(a) Yes. On a federal level, several tests to evaluate independent contractor status govern whether contingent workers should be treated as employees for employment purposes. There is no single test to evaluate independent contractor status for all purposes and compliance is often complicated by the fact that different tests may apply. These tests include the following:

• The Economic Realities Test (29 C.F.R. §§ 795.100 - 795.115): The US Department of Labor (DOL) published a new final rule for classifying workers as employees or independent contractors under the Fair Labor Standards Act (FLSA), effective 11 March 2024 (though, as of October 2024, the rule continues to face pending legal challenges). The final rule adopts a six-factor totality-of-the-circumstances test, which asks whether, as a matter of economic realities, the worker depends on the potential employer for continued employment, or is instead operating an independent business. The six-factors are: (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the potential employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) the extent to which the work performed is an integral part of the potential employer's business; and (6) the skill and initiative required. The rule does not give precedence to any of the six factors, and the analysis allows for consideration of other relevant, but not named, factors, which "in some way indicate whether the worker is in business for themself."
• The Common Law Test: Used in the context of Title VII of the Civil Rights Act of 1964 (Title VII), the Americans with Disability Act (ADA), the Age Discrimination in Employment Act (ADEA) and the Employee Retirement Income Security Act of 1974 as amended (ERISA), the common law test focuses on the company's right to control the manner and means by which the work is performed and, accordingly, the worker's status.

(b) No. With specific exceptions that do not involve contingent workers, the determination of employee status and the tax implications thereof are based on an analysis of the facts and circumstances. However, Treas. Reg. Section 31.3121(d)-1, Treas. Reg. Section 31.3306(i)-1 and Treas. Reg. 31.3401(c)-1 provide guidance to define who can be considered an employee.

(c) Yes. If the contingent workers are treated as employees, the Internal Revenue Code and ERISA would require that a tax-qualified plan provides coverage if the contingent workers satisfy certain requirements on hours of service ("Hours of Service").

(a) No.

(b) Not directly. However, to the extent a contracting entity meets the requirements of Section 530 of the Tax Reform Act of 1978 ("Section 530"), the IRS is precluded from reclassifying any workers who were treated as "independent contractors" by the contracting entity as employees. 

In effect, Section 530 creates a safe harbor from any retroactive findings of misclassification by eliminating, under certain circumstances, a taxpayer's past liability for employment taxes where the taxpayer acted consistently and in good faith in treating the workers as independent contractors. To qualify for the safe harbor, a company must satisfy the following three requirements:

• Reporting consistency. The company filed all federal tax returns consistent with the independent contractor classification, such as by using Form 1099-NEC, in a timely manner. 
• Substantive consistency. The company treated the workers, and any workers who were similarly situated, as independent contractors. This requirement is not satisfied if the company treated similar workers as employees.
• Reasonable basis. The company had a reasonable basis for not treating the workers as employees. The company must show that it reasonably relied on one of the following: (i) a related court case or IRS ruling; (ii) a prior IRS audit; (iii) the practice in a significant segment of the industry; or (iv) some other reasonable basis, such as the advice of an attorney or accountant.

(c) There is no safe harbor that would exclude the contingent workers from coverage if they are considered common law employees and they work the required number of Hours of Service.

For tax, not at the federal level. However, individual states and localities have enacted mandates that impact worker classification and the status of contingent workers. 

For employment, not at the federal level. However, individual states have enacted laws impacting worker classification and the status of contingent workers that will take effect in the coming months.

With the rise in digital platform services, we are seeing an increasing global trend in case law and legislation aimed at protecting platform workers' labor rights. For more insight on these developments, along with other employment law updates, click here.

Misclassification risks are complex, given the various classification tests that apply on a federal level. In addition to the federal tests, every state also applies its own laws in relation to whether contingent workers should be treated as employees. In addition, federal agencies have indicated a renewed interest in ensuring that workers are properly classified. Penalties resulting from misclassification can be staggering. Published settlements for misclassification claims are often in the hundreds of millions of dollars for large, multistate businesses. For smaller regional and local businesses, multimillion-dollar liability is not uncommon.

The result of misclassification is noncompliance with laws that apply to an employment relationship. (See the list of penalties in the section on maximum penalties from an employment perspective.)

• The new DOL rule has the potential to have a significant effect on the "gig economy," as workers like meal delivery workers and rideshare drivers could be considered employees under the rule. As such, gig economy companies in the US are engaging in litigation and lobbying efforts to defend their business models that rely on independent contractors. 
• In addition, federal agencies, such as the Equal Employment Opportunity Commission and the Federal Trade Commission, have signaled their intent to provide additional protections for workers in the context of complex employment relationships, which include the gig economy.

That said, there have been some favorable updates for gig economy companies. For example, in California, voters approved Proposition 22, a law that requires app-based companies to classify their drivers as independent contractors if certain conditions are met. These conditions include allowing workers to choose their own dates, times and hours of work, reject a request for an assignment, and perform services for another company and any other kind of work. Other requirements include a written agreement, minimum earnings guarantees, healthcare subsidies, expense reimbursement, insurance for injuries, and training on anti-discrimination, anti-harassment and safety matters. The constitutionality of Proposition 22 was upheld in March 2023, and again in July 2024.

Under federal law, the penalties for misclassification include the following:

• Unpaid minimum wage and overtime compensation
• Unpaid federal, state and local income tax withholdings
• Social security and Medicare contributions owed under Federal Insurance Contributions Act (FICA)
• Workers' compensation and unemployment insurance premiums, including federal unemployment taxes owed under Federal Unemployment Tax Act (FUTA)
• Interest and civil penalties
• Liquidated damages

Additional penalties may apply depending on the state in which the misclassification occurs.

There is a risk of contingent workers being reclassified as employees for tax purposes, which could trigger the penalties described below.

However, to the extent employing entities satisfy the requirements of a Section 530 safe harbor, the risk may be mitigated.

• If contingent workers are reclassified as employees, their compensation will be subject to income tax withholdings, social security and Medicare taxes, employer unemployment contributions, etc. Employees could also become eligible for employer plan benefits.
• Where withholding has not occurred, the employer can be held liable for the withholdings not deducted.
• Unless there was intentional disregard, the withholding taxes that the employer will be held liable for will be reduced under Code Section 3509.
• There is a potential penalty for each W-2 that was not issued by the employer of USD 580 (for 2023 forms) (see Section 6721/6722).

A negligence penalty under Section 6662 equal to 20% of the payroll taxes not paid is possible, but unlikely.

There is a risk of contingent workers being reclassified as employees for tax/social security purposes, which could trigger the penalties below.

However, to the extent employing entities satisfy the requirements of a Section 530 safe harbor, the risk may be mitigated.

• If contingent workers are reclassified as employees, their compensation will be subject to income tax withholdings, social security and Medicare taxes, employer unemployment contributions, etc. Employees could also become eligible for employer plan benefits.
• Where withholding has not occurred, the employer can be held liable for the withholdings not deducted.
• Unless there was intentional disregard, the withholding taxes that the employer will be held liable for will be reduced under Code Section 3509.
• There is a potential penalty for each W-2 that was not issued by the employer of USD 580 (for 2023 forms) (see Section 6721/6722).

A negligence penalty under Section 6662 equal to 20% of the payroll taxes not paid is possible, but unlikely.

A tax-qualified plan may lose its qualification (tax-advantaged status) for failure to cover all required participants. This could result in a loss of deductions and income inclusion for certain highly compensated participants.

The risk rating given is based on the assumption that they are considered employees but not allowed to participate in the pension plan. The IRS is very unlikely to disqualify the plan, especially since there are various correction programs available.

A tax-qualified plan may lose its qualification (tax-advantaged status) for failure to cover all required participants. This could result in a loss of deductions and income inclusion for certain highly compensated participants. This would require a factual analysis.

Possibly. Directors, officers and other responsible employees can be held individually liable under Section 6672 for payroll taxes not withheld.

The IRS could attempt to levy criminal penalties for certain kinds of willful, false or fraudulent failures. For example, in the case of willfully providing a false Form W-2, the penalties range from a USD 1,000 fine to a year in prison according to Code Section 7204. If the IRS obtains a conviction against an individual or the employing entity for the felony of "attempting to evade or defeat tax," penalties include fines as high as USD 100,000 (for individuals) or USD 500,000 (for a corporation), or five years in prison. See Code Section 7201.

In practice, the risk of criminal sanctions is low. There is no risk for pensions.

This is a combined risk rating across all areas, including likelihood of challenge, impact of challenge and uncertainty of law.