Ohio Cracks Down on Employee Misclassification

Attorney General Richard Cordray has announced the collaboration of state agencies to combat the misclassification of workers.

In an unprecedented move to prevent misclassification, the Ohio Department of Job and Family Services, Ohio Department of Taxation, and Ohio Bureau of Workers’ Compensation joined forces in an agreement to release and exchange information. The agreement is believed to be the first of its kind in the state and emphasizes the commitment of Ohio leaders to hold accountable those abusing the system.

A culmination of six months of work by a task force led by Cordray, the agreement opens the door for sharing relevant information, coordinating enforcement efforts, leveling the playing field for law-abiding businesses, and protecting state and local government from being defrauded of lawful revenues. This task force will continue to assess the problem, lay the groundwork for more vigorous enforcement efforts, and make recommendations to policymakers and elected leaders as they arise.

A report compiled by the Attorney General’s Office estimates that the extent of annual costs from worker misclassification may be $100 million for unemployment compensation, more than $510 million in BWC premiums and almost $180 million in forgone state income tax revenues. Additionally, misclassification is estimated to have cost Ohio cities and villages more than $100 million in local income tax revenues in 2006, and cost school districts $7.8 million in 2008.

IRS Has Much Work to do to Improve Worker Misclassification

The Treasury Inspector General for Tax Administration (TIGTA) released its review on the effectiveness of actions Internal Revenue Service had taken and planned to take to address the misclassification of employees as independent contractors. The report is titled , “While Actions Have Been Taken to Address Worker Misclassification, an Agency-Wide Employment Tax Program and Better Data Are Needed”. Yes that was the title and not the full report, but as you might have garnered the TIGTA doesn’t think the IRS is doing enough to address the issue. The highlights of this report were:

  • To praise actions the IRS had taken to address worker classification (see list below) but suggested that more needs to be done.
    • o Form SS-8 and Form 8919 
    • More presentations to professional associations 
    • The Questionable Employment Tax Practices program
    • o The Employment Tax Examination Program o The Classification Settlement Program
    • o The Specialist Referral System
    • o The Service Wide Employment Tax Research Program
  • To point out that the IRS does not have and agency-wide employment tax program to address worker classification. The IRS business divisions communicate and coordinate with each other regarding employment tax issues. However, there is no single point of accountability for employment tax below the IRS Deputy Commissioner level, and there is no agency-wide strategy to coordinate the decision-making process and efforts among the divisions.
  • To demonstrate that the IRS has limited and outdated data (some more than 20 years old) regarding the overall impact of worker misclassification and that the tax impact of worker misclassification is likely to be markedly higher than the most recent tax gap estimates suggest.

Interesting enough was that the IRS agreed fully with the TGITA’s findings and had submitted the following resolutions to address the deficiencies.

  1.  The Director, Specialty Programs, Small Business/Self-Employed Division, will work with the Research function to coordinate a study that addresses worker classification and other employment tax issues. They have already started the planning for the effort, which will begin early in Fiscal Year 2009.
  2. The Director, Specialty Programs, Small Business/Self-Employed Division, will coordinate an effort with all business divisions, the Criminal Investigation Division, and the Office of Chief Counsel to develop an agency-wide employment tax plan that addresses worker classification along with other employment tax issues.

So it appears that the IRS is increasing not only the collection of data on worker classification to better address worker classification, but also the sharing of that data amongst the various agencies. We hate to speculate here but does anyone have a feeling that the groundwork for some of the Independent Contractor bills that died in the 110th session of Congress will be resurfacing again soon? Given the $345 Billion tax gap, or according to the TGITA “unreliable and outdated” IRS estimates, it is probably safe to assume that more than the TGITA will be calling for stepped up enforcement of worker classification in 2009.

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Third Party Arrangements Don’t Always Protect Companies from a 1099 Misclassification Lawsuit


Quite often companies are mislead or are under the assumption that if you hire an independent contractor (IC) through a third party you have no risk or exposure to misclassification penalties.  Wrong!  Nokia recently settled a lawsuit in which that’s exactly what they thought.  Here are the highlights of their case:


Key Facts:

  1. Nokia contracted with a third party to staff engineers for Field Support Centers.
  2. Engineers were responsible to provide Nokia’s field techs with phone support as needed.
  3. Engineers routinely worked in excess of 40 hrs/week, but were not paid OT
  4. Engineers worked on Nokia property, used Nokia equipment and worked under Nokia’s supervision and control.
  5. Engineers were engaged and paid through a third party.
  6. Engineers and other Field Support Center workers performed nonexempt work; were treated as ICs.


Case Findings:  The third party erroneously classified engineers and other worker as ICs.  Class Action lawsuit filed against both Nokia and third party.  Nokia settled lawsuit out of court for an undisclosed amount.  Nokia believed they were insulated due to the third party arrangement and that their contracts with the third party would protect them.  Unfortunately, the third party did not qualify the ICs correctly and Nokia wound up settling.  It’s important to recognize and understand that the company (in this case Nokia) who is the beneficiary of the services rendered is not exempt from the risk.  Therefore, it’s imperative that you and your suppliers properly qualify and classify the workers so it doesn’t cost you in the long run. 


Audit Trigger – Form SS-8 Filed

The SS-8 is an IRS Form that either a worker or a company can submit to the IRS for an official determination of the worker’s status (IC or employee). 





Why would someone file an Form SS-8? 


There can be a multitude of reasons why a worker would file an SS-8.   

Here is just one example:  There have been occasions when a company is doing very well or is about to go public.  The stock is soaring; employees are getting large bonuses, stock options or trips for recognition etc.  Now an independent contractor, who is working just as hard and making a sizable contribution to the company’s success, typically is not getting any additional compensation or recognition.  They are being paid for their performance.  However, with all the perks they see employees getting, they can get a bit disgruntled or jealous and simply file a SS-8.  If the IRS finds the worker should have been an employee, the company is in hot water.  The company will have to pay the IRS back taxes, penalties and perhaps even fines.  It doesn’t stop there…  since the worker is now an employee, the company now has to provide all the benefits it provides to it’s employee base which includes:  holiday pay, overtime, health benefits, vacation as well as participation to the company’s stock purchase plan to name a few.  Bottom line, a filed SS-8 can result in a significant financial hardship on a company. 

The Audit Trigger – Unemployment Claim Filed

With corporations downsizing at a record pace, it’s inevitable that sooner or later an independent contractor will file a claim for unemployment benefits.  This is one of the easiest audit triggers that taxing authorities can follow up on.  Here’s how it works: 


Companies are required to submit quarterly reporting to the state taxing authorities on all their W2 employees paid during each calendar quarter, which includes employee’s name, social security number and the total amount paid.


Independent contractors are not employees and do not have statutory taxes withheld from their compensation, nor are they reported for state unemployment insurance purposes (SUI).  If the independent contractor files an unemployment claim, a simple cross-referencing will show that there is no match between the two.  A no match results in the following possibilities:

  1. The company failed to report the wages paid to the taxing authorities
  2. The SSN is inaccurate
  3. This individual was not a W2 employee of the company


The end result – the taxing authorities must investigate why there is a discrepancy and is required to investigate.  This mis-match can definitely trigger a worker misclassification audit.

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