For years now, the Connecticut Department of Revenue Services (DRS), the Connecticut Department of Labor (DOL) and the Internal Revenue Service (IRS) have been targeting Connecticut employers for worker misclassification audits. When a misclassification is discovered, these government entities can share information about employers who have misclassified employees as independent contractors. Thus, when one of these government entities finds a misclassification during an audit, audits from the other governmental entities are likely to arise.

When a misclassification is discovered, the employer will be subjected to various federal and state taxes, penalties and interest charges. A misclassification occurs when an employee is incorrectly treated as an independent contractor. As a result, the worker does not have income taxes or payroll taxes withheld from his/her pay and is not issued a Form W-2. Businesses aren’t the only employers targeted for such audits. Charitable organizations, public school systems, cities, towns, and even State departments are subject to audit.

The IRS and the DRS have historically used a 20-factor test to determine if a worker is an employee or independent contractor. The factors are used to determine if the service recipient has the right to control the service provider, not only as to the result to be accomplished, but also as to the details and means by which that result is accomplished. If such control is found, the worker is deemed to be an employee. The 20 factors are used to determine if the service recipient has behavior, financial, or relationship control of the worker. We refer to this as the “IRS Control Test”. The DRS uses the IRS Control Test.

However, the DOL, uses a stricter three-part test for determining if a worker is an independent contractor referred to as the “ABC Test.”

To qualify as an independent contractor under the ABC Test:

A. The worker must be free from control and direction in connection with the performance of the service (the “A Test”);

B. The service must be performed outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which such service is performed (the “B Test”); and

C. The worker must be customarily engaged in an independently established business of the same nature as that involved in the service performed (the “C Test”).

The A Test is basically the same as the IRS Control Test used by the Connecticut DRS. A worker who qualifies as an independent contractor under the A Test, generally will qualify as an independent contractor under the IRS Control Test. Such a worker could properly be treated as an independent contractor for federal and Connecticut income and payroll tax purposes. However, a worker who satisfies the DOL A Test, but does not also satisfy both of the B Test and the C Test, will be deemed an employee under the ABC Test for DOLs. This results in the absurd situation in which a worker is treated as an independent contractor for income and payroll tax purposes and as an employee for DOL purposes, such as unemployment insurance, workers compensation, fringe benefits and labor and employment laws.

So, what can a Connecticut employer do when the DOL correctly determines that a worker is misclassified as independent contractor and should be re-classified as an employee because the worker (who does satisfy the IRS Control Test and the DOL A Test) does not satisfy the DOL B Test and/or C Test? Keep in mind, a DRS audit is likely to follow a DOL audit.

Our suggestion is to concede to the DOL that the worker is an employee because he or she did not satisfy the B Test and/or the C Test, while getting a written statement from the DOL if they concede that the A Test was satisfied. The statement from the DOL that the A Test (and, thus the IRS Control Test used by the DRS) was satisfied might not guarantee that the DRS will not respect the worker’s independent contractor status for income and payroll tax purposes, but it does put the employer in the best possible position with respect to a future IRS or DRS worker classification audit.

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Photo of Ray Casella Ray Casella

Ray practices in all areas of federal, state and local tax law. He has extensive experience representing tax-exempt organizations including schools, private foundations and public charities. Ray regularly deals with federal and state income tax issues, Connecticut sales and use tax issues, federal and state payroll tax issues, and private foundation excise taxes.