Independent Contractor Alert: Pending Legislation

There are two pieces of legislation pending in Congress that have a high likelihood of passing before the end of this 2010 calendar year. Both of these pieces of legislation regard Independent Contractors and the way in which a company recognizes them and deals with them. If you are a company that deals with independent contractors you need to be prepared to deal with this legislation if it passes.


The first bill is The Fair Playing Field Act of 2010. This legislation will amend the Internal Revenue Code to eliminate a “loophole” that has allowed companies to avoid paying penalties for improper classification of independent contractors. The so-called loophole that the Fair Playing Field Act seeks to close is Section 530 of the Revenue Act of 1978. (You can read more about Section 530 by clicking here.)That law currently affords businesses a safe harbor to treat workers as independent contractors for employment tax purposes if the company has had a reasonable basis for such treatment and has consistently treated such employees as independent contractors by reporting their compensation on Form 1099s.

Going forward, the Fair Playing Field Act would eliminate the continued use of the Section 530 safe harbor. It would require the Treasury Secretary to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. The act would also prohibit the IRS from making retroactive assessments for past unpaid taxes in cases in which the business consistently treated the worker involved as an independent contractor and filed Form 1099s each year for the worker, unless the business had “no reasonable basis for not treating such individual as an employee.”

One major provision of the Act would require businesses who use independent contractors “on a regular and ongoing basis” to provide them with a written statement informing them of their federal tax obligations, notifying them of the employment law protections that do not apply to them, and telling them how they can seek a determination of their status from the IRS.

The second piece of pending legislation is Employee Misclassification Prevention Act. It would amend the Fair Labor Standards Act (FLSA), the federal law mandating the payment of minimum wage and overtime for employees who work more than 40 hours in a work week, creating a new labor law offense: misclassification of an employee as an independent contractor. EMPA would also impose strict record-keeping and notice requirements upon businesses with respect to workers treated as independent contractors, expose such businesses to fines of $1,100 to $5,000 per employee for each misclassification, and double the liquidated damages provisions under the FLSA for violations of the minimum wage or overtime provisions.

The paperwork burden and monetary fines associated with both these pieces of legislation can be significant. It is recommended that companies that use independent contractors make a concerted effort to reevaluate those relationships and determine how things might need to be changed.

Independent Contractors: Perhaps the Government Should Clean Up Its Own Mess

I have a WIN-WIN-WIN suggestion based on the following news story I heard on the WSB radio in Atlanta this morning. Scott Slade reported:

ONE REASON THE POSTAL SERVICE LOSES SO MUCH MONEY IS ITS USE OF THE PRIVATE-CONTRACTOR GAME. NEWLY RELEASED AUDITS SHOW THE AGENCY HAS HIRED BACK HUNDREDS OF FORMER TOP EXECUTIVES AND LOWER-LEVEL WORKERS AS PRIVATE CONSULTANTS, SOMETIMES AT TWICE THEIR OLD PAY SCALES.... THIS WEEK THE POSTAL SERVICE IS EXPECTED TO REPORT BILLIONS MORE IN LOSSES DUE TO DECLINING VOLUME. IT FACES A BUDGET GAP OF $230 BILLION OVER THE NEXT 10 YEARS.

Now if this was a large company in the private sector the Department of Labor and the IRS would be all over this abuse of the use of INDEPENDENT CONTRACTORS. I am pretty sure what the Post Office is doing would not pass the IRS rules for independent contractors. If you need to be remind of what these are you can read my post The IRS and HR: Who is an Employee?

What are the WINS in the IRS and USDOL cleaning up the Post Office?

• Win #1: The Post Office will stem the loss of money. We need the Post Office to survive. (At least at my house anyway, my wife works for an envelope company. Send more letters!)
• Win #2: The investigation of the Post Office will give the government some badly needed credibility. It will show they hold themselves to the same standard as they hold the private sector. (Well almost, you still cannot sue the government.) It could serve as a strong warning to the private sector to clean up their IC issues.
• Win #3: Having investigators occupied with the Post Office will keep some of them out of the field investigating private companies. Someone out there, perhaps you, might get a reprieve.

There you have it. A WIN-WIN-WIN suggestion to start off a Monday. Do you see any other positives that could come out of this? What about the downside?

Independent Contractor Safe Harbor Now a Minefield

Yesterday I listened to a webinar put on by the law firm of Smith, Gambrell & Russell. There were multiple topics, but the one part that most caught my attention was conducted by attorney Tracie Johnson Maurer. Her topic was Status of the Independent Contractor Employment Tax Forgiveness under Section 530 of the Revenue Act of 1978. Independent Contractor classification has long been, and still is, an area of consternation for employers. Many a company has run afoul of the IRS by improperly classifying workers as independent contractors when the IRS classified them as employees. (I wrote about this most recently on April 15, 2010 in the IRS and HR: Who is an Employee). Of course we all know the reason the IRS argues for employee status is that it is easier to collect taxes from companies than it is to collect from the independent individual. As you can see from Ms. Maurer's topic head this has been an issue since 1978.


In 1978, in the Revenue Act, and again in 1996 in the Small Business Job Protection Act, Congress tried to clarify the issue by creating a SAFE HARBOR provision that protected companies in certain instances of misclassification. The language of this measure is:

The Revenue Act of 1978 produced Section 530 to address the controversies that were arising between the IRS and business taxpayers over whether businesses had correctly classified certain workers as self employed, i.e., independent contractors, rather than as employees. Section 530 "...generally allows a taxpayer to treat a worker as not being an employee for employment tax purposes (but not income tax purposes), regardless of the individual's actual status under the common-law test, unless the taxpayer has no reasonable basis for such treatment...[However, it has been] the position of the IRS, based on legislative history, that section 530 can only apply after a determination has been made that a worker is an employee under the common-law test."



"Under section 530, a reasonable basis for treating a worker as an independent contractor is considered to exist if the taxpayer:


(1) reasonably relied on published rulings or judicial precedent,

(2) reasonably relied on past IRS audit practice with respect to the taxpayer,

(3) reasonably relied on long-standing recognized practice of a significant segment of the industry of which the taxpayer is a member, or

(4) has any other reasonable basis for treating a worker as an independent contractor.



The legislative history states that section 530 is to be "construed liberally in favor of taxpayers".

Ms. Maurer makes it clear in her presentation that the safe harbor has limited use and that you still have to use the IRS 20 factor rules and she says "An employer-employee relationship can be established by one factor (i.e., payment of the worker’s social security taxes; the worker provides services solely and on a full-time basis to the employer) or any combination of factors." So it is a tricky path to try to follow. The safe harbor is in effect even if the independent contractor failed to pass the 20 Factor test if they meet three conditions. These are:

1. The business must have filed all required tax returns, including informational reports such as 1099s, consistently with the employer’s treatment of the worker as an independent contractor.

2. All workers holding substantially similar positions must have been treated as independent contractors.

3. There must be a reasonable basis upon which to believe the worker is an independent contractor.

Now, due to budget pressures (you know that multi-trillion dollar debt we now have) there is a new emphasis on making money. The IRS is once again considering revising their interpretation of the laws. According to Ms. Maurer "Federal budget for FY 2011 contains proposed provisions which would allow the IRS to issue regulatory guidance on employment tax classification and to reclassify workers found to have been misclassified even if otherwise prohibited by Section 530." The IRS will have $25 million more to hire more compliance officers and they have already announced they will be auditing 6000 businesses for IC violations.

So be forewarned. Know whether you are properly classifying workers as Independent Contractors. Guidance can be found in this post Independent Contractor: The Devil in Disguise.

The IRS and HR: Who is an Employee?

Here is a little humor to start off TAX DAY.
A man is on his death bed and his best friend is there beside him. The man says to his friend "Fred, I want you to do me a favor. After I am dead and cremated I want you to put my ashes in an envelope and send them to the IRS. And on the outside of the envelope I want you to write a message." Fred asks "What is the message?" The man answers "I want you to write NOW YOU HAVE EVERYTHING."

On this TAX DAY I thought it appropriate to talk about the fact that the IRS exerts a great deal of control over a company or organization that Human Resources must pay attention to, not the least of which is defining who is an employee. The IRS looks at four catagories of people who deliver services to an employer. These include common-law employees, statutory employees, statutory non-employees and, of course, independent contractors. Here is a quick break down:

• Common- Law employee: Under common-law rules, anyone who performs services
  for you is your employee if you have the right to control what will be done and how it will be done. Pretty simple.
• Statutory employees: If workers are independent contractors under the common  law rules, such workers may nevertheless be treated as employees by statute, “statutory employees,” for certain
  employment tax purposes. These workers include some drivers, full-time life insurance agents, some home workers, and traveling sales agents who may sell goods for you and others.
• Statutory non-employees: These include direct sellers, licensed real estate agents, and some companion sitters.
• Independent contractors: These are people over which the employer does not exercise behavioral control or financial control and with whom they have a well-defined relationship.

Who is an independent contractor and who is not is frequently an area of confusion for many employers. While the IRS used to have a 20-factor test, today the more frequently look at the amount of control you have over the person's behavior versus the outcome of their work. They look at how you pay the individual and whether they can work for anyone else at the same time. And they look at whether there is a written contract.
 
The quick and dirty rule is: If it looks like a duck, walks like a duck, quacks like a duck the IRS is going to consider it a duck. And if you have improperly classified your "duck" as a "non-duck" then you are going to owe back taxes and probably penalties for that "duck" and all like "ducks."
 
Here is the IRS's Publication 15-A Employer's Supplemental Tax Guide that offers a pretty understandable definition of each of the catagories listed above, especially that of independent contractor. I would suggest you click on this link, download the document and read it. If you need further help here is a book that might be able to provide some further guidance. Surprisingly Simple: Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.

Given the aggressive agenda of enforcement that both the USDOL and the IRS have laid out for employers for the next couple of years it is important for HR professionals to understand the wage & hour issues and tax issues that inadverent misclassifications may cause.

You have been warned!

Independent Contractor: The Devil In Disguise

In the daily news briefings today was a small article with big news. FedEx succumbed to the same problem that has plagued many a business, both small and large. They classified drivers as independent contractors. Fed Ex was sued for this misclassification and lost a $14.4 million settlement for 200 drivers. $720,000 per driver! Pretty hefty fine.

I don't know the particulars of this case, but I see this happen frequently in smaller businesses. They think they can have someone come in as an independent contractor, thus avoiding taxes. Unfortunately this arrangement is not quite as cut and dry as that and businesses get in trouble. The "contractor" negotiates a deal that includes some benefits, for example health benefits. Well that starts messing the relationship up. And when that relationship gets messed up taxes and penalities have to be paid.

There are definite rules to who is and who is not an independent contractor. Here are the rules according to the IRS. And here is another set according to the Fair Labor Standards Act. Lastly, here is another set from the perspective of the independent contractor from Nolo on Preserving your status as an Independent Contractor.

If you are an employer read these rules very carefully and make sure you comply if you are hiring someone as a contractor. A mistake can be very expensive. Remember $720,000 per person for Fed Ex, and that was on appeal.