What Did FedEx Do Wrong?

Last Updated May 27, 2008 4:00 PM EDT

What Did FedEx Do Wrong?Just before Christmas, the IRS slapped Federal Express with a hefty fine: $319 million in penalties and back taxes for misclassifying drivers in its ground-delivery division during tax year 2002. The IRS charges that the 15,000 drivers should have been treated as employees, rather than independent contractors (ICs).

If you've read our latest Crash Course, on managing independent contractors the right way, you may be wondering where exactly FedEx went wrong. According to Reuters' coverage of the story, the ICs drive their own trucks, own their routes, and can even subcontract with other drivers to deliver packages -- all hallmarks of an independent contractor relationship. But FedEx has violated at least three important criteria of IC status:

1. Behavioral Control. Under IRS rules, the employer of an IC can only control the result of the work, not when or how the contractor completes it. But according to the labor watchdogs at FedEx Watch, the company enforces policies for customer interaction, sets specific delivery schedules, and even dictates how drivers hold their keys.

2. Core Business Activity. FedEx's main business is delivering stuff. It's not like they manufacture gumballs and then hire a trucking firm to ship the product: Delivery is the product. And as the IRS points out, "If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities."

3. Industry Standards. Under the Revenue Act of 1978, companies that violate classification rules can sometimes qualify for tax relief if their competitors also hire ICs for the same type of job. Bad news for FedEx: their No. 1 competitor, UPS, hires drivers as employees.

New stories like this one are about to become more common: On November 6, the IRS announced that it is upping its vigilance on worker misclassification. Under the new Questionable Employment Tax Practice initiative, tax agencies in 29 states will share information with the IRS to help track down out-of-compliance companies. To avoid the fate of FedEx, read our Crash Course, "How to Manage Independent Contractors."

(Image of FedEx mailer as hat by Billy Verdin, CC 2.0)