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Government Scrutiny of Misclassified Independent Contractors

Correcting Worker Classification Analyzing Payroll Tax Impact Correcting Worker Classification, Analyzing Payroll Tax Impact, and Avoiding Benefits Pitfalls With Leased Employees

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURS DAY, JUNE 6, 2013

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Mary S amsa Partner McDermott Will & Emery Chicago Mary S amsa, Partner, McDermott Will & Emery, Chicago S tephen D. Erf, Partner, McDermott Will & Emery, Chicago Ruth Wimer, Partner, McDermott Will & Emery, Washington, D.C.

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Government Scrutiny Of Misclassified Independent Contractors

June 6, 2013

SPEAKERS SPEAKERS

Stephen Erf, Partner McDermott Will & Emery LLP Chicago Office Mary K. Samsa, Partner McDermott Will & Emery LLP Chicago Office Ruth Wimer, Partner McDermott Will & Emery LLP Washington, DC Office (312) 984‐7637 serf@mwe.com (312) 984‐2142 msamsa@mwe.com (202) 756‐8614 Rwimer@mwe.com

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Agenda Agenda

 Implications of misclassification p c

• c

c

•  Current government enforcement environment

 IRS SS‐8 Program  Determining tax owed (Code Section 3509 retroactive relief and Code Determining tax owed (Code Section 3509 retroactive relief and Code Section 530 safe harbor)  IRS Voluntary Classification Settlement Program  State initiatives  Other Issues

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Implications of Misclassification Implications of Misclassification

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Incentives for Organizations to Treat Workers as Nonemployees

 By treating its workers as nonemployees, an organization can realize b l b d h l b l f substantial cost savings by avoiding the liability for:

 Employment taxes, unemployment insurance, and other employer surcharges;  Minimum wage and overtime pay (where applicable) under the Fair Labor Standards Act;  Employee benefits Employee benefits.

• Potential exposure for unpaid workers designated as “volunteers” or “interns”

 Multiple government agencies have an enforcement stake, to the extent that the improper classification of workers as independent contractors causes individuals to be denied the protections provided by social insurance (S i l S i d M di ) l l programs (Social Security and Medicare), employment regulatory provisions, and coverage under employee benefits programs.

 The IRS, state and local tax authorities have a self‐interested agenda to the extent that income tax would normally be withheld at the source from employee wages

• Most of worker protection statutes only apply to “employees;” and not to contractors,

p y pp y p y ; ,

• wners, or partners.

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Multiple Stakeholders for Enforcement Of Worker Classification Issues

 IRS, State and Local tax authorities (where applicable)

 Employee wages generally subject to income tax withholding as and when paid.

• Both IRS/Treasury and Congress view this area as a substantial gap to tax compliance.

 Employee wages also subject to Social Security and Medicare (“FICA”) taxes:

• 2 Components to the FICA tax: (i) Employer’s share of FICA; (ii) Employee’s share of FICA.

 U.S. Department of Labor and related state employment agencies enforce:

 Unemployment insurance/tax liability;  FLSA ‐ Employee minimum wage and overtime rules;  State worker’s compensation insurance; and S a e

• e

co pe a o u a ce; a d  Coverage under employee benefit plans.

 Individuals/Class of Affected Workers could potentially sue for minimum wages, overtime pay and liquidated damages.

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From the 2009 GAO Report From the 2009 GAO Report

Table 2: Key Federal and State Agencies Affected by Employee Misclassification Agency Agency Areas potentially affected by employee misclassification DOL Minimum wage, overtime, and child labor Provisions Job-protection and unpaid leave Safety and health protections IRS Federal income and employment (payroll) taxes Department of Health and Human Services Medicare benefit payments DOL, IRS, and the Pension Benefit Guaranty Corporation Pension, health, and other employee benefit plans Equal Employment Opportunity Commission Prohibitions of employment discrimination based

• n factors such as race, gender, disability, or age

National Labor Relations Board The right to organize and bargain collectively Social Security Administration Retirement and disability coverage and payments State agencies Unemployment insurance benefit payments State income and employment taxes Workers’ compensation benefit payments p p y

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Governmental Agency Concerns g y

 If the IRS

 Concern is that the appropriate revenue is not being collected and remitted

f h  If the DOL

 Concern is that workers who technically should be “employees” are not getting the protection of the labor laws enacted for their benefit

 If the National Labor Relations Board (NLRB)  If the National Labor Relations Board (NLRB)

 Concern is that the right to organize and bargain collectively is being impacted

 If the Equal Employment Opportunity Commission (EEOC)

 Concern is that rights of workers to protect themselves against various employment g p g p y discriminations based on factors such as race, gender, disability or age is impacted

 If the Occupational Health and Safety Administration (OSHA)

 Concern is enforcement of safety and health protection for employees/workers

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IRS: Tax Aspects IRS: Tax Aspects

 Companies that misclassify underpay federal employment taxes and

• p

y p y p oy state unemployment taxes and thereby also fail to withhold income taxes otherwise due  Estimated $8 Billion in lost revenue  Misclassified individuals generally will take tax deductions as independent contractors (to lower their taxes due) which as employees they cannot claim

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IRS: Tax Aspects IRS: Tax Aspects

 IRS determined independent contractor misclassification S p

•  100% of the FICA taxes (7.65%) PLUS

 100% of the FICA taxes you should have paid on the worker behalf (7.65%) PLUS ( )  All FUTA tax that should be paid (6.2% of the first $7,000) PLUS  Potential 35% of all wages that were paid to employees misclassified for failure to withhold federal income tax (Code Section 3403) PLUS  Potential 20% of all taxes due under the bullet point above that should have

• po
• been withheld but were not due to negligence or intentional disregard (Code

Section 6662)

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Department of Labor Aspects Department of Labor Aspects

 The DOL uses a variety of remedies to enforce compliance O y o

• p
• Recommend changes in employment practices to bring the employer into

compliance

• Injunction proceedings
• Payment of any and all back wages due to employees
• Willful violators may be prosecuted criminally and fined up to $10,000

 A second conviction may result in imprisonment

• Employers who willfully or repeatedly violate the minimum wage or

Employers who willfully or repeatedly violate the minimum wage or

• vertime pay requirements are subject to civil money penalties of up to

$1,100 per violation.

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EEOC Aspects EEOC Aspects

 Misclassification impacts the rights of workers to protect themselves

• p

g

• p o

against various employment discriminations based on factors such as race, gender, disability or age

 Title VII of the Civil Rights Act  Americans with Disabilities Act  Age Discrimination in Employment Act

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EEOC Aspects EEOC Aspects

 EEOC Example O p

 The Age Discrimination in Employment Act (ADEA) prohibits employment discrimination against employees who are 40 years of age or older  Similar to the Americans with Disabilities Act, in order to have standing to bring an ADEA claim, the worker must be an employee, and not an independent contractor.  In Shah v. Deaconess Hosp., 355 F.3d 496 (6th Cir. 2004), the Court held that a surgeon with surgical privileges was not an employee of the hospital and surgeon with surgical privileges was not an employee of the hospital and therefore was not entitled to bring a suit under the ADEA or under Title VII.

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Current Government Enforcement Initiative Current Government Enforcement Initiative

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How do you Determine Independent Contractor Status?

IRS DOL EEOC

Factor Test Economic Realities Test Common Law Agency Test

Independent Contractor Status?

Factor Test Economic Realities Test Common Law Agency Test

Behavioral Control: A worker is an employee when the business has the right to direct and control the worker and how the work is done.

• Instructions

T i i

• The nature and degree of control exercised by

the alleged employer.

• The skill and initiative required for performing

the job.

• If control is retained by the “employer” over the details of the work, it reflects

an employee relationship.

• If the worker is engaged in a distinct occupation or business, it reflects an

independent contractor relationship.

• If the kind of occupation in the particular locality is usually done under the

di i f i li i h i i i fl i d d

• Training

____________________________ Fi i l C t l A k i ______________________________________

• The extent of the relative investments of the

direction of a specialist without supervision, it reflects an independent contractor relationship.

• If the occupation is highly skilled, it reflects an independent contractor

relationship. ______________________________________________________________

• If the “employer” supplies the instrumentalities, tools, and the place of work

Financial Control: A worker is an independent contractor when he/she has a right to direct or control the business part of the work. – Significant investment: – Expenses – Opportunity for Profit/Loss The extent of the relative investments of the worker and the alleged employer.

• The degree to which the worker’s opportunity for

profit and loss is determined by the alleged employer. If the employer supplies the instrumentalities, tools, and the place of work for the worker, it indicates an employment relationship. If the worker is in business, this may indicate an independent contractor relationship. Opportunity for Profit/Loss ____________________________ Relationship of the Parties: – Employee benefits – Written contracts ______________________________________

• The extent to which services are part of the

alleged employer’s business.

• The permanence and duration of the relationship.

______________________________________________________________

• The longer the period of time the worker performs services, the more likely

the individual will be considered an employee.

• If payment is by the job (as opposed to periods of time), it reflects an

independent contractor relationship.

• If the work is a part of the regular business of the employer, this reflects an

l t l ti hi employment relationship.

• If, through the parties’ conduct and words, it is clear that they intended to

create an independent contractor relationship, this will help support a finding of independent contractor classification.

IRS Worker Classification Examinations IRS Worker Classification Examinations

 IRS National Office, Employment Tax Branch renewed commitment of focus p y and resources on examination and enforcement of worker classification issues.

 IRS indicates that it will be focusing on (currently unspecified) industries that have not previously received examination attention on this issue.  Congress regularly identifies the improper classification of independent contractors as a significant issue contributing to the “Tax Gap.”

 Internal Revenue Manual and Agent Training Materials provide tremendous insights to the approach in IRS worker classification examinations.

 1996 IRS Training Materials remain a core reference for IRS examiners.

 Addition of IRC Section 7436 creates jurisdiction for U.S. Tax Court to hear cases involving worker classification issues

 Tax Court generally lacks jurisdiction to hear employment tax cases.

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IRS Employment Tax National Research Program (NRP) IRS Employment Tax National Research Program (NRP)

 IRS initiative to examine 6,000 employers over the years 2010, 2011, and 2012.

 The audits will focus on 5 primary employment tax issues:

1. Worker classification;

• 2. Proper reporting and taxation of employee fringe benefits;
• 3. Employee expense reimbursement practices;

4 Officer compensation with particular emphasis on owner‐employees; and

• 4. Officer compensation, with particular emphasis on owner‐employees; and
• 5. Non‐filers.

 Employers will be selected at random.  Among the 6,000 employers to be audited will be:

• 500 nonprofit employers;
• 330 governmental entities;

330 governmental entities;

• 36 universities.

 NRP Exams will be conducted by experienced IRS Employment Tax Specialists.

‐ Assigned agents will have experience in either the Large Business & International (LB&I), Small Business/Self‐Employed (SB/SE), or Tax‐Exempt and Government Entities (TE/GE), as appropriate to the selected employer.

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NRP Exams Will Have Specific Focus on Worker Classification Issues

 As part of its research, IRS will develop both Section 530 and common law analysis of worker classification position law analysis of worker classification position.

 IRS will start with Section 530 analysis.

• Will first evaluate consistent treatment of similarly‐situated workers, and timely filing
• f IRS Forms 1099 and K‐1.
• In NRP exams IRS is trying to measure the revenue impact if the Section 530 safe

g harbor were eliminated.

 Legislation sponsored by Rep. McDermott and Sen. Kerry seeks to eliminate established industry practice as “reasonable basis” for Section 530 relief.

• Not simply the merits of employer’s Section 530 position.

 IRS will also analyze whether the worker should have been treated as an l d h f l employee under the 20‐factor common law test.

• Internal Revenue Manual (IRM) (Section 4.23.8(5)) generally requires IRS agents to

first determine whether the taxpayer qualifies for relief under Section 530.

• Once the Section 530 test is satisfied, the IRS can no longer make an assessment of

liability based upon the 20‐factor test.

 IRS worker interviews likely to be the most invasive aspect of NRP exams.

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Definition of “Employee” under Internal Revenue Code and Common Law

 The Internal Revenue Code (“IRC”) defines “employee” only for Social Security d M di (“FICA”) and Medicare (“FICA”) tax purposes.

 Not a particularly helpful definition: “any individual who, under the usual common law rules applicable in determining the employer‐employee relationship, has the status of an employee.” (IRC Section 3121(d)(2).)

 U.S. Supreme Court has cited selected factors that suggest whether an individual should be classified as an “employee,” for employment tax purposes. (Nationwide

Mutual Insurance Co. v. Darden, 503 U.S. 318, 323‐24 (1992).)

 Rev Rul 87‐41 lists 20 Common Law Factors that the courts and the IRS generally 

• Rev. Rul. 87‐41 lists 20 Common Law Factors that the courts and the IRS generally

consider in classifying a worker as an employee or independent contractor.

 These factors, which are derived from prior cases and IRS rulings, are to be used to help determine a service provider’s work status under the common law rules.

 No one factor is determinative.

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IRS: The 20 Common Law Factors S 0 o

• 1.
• Instructions. The right to say when, where and how the worker is to perform and the right to require compliance with the

instructions may indicate control and an employer‐employee relationship. 2 Training Training practices may indicate control if the individual in question is required to work with an experienced employee 2.

• Training. Training practices may indicate control if the individual in question is required to work with an experienced employee,

attend meetings, or undertake other activities which indicate that the services are to be performed in a particular manner. 3.

• Integration. When the success or continuation of a business depends to an appreciable degree upon the performance of certain

services, the workers who perform those services must necessarily be subject to a certain amount of control. 4. Services Rendered Personally. If the services must be performed personally, presumably the methods used to accomplish the work are important in addition to the results, thereby indicating an employer‐employee relationship. 5. Hiring and Paying Assistants. When a job requires the individual to have assistants, that worker's status may be an independent 5. Hiring and Paying Assistants. When a job requires the individual to have assistants, that worker s status may be an independent contractor if he hires, supervises and pays the assistants instead of the business for whom he is performing services. 6. Continuing Relationship. A continuing relationship between the business and the worker may indicate the existence of an employee‐employer relationship. 7. Set hours of work. Requiring services to be performed according to a strict schedule indicates control and an employer‐employee relationship. 8. Full time required. If the worker must devote substantially full time to the business for whom the services are performed, the q y p , business has control over the amount of time the worker spends working and impliedly restricts the worker from doing other gainful work. (An independent contractor, on the other hand, is free to work when and for whom he or she chooses.) 9. Doing work on employer’s premises. Furnishing a place to work as well as the supplies to perform the work are factors that may indicate an employer‐employee relationship. 10. Order or sequence set. Because of the nature of a particular occupation, the business for whom the services are performed may not set the order of the services or may set the order infrequently. It is sufficient to show control and indicate an employer‐ employee relationship however if the business retains the right to do so employee relationship, however, if the business retains the right to do so.

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IRS: The 20 Common Law Factors IRS: The 20 Common Law Factors

11. Oral or written reports. While reports are common from all types of workers, and required under most contracts, the IRS attributes a degree of control to such requirements that can indicate an employer‐employee relationship. 12. Payment by hour, week, month. Payment by the hour, rather than by the job, is an indicator used to determine the probability or lack of probability that a worker will be subject to detailed supervision and, therefore, be classified as an employee. 13. Payment of business or traveling expenses. The IRS views payment of business and travel expenses as indicative of a right to regulate and direct the underlying business activities and an employer‐employee relationship. 14. Furnishing of tools and materials. If significant tools, materials, and other equipment are provided to the worker, this may indicate an employer‐employee relationship. Si ifi t i t t If th k i t i f iliti th t d i f i i d t t i ll i t i d b 15. Significant investment. If the worker invests in facilities that are used in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party) that factor tends to indicate that the worker is an independent contractor. Generally, the use of a home office is discounted as a significant investment in facilities. 16. Realization of profit or loss. A worker who can realize a profit or suffer a loss as a result of his services is generally an independent contractor. 17. Working for more than one firm at a time. The performance of more than minimal services for other unrelated persons or firms at the same time is a factor indicating the existence of an independent contractor relationship. the same time is a factor indicating the existence of an independent contractor relationship. 18. Services available for public. A worker who consistently and regularly makes his or her services available to the general public is an independent contractor. 19. Right to discharge. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. An independent contractor, on the other hand, generally cannot be fired so long as the independent contractor produces a result that meets the contract specifications. 20. Right to terminate. The worker’s right to end his or her relationship with the business at any time without incurring liability g g p y g y indicates an employer‐employee relationship.

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IRS: The Test of “Control” IRS: The Test of Control

 One factor that has clearly emerged as significant from both the courts, and Section 31 3401(c) 1(b) of the Employment Tax Regulations is the level of Section 31.3401(c)‐1(b) of the Employment Tax Regulations, is the level of direction or control that the Company has over the manner in which the services are performed.  Individuals that were free to use their own methods and were not directed Individuals that were free to use their own methods and were not directed

• r supervised in their daily activities were found to exhibit characteristics of

independent contractors.

 de Torres v. Comm’r, TC Memo 1993‐161 (civil engineer); Shelly v. Comm’r, TC Memo 1994‐432 (minister); Hunter v. Comm’r, TC Memo 1994‐524 (advertising seller); Apollo Drywall, Inc. v. U.S., 71 AFTR 2d 93‐1689 (WD Mich. 1993) (dry waller).

 Workers under a contract with specified guidelines or instructions, or a schedule

• f specific duties, were deemed to be employees.

 Webber v. Comm’r, 103 TC 378 (1994) (minister); Laraway v. Comm’r, TC Memo 1992‐705 (auto mechanic); Casety, Jr. v. Comm’r, TC Memo 1993‐410 (paralegal); Moore v. U.S., 70 AFTR 2d 92‐5284 (W.D. Mich. 1992) (trucker). www.mwe.com 26

IRS: The Test of “Control” IRS: The Test of Control

 The determination of control may be a matter of degree.  Different standard for “control” applies in the case of professionals, such as doctors, lawyers, accountants, etc.:  “The methods by which professional men work are prescribed by the  The methods by which professional men work are prescribed by the techniques and standards of their profession. … Therefore, the control

• f an employer over the manner in which professional employees shall

conduct the duties of their positions must necessarily be more tenuous and general than the control over the nonprofessional employees [ h i dd d] ” ( ’ ( ) ) [emphasis added].” (James v. Comm’r, 25 T.C. 1296 (1956).)

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Continuing Relationship between Organization and the Worker

 A continuing or recurring relationship between an exempt organization and k d h bl d f l l a worker provides another possible indication of an employer‐employee relationship:

 The length of a working relationship between an organization and an individual is not necessarily determinative of the status of a worker. The IRS held that an individual providing services for only three months of a one year contract was an p g y y employee based upon other factors including:

• The organization exercised significant direction and control over the manner in which job

was performed; and

• All necessary tools, equipment, and materials were provided to the individual. (PLR

199923014.)

Th d i f h l i hi b l k l ifi i  The duration of the relationship may be relevant to worker classification:

• The IRS has argued that the expectation that the working relationship will continue

indefinitely is considered evidence of an intent to create an employment relationship.

• In contrast, the intent to create a long‐term, as opposed to indefinite, relationship is a

neutral fact that should be disregarded. (FSA 200127004.)

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Restrictions on Ability to Perform Work for Others Restrictions on Ability to Perform Work for Others

 The performance of more than de minimis services for multiple unrelated organizations or businesses at the same time generally unrelated organizations or businesses at the same time generally indicates that the individual is an independent contractor. (Rev. Rul. 70‐ 572.)

 However, a worker that performs more than de minimis services for multiple

• rganizations may be an employee of each of the organizations, especially

g y p y f g , p y where the organizations are part of the same service arrangement.

 An individual that makes their services available to the general public on a regular and consistent basis indicates an independent contractor l i hi ( l 6 66 )

• relationship. (Rev. Rul. 56‐660.)

 By comparison, the restriction that the individual perform services for one

• rganization on an exclusive basis, or subject to an unreasonably restrictive

noncompete agreement, suggests an employer‐employee relationship.

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IRS Training Materials – 3 Factor Test IRS Training Materials – 3 Factor Test

 IRS Training Materials (1996) included a list of guidelines and factors that g g grouped certain of the 20 factors into 3 categories:

1. Behavioral Control

• Does the organization control the manner/method in which services are performed?
• Does the organization provide instructions or training?

2 Financial Control 2. Financial Control

• Does the worker bear a risk of financial loss?
• Does the worker make services available to others?
• Does the worker have an investment in his own tools/equipment? Unreimbursed expenses?
• Is the worker paid on regular, periodic basis? Or in response to invoice for services?

3. Relationship Control

• How long / exclusive is organization’s relationship with worker?
• Terms of contract for services at arm’s‐length? Worker covered for employee benefits?
• Are services performed by the worker a key aspect of, or integral to the activities of the
• rganization?

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Department of Labor ‐ Wage & Hour Issues

 Fair Labor Standards Act (“FLSA”)

 Enforced by the Wage and Hour Division (“WHD”) of U.S. Department of Labor (“DOL”) and private plaintiffs and private plaintiffs  Covered employees are entitled under the FLSA to receive:

• Compensation at least equal to the minimum wage rate

 2013 Federal minimum wage rate is $7.25/hour 2013 California state minimum wage rate is $8 00/hour  2013 California state minimum wage rate is $8.00/hour  2013 City/County of San Francisco minimum wage rate is $10.55/hour

• Overtime pay equal to at least one and one‐half times their “regular rate” of pay for each hour they

actually work over the applicable FLSA overtime threshold.

 U.S. DOL overtime rules – maximum 40 hour work week. lif i i h k k/8 h k d  California measures overtime as 40 hour work week/8 hour work day.

• “White Collar Exemptions:”

 Executives, “learned professions,” and core administrative functions requiring discretion and skill;  Minimum compensation in excess of $455/week ($23,660 annually); and,  Primary duty is management.

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Department of Labor ‐ Wage & Hour Issues Department of Labor ‐ Wage & Hour Issues

 Federal law generally does not pre‐empt or displace state law in the wage/hour area.

 Federal/state rules may provide differences both in terms of limitation thresholds, and exemption/coverage exemption/coverage.  Generally presume that the standard more favorable or protective to the employee controls.

 Memorandum of Understanding between IRS and DOL for collaboration and information sharing in worker misclassification cases. (September 19, 2011)

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DOL/FLSA ‐ “Economic‐Realities Test” DOL/FLSA ‐ Economic‐Realities Test

 Rather than using the common law test, the FLSA examines 6 factors to determine whether the “economic reality” of the employment relationship y p y p the worker is one of economic dependence:

• Degree to which the organization controls the way in which the work is

performed;

‐ Control is a highly determinative criteria, in tax and wage & hour worker classification cases.

• The worker’s opportunity for profit or loss, depending on their skill;
• The worker’s investment in equipment or materials, or hiring assistants for the

task;

• The length of the working relationship, and whether the parties intended for

the relationship to continue for a long or indefinite period of time; the relationship to continue for a long or indefinite period of time;

• The degree of skill required to perform the individual’s work; and
• The extent to which the services provided are essential to, and an integral part
• f the operations/mission of the organization.

‐ (Imars v. Contractors Mfg Services, Inc., 165 F.3d 27 (6th Cir. 1998).)

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Employee Misclassification Prevention Act (HR 3178) Employee Misclassification Prevention Act (HR 3178)

 Proposed federal legislation may resurface – would amend FLSA as follows: p g y

 Requires notice directing independent contractors to DOL website providing further information about the rights of misclassified employees under the law.  Requires equivalent recordkeeping of wage and hour information for non‐ employees. employees.

• Or else: requires “clear and convincing evidence” to overcome strong presumption an

employee.

 New provision makes both willful and unintentional misclassification of employees a “prohibited act” under federal law. p  Penalties from $1,000 to $5,000 per worker for a violation of the notice or recordkeeping requirements, or misclassifying an employee.  Triple damages for willful violations of wage and hour laws in misclassification cases. cases.

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Employee Misclassification Prevention Act (HR 3178) Employee Misclassification Prevention Act (HR 3178)

 Additional directions to the DOL Secretary of Labor: y

 Establish misclassification website with ability for workers to file complaints

• nline, and advising of potentially greater rights under state and local employment

laws.  Amend the Social Security Act to establish penalties for misclassifying employees, i t d t l ith t dk i f

• r paying unreported wages to employees without proper recordkeeping, for

unemployment compensation purposes.  Direct the DOL to conduct “targeted audits” of certain industries that frequently misclassify employees.  Allow the DOL and IRS to share information on worker misclassification cases Allow the DOL and IRS to share information on worker misclassification cases.  Instruct state unemployment insurance agencies to increase audits to identify employee misclassification cases.

• Track and monitor states’ effectiveness in identifying employers who misclassify

employees.

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IRS SS‐8 Program IRS SS‐8 Program

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Making the Filing Making the Filing

 Complete and file the Form SS‐8

• p
• SS

 By answering a series of questions, the Form SS‐8 evaluates the position under the 20 factor test  Either the company or the worker can submit and initiate a Form SS‐8 p inquiry

 However, the IRS will generally require the other nonfiling party to ALSO complete a Form SS‐8

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What Happens Next? What Happens Next?

 Following the IRS’ evaluation, a determination letter is issued to both

• o

g S

• ,
• o

the company and the worker  The determination not only applies to the worker directly involved but also to all similarly situated workers  The filing itself is NOT an audit (specifically, not tax or penalties are assessed)  The IRS does recommend that prior filed employment tax returns by dj t d di l t fl t th l i adjusted accordingly to reflect the conclusion

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What if One of the Parties Disagrees? What if One of the Parties Disagrees?

 It is not an audit, so there is no appeal mechanism

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Determining tax owed (Code Section 3509 i li f d C d S i f retroactive relief and Code Section 530 safe harbor)

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Relief Provisions: Section 530 “Safe Harbor” Relief Provisions: Section 530 Safe Harbor

 Section 530 of the Revenue Act of 1978 prevents the IRS from retroactively reclassifying independent contractors as employees, if the

• rganization meets certain tests:

1. Reasonable Basis Test – requires that the organization relied upon:

‐ Case law, published IRS guidance, or a private letter ruling issued to the business; ‐ Previous IRS audit – for audits in 1997 or later, must have included an examination of the worker classification of substantially similar workers; substantially similar workers; ‐ Established Industry Practice – the organization must have relied upon this established industry practice.

2. Position or “Consistency” Test – Individuals holding substantially similar positions with the

business, as well as its predecessors, must have been consistently treated as independent contractors.

3. Tax Return Test – The organization must have filed information returns (IRS Forms 1099‐MISC, Box 7)

reporting remuneration as “nonemployee compensation.”

 If eligible for the safe harbor, Section 530 relieves the organization of liability for employment taxes even when the true status of the individuals is determined to be employees.

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Relief Provisions: Section 530 Relief Provisions: Section 530

 When conducting an employment tax examination, the Internal g Revenue Manual generally requires the IRS to first consider whether the business is eligible for safe harbor relief under Section 530.  In an effort to curb perceived worker classification abuses, there have been several recent legislative proposals to limit the application of S ti Section 530.

 Legislative proposals seeking to rescind the “Established Industry Practice” were first sponsored by the late Senator Ted Kennedy and (then) Senator Barack Obama, and are currently supported by the Obama Administration.

• This is a very commonly asserted basis for relief under Section 530. And its elimination

ld d i ll li i h b f b i li ibl f i li f would dramatically limit the number of businesses eligible for Section 530 relief.

 Note: Relief under Section 530 is limited to Federal employment taxes. The business remains potentially liable, under a separate analysis, for state and local (if applicable employment taxes).

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Relief Provisions – IRC Section 3509 Relief Provisions – IRC Section 3509

 IRC Section 3509 provides reduced employment tax rates when workers are reclassified: are reclassified:

 If Forms 1099 were issued to the workers:

• The Federal income tax withholding is computed at the rate of 1.5%
• The employer’s FICA liability is computed at the rate of 20% of the

employee’s share plus the entire employer’s share employee s share plus the entire employer s share.  If Forms 1099 were not issued:

• The Federal income tax rate becomes 3%.
• The FICA rate is the employer’s share plus 40% of the employee’s share.

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 IRC Section 3509 rates are mandatory (where applicable). (See, Esser v. United States, 750 F. Supp. 421. (D. Az. 1990); I.R.M. 4.23.8.5.2(1); PMTA 2009‐034; CCA 200825043; and FSAs 1999‐637, 1999‐706, 1998477.)  IRC Section 3509 rates do not apply in cases involving either intentional disregard of the employment tax rules, or if the workers are statutory employees.

(Note: Offset for taxes paid by independent contractors under Sections 3402 and 6521 is not available if IRC Section 3509 applies.)

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IRS Voluntary Classification Settlement Program y g

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Other Relief Provisions – IRS Classification Settlement Program (CSP)

 Relief from interest under IRC Section 6205  Offset of taxes paid by workers under IRC Sections 3402(d) and 6521  IRS Worker Classification Settlement Program (“CSP”) (IRM 4.23.6 (1999))

 Limited to setting of IRS worker classification examinations. Voluntary program which requires prospective treatment of workers as  Voluntary program which requires prospective treatment of workers as employees and a closing agreement.  Limits employment tax liability to IRC Section 3509 rates (if applicable), and for only a single year.

• Further permits settlement without the additional cost of penalties or interest.

No liability for employment taxes and CSP does not apply if organization  No liability for employment taxes, and CSP does not apply, if organization qualifies for Section 530 safe harbor.  If organization has a “colorable argument,” but cannot satisfy all elements for Section 530 relief, CSP settlement at 25% of IRC Section 3509 rates, and for a single year.  Timely filing of Forms 1099 required (de minimis errors permitted) Timely filing of Forms 1099 required (de minimis errors permitted).

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Other Relief Provisions – IRS Voluntary Classification Settlement Program (VCSP)

 IRS Program borrowing settlement terms from the current CSP for voluntary disclosures.

 Limits employment tax liability to 10% of IRC Section 3509 rates, and for only a single year.

 Further permits settlement without the additional cost of penalties or interest.  IRS will not subject any prior years to worker classification examination.

* Must agree to extend employment tax statute of limitations for assessment for an additional 3 years, for each of the 3 years beginning after the VCSP closing agreement is executed.  To be eligible to participate in VCSP:  To be eligible to participate in VCSP:

 Must have consistently treated the workers as nonemployees.  Must have filed all required Forms 1099 reporting compensation paid to subject workers for the 3 preceding calendar years.  Must not currently be under IRS exam, or under exam by either DOL or any state agency on worker classification issues. Also must be in compliance with prior exams.

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Modifications Under Announcement 2012‐45

 Permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate  Clarify the current eligibility requirement that a taxpayer that is a member of an affiliated group within the meaning of Internal Revenue C d (C d ) S ti ( ) i t ligibl t ti i t if b Code (Code) Section 1504(a) is not eligible to participate if any member

• f the affiliated group is under employment tax audit

 Clarify that a taxpayer is not eligible to participate if the taxpayer is contesting in court the classification of the class or classes of workers contesting in court the classification of the class or classes of workers from a previous audit by the IRS or the DOL  Eliminate the requirement that a taxpayer agree to extend the period of limitations on assessment of employment taxes as part of the closing limitations on assessment of employment taxes as part of the closing agreement with the IRS

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Modifications Under Announcement 2012‐45

 Additionally, Announcement 2012‐46 temporarily expands the VCSP to taxpayers who would otherwise be eligible, but have not filed all required Forms 1099 for the previous three years with respect to the workers to be reclassified, provided the taxpayer pays 25 percent of the employment tax liability that would have been due on the compensation being reclassified for the most recent tax year and compensation being reclassified for the most recent tax year, and meets certain other requirements, including filing Forms 1099 for the past three years and paying an additional graduated penalty.  The expanded eligibility is only available for applications filed by The expanded eligibility is only available for applications filed by June 30, 2013.  News Release IR 20‐13‐23 provides additional details on these programs – it is clear the IRS is doing what it can to encourage voluntary g g y compliance.

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State Initiatives State Initiatives

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IRS Sharing of Worker Classification Information with State Agencies

 The IRS already has established information sharing practices with many of y g p y the states. ‐‐ Information gained in NRP exams is likely to be shared as well.  Worker classification is a recurring federal and state employment tax examination issue.  New coordination of worker classification issues between IRS, DOL, and New coordination of worker classification issues between IRS, DOL, and State Employment Authorities.

 Formalized information sharing agreements between the IRS and states established beginning in 2007. ‐‐ Present count is 39 states.  Exams by either state employment/labor agencies or the IRS SS‐8 Unit frequently y p y / g q y initiated by disgruntled former worker(s) making claims for state unemployment benefits.  State level claims may ultimately generate IRS worker classification exams.  Don’t assume that state unemployment/worker’s compensation claim for a single k ll “ ” b h worker will just “go away” by paying the assessment.

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State Worker Classification Examinations ‐ Employment Tax State Worker Classification Examinations ‐ Employment Tax

 Questionable Employment Tax Practice (QETP) initiative: Q p y (Q )

 Provides centralized, uniform means for IRS and state employment authorities to exchange data/leverage resources for employment tax enforcement.  Collaborative effort between:

• U.S. DOL
• National Association of State Workforce Agencies (NASWA)
• Federation of Tax Administrators
• Initial participating workforce agencies from the states of California, Michigan, New

Jersey, New York, and North Carolina.

 Emphasis on pursuing businesses/industries with recurring practices of misclassifying workers as independent contractors.

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State Worker Classification Examinations ‐ Employment Tax State Worker Classification Examinations ‐ Employment Tax

 Many states have more demanding criteria than the federal 20 common law f / factors and/or Section 530.  47 states and the District of Columbia follow a common law test which emphasizes degree of control exercised over the worker.  31 states, including California, apply various forms of the “ABC Test:” g A. Direction and control; B. Close integration of services with business of service recipient; C. Worker customarily engaged in independent trade, profession or business in nature of services performed. business in nature of services performed.

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State Worker Classification Examinations ‐ Employment Tax State Worker Classification Examinations ‐ Employment Tax

 California is particularly stringent in examination and California is particularly stringent in examination and enforcement of worker classification issues.

• Payments to independent contractors are separately

reported to Employment Development Dept. (EDD).

• Process makes independent contractors far more

Process makes independent contractors far more transparent to California Franchise Tax Board (FTB).

• California generally requires state income tax withholding
• n payments to nonresident individuals or corporations that

do not maintain a permanent place of business in California. p p  Fundamentally different from federal rules which do not require withholding on payments to independent contractors

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State Worker Classification Examinations ‐ Employment Tax State Worker Classification Examinations ‐ Employment Tax

 Several states, including Colorado, Delaware, Illinois, Indiana, Maryland, Mi N H hi N J Rh d I l d d W hi h Minnesota, New Hampshire, New Jersey, Rhode Island, and Washington have adopted legislation which makes it “fraud” for an employer to “knowingly” misclassify its workers in order to deprive them of the protection of:

 FLSA and state law prevailing wage and overtime pay rates;  Federal and state unemployment insurance coverage; p y g ; and  State worker’s compensation insurance coverage.

 Many of these state statutes specifically target the construction industry.

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State “Workplace Fraud” Acts State Workplace Fraud Acts

 Under these Workplace Fraud Acts, employers face potential threat of:

1. Significantly increased recordkeeping requirements; 2. Increased fines and/or administrative penalties; 3. “Stop work” orders to rein‐in violations.

 Many statutes create a private right of action for knowingly misclassified workers:

 Entitled to trebled (i.e., tripled) civil damages + attorney’s fees.  Three (3) year statute of limitations to bring claims.

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Other Issues Other Issues

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Employee Benefit Plan Coverage Issues Employee Benefit Plan Coverage Issues

 Vizcaino, et al. v. Microsoft, 97 F. 3d 1187 (9th Cir. 1996).

 Results‐oriented decision: Demonstrates the importance of precisely defining the population of “employees” for purposes of employee benefit plan coverage, to avoid retroactive benefits claims under employee retirement or health and welfare plans.

 Microsoft settled IRS worker classification case, and agreed to recharacterize a group of highly‐skilled workers referred to as “free‐lancers ” as employees for employment tax highly skilled workers, referred to as free lancers, as employees, for employment tax purposes.  The free‐lancers had previously contractually waived the rights to any employee benefits.

 Following the IRS settlement, the free‐lancers sued for retroactive benefits coverage under:

( )  The 401(k) Plan, which included matching contributions in Microsoft stock;  The Microsoft (IRC Section 423) Employee Stock Purchase Plan.

 Holding: 9th Circuit granted the retroactive claims for employee benefits, relying upon the IRS employment tax settlement reclassifying the free‐lancers as the common law employees of Microsoft.

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Employee Benefit Plan Coverage Issues Employee Benefit Plan Coverage Issues

• Best Practice: Most well‐drafted employee retirement or health and

e c ce

• p oy
• welfare plans now contain so‐called “Microsoft‐language” to prevent

retroactive claims for benefits from workers reclassified as employees.

 Model closing agreements used in most IRS worker classification settlements t th l ifi ti f th k “ l ” now comment on the classification of the workers as “employees” on a prospective basis only.  The Internal Revenue Manual (“IRM”) provides for the analogous settlement terms for worker classification cases settled under the IRS Worker Classification Settlement Program (“CSP”). (IRM 4.23.10.10.2.)

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Employee Benefit Plan Coverage Issues Employee Benefit Plan Coverage Issues

 Healthcare Reform

•  Independent contract status is now even more relevant for purposes of

counting employees to determine which employers are subject to minimum health requirements and also to which individual workers are entitled to benefits benefits.  Any error under this and not providing coverage when the organization should have can have costly penalties associated with it.

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Best Practices and Reducing Corporate Exposure Best Practices and Reducing Corporate Exposure

 Policy and procedures for classifying independent contractors y p y g p

 Getting everyone on the same page  Possibly a gatekeeper who has to sign off on classification

 Use of independent contractor agreements

D ll i d d t t t f th h ?  Do all independent contractors for the company have one?  Remember, agencies will give some deference to the agreements so long as the wording matches actual practice

 Conduct an internal compliance review

 As with any compliance review by any agency, your process and procedures are crucial to supporting your position  Get your house in order now

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Best Practices and Reducing Corporate Exposure Best Practices and Reducing Corporate Exposure

 If contractor could be an employee, ensure they are “exempt”

 Find way to monitor hours for those that would be non‐exempt

 Modify employee benefit plans to expressly exclude contractors

 Microsoft language

 Utilize contractors who are employed by someone else

 Require entity to withhold taxes and social security, provide unemployment and workers compensation insurance, ensure providing benefits to self or own employees

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Best Practices and Reducing Corporate Exposure Best Practices and Reducing Corporate Exposure

 Consider carrying worker’s compensation coverage despite contractor

• y g
• p
• g

p

• status

 Exclusive remedy for injuries or accidents  May not be available in all states for contractors  Charge the contractor

 Consider converting contractors to contractual employees

 Does not protect against past liability

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Questions? Q

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