Employee/Worker Classification Matters Importance of Worker Classification from Tax Perspective –Fundamental to Internal Revenue Code system –Employment Taxes FICA, FUTA (small amount) & Income Tax 15.3% FICA (slightly less this last year) Income tax withholding – 25% plus may be possible 60% roughly of all revenue (or more) from employment tax system per IRS Classification of employees is important to shore up revenue
Reasons Why Employment Tax System is Important Compliance is high when there is withholding, but less so when there is disclosure and no withholding (for example, Form 1099-Misc) Bigger gap when no disclosure Fundamental to keep system working
Study on Worker Classification Government Accounting Office Report on Worker Classification, August 10, 2009, GAO - 09-717 U.S. Treasury Inspector General for Tax Administration report on Worker Classification http://www.treasury.gov/tigta/auditreports/2009re ports/200930035fr.html (February 4, 2009)http://www.treasury.gov/tigta/auditreports/2009re ports/200930035fr.html
Legislative Efforts Legislation Proposed on Worker Classification to Remove Section 530 Relief –The Taxpayer Responsibility, Accountability and Consistency Act of 2009 (S. 2882, H.R. 3408) Employee Misclassification Prevention Act (S. 3254, H.R. 5107), introduced in April 2010. –This law would amend the Fair Labor Standards Act of 1938 to require companies to notify both employees and non-employees of their classification, and to require companies to keep detailed records of non- employees who perform labor or service for remuneration. The Fair Playing Field Act of 2010 (FPFA) (S. 3786 and H.R. 6128). –Would revise the current tax law governing employment status determinations by repealing Section 530. Legislation would not likely pass now.
Questionable Employment Tax Program –35 States – IRS & States shares employment tax information – perhaps workers’ comp audit –For IRS it is just a referral program, but it is a lead –IRS shares information with the states –On June 17, 2010, DOL hearing on Fair Labor Standards Act legislation regarding employee classification issues http://www.irs.gov/newsroom/article/0,,id=17545 7,00.html
Employee Tax National Research Program Audit 6,000 audits through 2012 over three years Full scale audits – random –Large, small and mid-size –Government also Audits to gather information on compliance –Tailor to be sure that audits ensure compliance and to target audits –Worker classification a key piece to audit – will not be only piece of audit –Will continue audit regardless of whether Section 530 relief is met – (different than regular audit)
Common Law Standard Right to direct and control service provider and how service is performed Right may not be exercised and may not be exercised in full – it is the right that is key. Statutory Exceptions –Corporate officers are employees –Certain real estate agents and direct sellers are not employees for employment taxes
Rev. Rul. 87-41 20 standard test Too much of a checklist – –IRS revamped –Training materials added in 1996 Weighing factors Sum total of circumstances Behavior, Financial & relational control are key Facts & Circumstances
Tax Court Guidance Uses 7 or 8 factor test depending upon where you are in the country Go to same facts, but group factors in a little different manner Supreme Court - Darden case –Nationwide Mutual Insurance Company v. Darden, 503 U.S. 318, 112 S. Ct. 1344 (1992).
Context Matters in Determining Issue Employee versus partner – can you be both an employee and a partner? Not necessarily –Sometimes entry level employees – told they are a minor partner in a related partnership Disgruntled employees sometimes will raise these issues Temporary agency or leased employee versus actual employee can be an issue
Assistance from IRS Form SS-8 can be secured from IRS to ask for a ruling on a particular case –The employer or employee can ask for the ruling –Most are submitted by workers –The IRS has a process to seek information from both parties - IRS makes a ruling –Handled by the IRS in the Northeast –The ones dealing with Federal government and third-parties ruled on by Treasury
Case Law Bruecher Foundation, 105 AFTR2d 2020 (5 th Cir.). http://scholar.google.com/scholar_case?case=13533649387760621 263&q=%22bruecher+foundation%22+5th+circuit+2010&hl=en&as_ sdt=2,44 –IRS won at Section 530 –Ruled on specifics of case –Recent example of worker classification case relating to Section 530 LaDue v. Commissioner, T.C. Summ.Op. 2011-41 (2011), off-duty policeman is self-employed and liable for taxes and not Jacksonville, even though police department sets rules
Liability Employers are liable for full taxes, plus potentially penalties and interest –What happens if don’t withhold on a particular piece of income? Full employment taxes and income withholding can be due Section 530 Relief can eliminate liability IRC 3509 can reduce liability Classification Settlement Program
Section 530 Relief Section 530 is law until changed –Employer gets relief for past –Employer can continue to get relief as long as Section 530 relief is met –Once 530 satisfied, the audit is over –Zero bill –Can have Section 530 for one class, but not all classes of workers Discussed in much detail in the IRS materials provided from 1996
Section 530 Relief Reasonable Basis First, you had a reasonable basis for not treating the workers as employees. To establish that you had a reasonable basis for not treating the workers as employees, you can show that: –You reasonably relied on a court case about Federal taxes or a ruling issued to you by the IRS; or –Your business was audited by the IRS at a time when you treated similar workers as independent contractors and the IRS did not reclassify those workers as employees. – You may not rely on an audit commenced after December 31, 1996, unless such audit included an examination for employment tax purposes of whether the individual involved (or any other individual holding a substantially similar position) should be treated as your employee; or –You treated the workers as independent contractors because you knew that was how a significant segment of your industry treated similar workers; or –You relied on some other reasonable basis. For example, you relied on the advice of a business lawyer or accountant who knew the facts about your business.
Section 530 Relief Cont’d Substantive Consistency –In addition, you (and any predecessor business) must have treated the workers, and any similar workers, as independent contractors. –If you treated similar workers as employees, this relief provision is not available. –If you are paying an individual who is providing services as a test proctor or room supervisor assisting in the administration of college entrance or placements examinations, the substantive consistency requirement does not apply with respect to services performed after December 31, 2006, (and remuneration paid with respect to such services). –The provision applies if the individual (1) is performing the services for a tax-exempt organization, and (2) is not otherwise treated as an employee of such organization for purposes of employment taxes.
Section 530 Cont’d Reporting Consistency –Finally, you must have filed all required federal tax returns (including information returns) consistent with your treatment of each worker as not being employees. –This means, for example, that if you treated a worker as an independent contractor and paid him or her $600 or more, you must have filed Form 1099-MISC for the worker. –Relief is not available for any year and for any workers for whom you did not file the required information returns.
Liability Can be Reduced by IRC 3509 Section 3509 of the IRC –Not Optional –For worker classification, if no intentional disregard by employer, and FICA and income tax exclusion occurred –Small portion of income and FICA tax permitted –3509 rates – employer cannot get abatement for any income taxes that worker may have paid. Income taxes may have already been paid by the worker on a Form 1099
IRC 3509 Rates 1.5% of wages for income tax withholding 20% of amount which otherwise would have been for employee FICA rate Employer taxes owed in full Employee cannot get any relief just because the employer paid all of the taxes (or vice versa)
Classification Settlement Program Program IRS had for at least 15 years –Started as temporary pilot If Prospective Change by Employer, then the IRS will agree to further reduction Employer liability cut down further –Employer agrees to reclassify workers –Liability limited to one year to settle all years –Depending upon Section 530 relief and other arguments, could be 25% to 100% of liability
Tax Court Can go to tax court if necessary There are special processes for employers to contest employee classification in order to go to tax court
Employee Leasing Who is the employer? –Can be leasing or Professional Employee Organization (PEO) or contingent workforce –Can be murky as to who is an employer –Employers should be cautious (employers assume that PEO will always be responsible) The PEO will not necessarily responsible for employment taxes The right to direct and control is the standard per the IRS Blue Lake Rancheria v U.S., California (9 th Cir) – Docket # 08-4206 –Dealing with Indian Tribe with PEO –Court ruled that the PEO was not the common law employer or co- common law employer –http://scholar.google.com/scholar_case?case=1490104966933 7692097&q=%22blue+lake+rancheria%22&hl=en&as_sdt=2,44
PEO Co-Employment –The IRS does not generally recognize –Rev. Rul. 66-162 – co-employment can be recognized in limited circumstances, one person employee of two entities, because both had the right to direct and control –Professional Executive Leasing, Inc. v. Commissioner, 89 TC 225, 232 (1987), affd, 862 F.2d 751 (9th Cir. 1988). –Chief Counsel Advice (“CCA”) 200415008 (April 9, 2004), joint liability may be possible in PEO context. –Sunshine Staff Leasing, Inc. v. Earthmovers, Inc.,199 B.R. 62 (M.D. Fla. 1996); and United States v. Total Employment Company, Inc., 305 B.R. 333 (M.D. Fla. 2004). PEO found liable with client employer.
Employee Plan Issues Retirement Plans – most plans have a box to exclude independent contractors –Correction may be possible via the Voluntary Correction Program –Example Part-time or seasonal employees excluded Temporary employees excluded Leased employees not excluded by terms of plan –IRC section 414(n) – Can this ever apply? The IRS has in the past been dubious of applicability
Welfare Plans Welfare Plans – health, life insurance, disability, severance and similar –Most documents are not drafted to exclude independent contractors –Most documents provide that coverage is provided to all “employees” –Risk is litigation – i.e., Vizcaino v. Microsoft Corp., 173 F.3d 713 (9th Cir. 1999 –See Wolf v. Coca-Cola Co., 200 F. 3d 1337 (11th Cir. 2000) plan properly excluded employee -ERISA section 510 retaliation claim is possible if act against an employee asserting rights
Private Causes of Action for Failure to Comply Courts seem split whether a private cause of action could exist if an employee is misclassified and there are no benefit issues. –See The Sea Clammers Doctrine: Reeling in Private Employment Tax Claims in Worker Misclassification Cases, J. Aaron Ball, 1 Depaul Business & Commercial Law Journal 215 (2002-2003)
Certain Plans Cannot Exclude Anyone Reclassified 403(b) Plan IRC 423 Equity Plans Cannot exclude independent contractors who are reclassified as employees by law Must live with the risk of reclassification with those programs
Other Tax Issues IRC 409A –Deferred compensation rules apply regardless of the title –Termination of employment may not occur just because an employee is classified as an independent contractor
Penalties for Failures Employers could be subject to a number of liabilities with respect to the information reporting and withholding errors. These liabilities include the following: Penalties for failing to file the correct information return (i.e. the W-2 did not show the correct amount). This would result in a $100 penalty for the incorrect filing with the government and a $100 penalty for the incorrect filing to the affected participant. A 10 percent penalty would be applied for failure to deposit the employer portion of FICA (based on amount of deposit). A 20 percent negligence penalty could be applied based on the amount that should have been deposited, although this seems very unlikely. Interest could be applied at the underpayment rate to the amounts described above. The employer could be held liable for the amount of income taxes it should have withheld in 2009.  Code Sections 6721 and 6722.  Code Section 6656 and Rev. Rul. 75-191, 1975-1 C.B. 376.  Code Section 6662.  Code Section 6601.  Treasury Regulation 31.3402(d)-1.
Personal Liability for Taxes is Possible When determining whether an individual is a responsible person liable for a corporation's failure to remit taxes to IRS, courts consider a non-exhaustive list of factors, including whether the individual: (1) serves as an officer or member of the board of directors; (2) owns substantial stock in the company; (3) manages day-to-day operations; (4) possesses the authority to hire or fire employees; (5) makes decisions as to the disbursement of funds and payment of creditors; (6) controls bank accounts and disbursement of records; and (7) possesses check-signing authority. Opplinger v. United States, 637 F.3d 889 (8 th Cir. 2011). IRC section 6672
Relief From Penalties & Interest Form 4670 can be used to get a credit for any income tax paid by the employee. IRC section 3402(d). Form 4669 can be used to get credit for Social Security and other taxes paid by the employee. IRC 6205. Interest free adjustment permitted if correction made by the return due date for the period in which error was ascertained. Treasury Regulation Section 31.6205-1(c)(2) and Instructions Form 941-X. See also Rev. Rul. 2009-39 discussing the interest free adjustments. Section 530 Relief is independent and may still provide full relief, depending upon the case.
Correction Generally Entirely new process – January 1, 2009 Issue Form W-2c, along with Form W-3c File Form 941-X to correct payroll taxes –Interest free adjustment is permitted if fixed quickly File a Reasonable Cause Statement Also corresponding forms for certain other situations (e.g., Form 944-X for annual returns) See IRS Publication 4341 (January 2010) providing guidance on corrections and completing forms.
Form 941-X - Example Line 12 and related used to correct employee classification errors on Form 941-X Quarter by quarter Form 941-X should be filed If IRC 3509 applies, can use rates on those forms – as long as not intentional and must be a complete failure to withhold Example - June 29 discovered error, must file 941-X by July 31
Voluntary Correction Outside of Audit? IRS is considering setting up a program but nothing yet Probably good to visit with the IRS on an informal basis Can ask the IRS to open a limited scope audit, but I do not recommend
Questions? Henry Talavera 1445 Ross Avenue, Suite 3700 Dallas, Texas 75287 (214) 468-3386