Reminder about Correct Worker Classification

The IRS has sounded a wake-up call to U.S. businesses:  floods, storms and other natural disasters do not excuse employers from proper worker classification!  Due to the growing demand for goods and services in response to the number of natural disasters in the United States within the past year, the IRS is urging businesses to properly classify workers so that they and their workers can meet their respective tax obligations.

In a June, 2006, fact sheet entitled IRS Reminds Businesses to Classify Workers Correctly, the IRS offers businesses basic information about worker classification as well as links to other relevant IRS publications.  The IRS fact sheet may be found online at http://www.irs.gov/newsroom/article/0,,id=158750,00.html.

Specifically, the IRS instructs businesses that most workers fall into one of two categories:  (1) independent contractors; or (2) common-law employees.  If the IRS determines, based on various defined factors, that the worker is an employee, the employer must withhold income taxes, withhold and pay Social Security and Medicare taxes and pay unemployment tax on wages paid to the employee.  Employers are generally not required to withhold or pay federal taxes for work performed by independent contractors.

The fact sheet also contains a link to an IRS brochure entitled Independent Contractor or Employee which highlights the factors the U.S. government will consider when determining if a worker has been properly classified for federal tax purposes.  For example, the IRS will consider the degree of behavioral and financial control the business has over the worker, whether the worker receives employment benefits and whether the worker and business have executed a written contract.

We recommend that all employers, including New England businesses recovering from recent flooding, accept the IRS’ guidance as an important reminder to comply with both state and federal laws when classifying a worker as either an employee or independent contractor.  The IRS is clearly sending a wake-up call to businesses that improper classification of workers could lead to penalties.

The IRS fact sheet is also an important reminder that the various federal and state laws addressing worker classification create a legal minefield for employers.  Accordingly, we also remind Massachusetts employers of the 2004 amendment to the Massachusetts Independent Contractor Law, which significantly narrowed the definition of “independent contractor” under Massachusetts law.  (See Schwartz Hannum PC Labor and Employment Law Update, May 2005.)  Although the recent IRS guidance provides a list of factors for determining proper worker classification for federal tax withholding purposes, the amended Massachusetts law governs other employee entitlements under wage and hour and workers’ compensation statutes.

Should you need assistance clarifying worker classification issues related to your business, please do not hesitate to contact the Firm.