Filed under: IC Compliance | Tags: Federal and State Agency Programs and Publications, Independent contractor misclassification
On Monday, March 11, 2013, Richard Reibstein, one of the co-publishers of this blog, submitted 17 pages of detailed Comments to the U.S. Department of Labor’s proposed data collection for its Worker Classification Survey. The Comments, which were officially received By the Labor Department on March 12, noted that, absent substantial revisions to close to three dozen of the proposed interview questions to be asked of workers selected for the survey, the information to be collected would not likely serve any “practical utility.”
The Survey had been announced by the Labor Department on Friday, January 11, 2013 and was the subject of a post by the co-publishers of this blog on Monday, January 14.
The Comments submitted by Richard Reibstein included both general comments as well as specific comments.
A portion of the general comments submitted by Richard Reibstein include the following:
As currently drafted, the information to be collected is unlikely to serve the interests of the Department in obtaining information that has “practical utility” because (a) many of the questions as drafted use language that is confusing, imprecise, and subject to more than one interpretation; (b) some of the questions seek information that is not pertinent to the stated purpose of the worker classification study; and (c) some of the questions fail to use classification-neutral wording and this can lead to skewed results. It is respectfully submitted that the proposed questions in both the worker interview and the employer interview parts be modified to (a) use classification-neutral language, (b) clarify language that is confusing, confounding, ambiguous, and imprecise, and (c) eliminate language that is neither meaningful nor pertinent to the issue of worker classification. Using the proposed language without eliminating these flaws in the current drafts would likely produce results that are skewed, meaningless, inaccurate, and without practical utility.
The specific comments addressed 35 of the proposed questions to be asked of workers to be interviewed; the specific comments also addressed five paragraphs of the proposed interview statements to be made to employers and employer representatives who will be surveyed.
The following are two examples of the specific comments addressing the proposed interview questions of workers :
22. In Item *QBEHAV1 on pages 25-26 of the Worker Misclassification Survey (OMB Attachment C Survey), Part III, Section 1 (“Behavioral Control”), the question states: “On your [main] job, do you report directly to a manager, supervisor, foreman or someone else who regularly oversees or approves HOW you do your work?” This is perhaps the most important question in the survey, yet it is phrased inconsistently with the well-established prevailing state of the law with regard to behavioral control, which has been consistently stated by the courts as whether the hiring party has the right to direct or control the manner and means by which the services are provided. Whether the hiring party “approves how you do your work” may apply even if the hiring party does not direct or control how the services are performed, but expresses approval of the way in which they are performed. Further, the issue of whether the hiring party controls or directs how the worker performs the services is distinguished from whether the hiring party controls what the worker produces (i.e., the end-product of the services), but these two issues are often confused by many and will likely be lost upon many respondents unless the distinction is drawn to their attention. Therefore, this key question should, it is respectfully submitted, be modified to state in sum and substance: “On your [main] job, do you report to a manager, supervisor, foreman or someone else who regularly oversees your work and directs and controls not only what you do, but also HOW you do your work?”
29. In Item *QRELATE1 on page 29 of the Worker Misclassification Survey (OMB Attachment C Survey), Part III, Section 3 (“Relationship”), the question states: “Besides your [main] job, do you perform similar work for others [IF NECESSARY: other companies or businesses]?” This question, it is respectfully submitted, does not address the key inquiry regarding control in a worker classification inquiry. As the courts have made clear, it is not mainly what the worker does but, more importantly, what the worker has the right to do. Thus, if a bona fide IC has the genuine right to perform similar work for other companies or businesses but chooses not to exercise that right for business or personal reasons at the time he/she is responding to the question, or for the past x number of months or for some other duration, the fact that he/she chooses not to exercise that right at the present time (or even for a reasonable period of time) is not an indicia of employee status. Rather, it is an indicia of IC status that the worker has such genuine right. Thus, the question should be modified in sum and substance as follows: “Besides your [main] job, do you have the right, if you so desire, to perform similar work for others [IF NECESSARY: other companies or businesses]?”
These Comments by Richard Reibstein also addressed statements to be made by the interviewers to employers and employer representatives, including the following:
Page 4 of Section 2 of the “Justification” (Part A) indicates that the DOL is having only 16-20 in-depth interviews conducted of employers, employer consultants, and employer representatives. This is woefully inadequate to gain a full understanding of worker classification in the U.S. from the employer/business perspective. Although Abt Associates “anticipates that recruitment will be challenging,” there is no reason not to conduct far more employer/business interviews. The information gathered from only 16-20 representatives of employers/businesses, and to focus on industries that the DOL “has identified as having a higher likelihood of employees being misclassified,” is likely to produce highly skewed information and data.
The full set of Comments submitted by Rich are available here.
Federal agencies typically review closely all comments submitted, and is expected that the Labor Department will review closely these 17 pages of Comments and revise their interview materials for both workers and employers/employer representatives.
Any others who submitted comments are encouraged to send a copy to the publishers of this blog, below. All such comments will be posted on this site.
Submitted by Richard Reibstein, Lisa Petkun, and Andrew Rudolph.
Filed under: IC Compliance | Tags: misclassification liability, IC Diagnostics, Court Cases/Decisions of Significance, Independent contractor misclassification
It is rare for a business to challenge an administrative determination concerning a single worker’s claim for unemployment insurance benefits. Indeed, many employers tend to delegate responsibility to handle administrative proceedings before state unemployment offices to companies providing “unemployment claims services.” This is because the issue in most unemployment cases is simply whether the claimant resigned without cause or engaged in misconduct that disqualifies him or her from benefits. But, unemployment proceedings that deal with the issue of whether the claimant is an employee or independent contractor (IC) is neither a simple or straightforward matter, nor does it typically affect only the unemployment benefits of the claimant.
Rather, as the following two cases show, a single claim won by a misclassified employee for unemployment benefits can lead to the beginning of an array of IC misclassification claims dealing with the company’s other ICs – unless the company engages in best practices.
The Recent Kansas Case on Exotic Dancers
On February 1, 2013, the Kansas Supreme Court issued a decision affirming an administrative determination commenced by a single exotic dancer’s claim for unemployment benefits. The Kansas Department of Labor initially determined that the claimant and all other similarly situated dancers were employees, not independent contractors as claimed by the adult club where the dancers worked. Milano’s v. Kansas Department of Labor, No. 102,114 (Kan. Sup. Ct. Feb. 1, 2013).
The owner of the adult club appealed to the courts, but lost at each level of appellate review. Last week, the Kansas Supreme Court ruled that the dancers were “employees” and not independent contractors. One of the key facts relied upon by the Court was that the club set various “house rules” which, if violated, could lead to fines or termination of the dancers.
Why would a business spend legal fees to contest an unemployment case all the way to a state’s highest court? As we stated in our White Paper on “How Companies Can Minimize the Risks” of IC misclassification: “If a business has not paid unemployment contributions to a state fund on behalf of that worker, the initial determination can have the same effect as an adverse audit . . . . Once a single worker is found to have been misclassified, the business is then normally charged for unpaid contributions for “all similarly situated” workers, along with costly penalties and fines.” In addition, an adverse administrative determination can be followed by class action claims for unpaid overtime or minimum wages and/or unpaid employee benefits, as shown by the next case that began as a claim for unemployment benefits by a single worker not classified as an employee.
The Massachusetts Franchise Cases
These cases involve the employee status of office cleaning workers who provided services to customers of Coverall North America under the terms of a janitorial franchise agreement they each signed with Coverall.
The first of the two Coverall cases involved a custodian who was required to sign a franchise agreement with Coverall in order to provide cleaning services to a Coverall customer. After the custodian was terminated by Coverall, she filed a claim for unemployment insurance. An administrative examiner ruled, after a hearing, that Coverall could not satisfy the statutory test in Massachusetts for independent contractor status. An administrative review board affirmed the examiner’s ruling. It found that Coverall could not establish each of the three requirements to establish the existence of an independent contractor relationship with the janitorial worker under Massachusetts law .
On appeal, Coverall argued that the franchised custodian was an IC, but the Supreme Judicial Court of Massachusetts affirmed the administrative determination. It found that it needed only to examine the third requirement for IC status – that the services were “part of an independently established trade, occupation, profession, or business of the worker” – which it found to be lacking. Coverall North America v. Commissioner of the Division of Unemployment, 447 Mass. 852 (2006).
It did not take long for the second shoe to drop, and the next legal challenge has been far more costly to Coverall. It involved far greater exposure – a class action lawsuit under the Massachusetts wage law for misclassification. The custodians alleged that they were employees under the wage laws and were entitled to an array of damages. A federal court found in their favor, holding that the workers were “employees,” even though they signed franchise agreements. Awuah v. Coverall North America, 707 F.Supp.2d 80 (D. Mass. 2010). The federal court then asked the state’s highest court to issue a ruling about certain types of damages, and the Massachusetts Supreme Judicial Court held that the janitorial workers were entitled to most of the damages they had sought. Awuah v. Coverall North America, 460 Mass. 484 (2011). The case is still pending and is being actively litigated today on motions for reconsideration.
Analysis and Best Practices
In a recent blog post, we noted that an adverse result favorable to one or more workers in any type of misclassification claim “is likely to be the first of a number of misclassification challenges for the [business involved].” This is often the case where the first matter involves an unemployment claim. In addition to costly class action lawsuits for unpaid wages and benefits brought by the workers, such as what occurred to Coverall, we noted that a business is also subject to “governmental audits by the IRS [and state tax authorities], workers compensation boards, and/or the federal and state Labor Departments.”
1. What should a business do when it receives notice that a worker, whom it classifies as an independent contractor, is seeking unemployment benefits or that an unemployment agency is conducting an audit?
Assuming there is a valid argument that the worker is an IC and not an employee, including situations where the worker is in the “grey area,” the following are suggested best practices, using IC Diagnostics™ tools where applicable.
First, recognize the potential consequences of an adverse determination by the unemployment agency. A finding that a single worker is not an IC but rather an “employee” eligible for unemployment benefits is not typically limited to the claimant. Rather, the decision is usually accompanied by an order directing the business to pay back contributions for the claimant “and all similarly situated workers.” Thus, in many ways, an unemployment claim can have the same effect as an audit covering most or all of the ICs retained by a business.
Second, submit a comprehensive position statement to the claims examiner or auditor. Address not only the factors listed in an unemployment statute or a publication published by the state agency for determining the status of the worker, but also other applicable indicia of employment status, such as those in the 48 Factors-Plus™ that the courts and administrative agencies have found to be pertinent to the issue of IC status. Sometimes, this submission must be done in a matter of days, so it is advisable to be prepared in advance.
Third, if an initial determination by a claims examiner or auditor is adverse, request a hearing – and treat the hearing as a mini-trial. The same comprehensive set of 48 Factors-Plus™ should be addressed at the hearing to the extent they are applicable, with admissible evidence and suitable witnesses to briefly introduce documentary and testimonial evidence.
** A word of caution: an appeal of a decision by a referee or ALJ ordinarily may only address evidence introduced into the record; therefore, a full record should be made at the hearing. **
Fourth, in the event the hearing officer, referee, or administrative law judge (ALJ) rules against the business, file an appeal. Brief the appeal as you would a court case; it is important and beneficial to win at the administrative level. Indeed, winning early before the issue of IC misclassification gains traction can avoid further legal fees and lessen considerably the likelihood that further administrative or judicial claims will ever be brought.
** A word of comfort: if a company receives an adverse determination, there are still ways to avoid adverse determinations in other legal proceedings – if the company takes certain of the steps described below. **
2. What should a business do today, before it receives notice that a worker it treats as an IC has made a claim for unemployment benefits (or filed some other type of misclassification claim)?
Companies can minimize or eliminate worker misclassification liability by enhancing their IC compliance before being challenged at the regulatory agency level or in court.
Companies that rely on ICs as one of their key sources of manpower or simply to supplement their existing workforce can take steps to minimize misclassification liability by ensuring that their relationships with such ICs are properly structured, documented, and implemented. Bona fide IC relationships are permitted in virtually all states in the U.S., although state law tests for IC status often vary from one state to another.
As described in our White Paper, businesses that rely on ICs should consider engaging in a form of IC Diagnostics™. This can start with an assessment of the company’s current level of IC compliance as measured on the IC Compliance Scale™. Depending on the level of IC compliance, alternatives to enhance compliance with IC laws may include restructuring, re-documentation, reclassification, or redistribution.
Where restructuring is suitable, some businesses may need only a little while others may benefit from moderate to substantial restructuring to enhance the likelihood of a successful defense to an unemployment proceeding and other IC misclassification challenges.
Regardless of whether a business’s IC relationships need restructuring or not, documentation of the IC relationship can be critical under most state and federal laws governing the status of workers. Many IC agreements have not been updated since the crackdown on IC misclassification began in 2007 or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status and the 48 Factors-Plus™ is an essential aspect of IC Diagnostics™.
The other compliance alternatives – reclassification or redistribution of ICs, are more fully described in our White Paper.
Many companies utilizing ICs are well aware that they may not be in full compliance with laws affecting ICs, but find themselves in a form of corporate paralysis, unaware that there are a number of ways they can minimize or avoid IC misclassification liability. Indeed, for most of those businesses, IC compliance in the areas of labor, tax, and employee benefits is readily attainable under IC Diagnostics™.
Your comments are invited.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, IC Diagnostics, Independent contractor misclassification
Last week, kgb USA, which operates a text message and Internet-based information service, consented to the entry of a federal court judgment to pay $1.3 million in unpaid minimum wage and overtime wages to its 14,500 current and former “Special Agents” in settlement of claims brought by the U.S. Department of Labor. Solis v. KGB USA, Inc., no. 5:13-cv-00227 (E.D.Pa. Jan. 15, 2013)
According to the Complaint, kgb USA provides an information service by answering text message questions as well as questions posted to its website by the general public. It hired thousands of “Special Agents” whose duties required them to quickly research, write, and send answers to questions posed by kgb USA customers. The Complaint further alleged, among other things, that the Special Agents:
- were dependent upon kgb USA for their employment,
- had no capital investment in the company,
- did not exhibit managerial skill and initiative in marketing or managing a business,
- were subject to control as homeworkers,
- had no opportunity for profit or loss,
- rendered services integral to kgb USA’s business,
- were paid a non-negotiable rate of five to ten cents per answer,
- did not receive overtime pay when they worked over forty hours in a week, and
- were, at times, paid less than the applicable minimum hourly wage.
The lawsuit alleged that from January 19, 2009 to December 4, 2012, kgb USA repeatedly violated the Fair Labor Standards Act (FLSA) by (1) misclassifying the Special Agents as independent contractors instead of employees, (2) failing to pay minimum wage and overtime amounts, and (3) failing to make, keep, and preserve adequate and accurate employment-related records of the “Special Agents.”
Under the terms of the consent judgment, kgb USA not only is required to pay $1.3 million to the Wage and Hour Division of the Labor Department for distribution to thousands of current and former employees, but also it must comply with the terms of the FLSA, including all applicable minimum wage, overtime, and reporting requirements. Further, once the consent judgment is approved by the federal court, it will be enjoined from “classify[ing] any worker as an independent contractor unless such person is a bona fide independent contractor under the provisions of the [FLSA] and does not meet the [FLSA]’s definition of employee.”
Analysis and Takeaway:
1. This is likely to be the first of a number of costly legal misclassification challenges for the settling company.
Companies that retain workers as ICs, including information technology and other Internet-based businesses, run the risk that their business models will fail to pass scrutiny not only with the U.S. Department of Labor but also with a number of other federal and state agencies if they do not pay attention to the requirements of applicable employment, tax, and benefit laws affecting independent contractors.
While kgb USA did not admit to any wrongdoing in the consent judgment with the Department of Labor, settlements of this nature often lead to other workforce and tax regulators examining whether the settling business may have failed to comply with an array of federal and state laws. In fact, under a Memorandum of Understanding signed on September 19, 2011 between the U.S. Department of Labor and the Internal Revenue Service (IRS), the “DOL will refer to the IRS, at DOL’s discretion and consistent with applicable law, . . . data that DOL believes may raise Internal Revenue employment tax compliance issues relating to misclassification.”
Further, under its “Misclassification Initiative,” the U.S. Department of Labor has entered into Memoranda of Understanding (MOUs) with 14 states and is actively pursuing MOUs with additional states as well. According to the U.S. Labor Department: “These MOUs will enable the Department to share information and to coordinate enforcement efforts with participating states . . . . Employers that misclassify their employees may not be paying the proper overtime compensation, FICA and Unemployment Insurances taxes, or workers’ compensation premiums.”
Thus, it would not be surprising if, shortly after the consent judgment is entered by the federal court, various state workers’ compensation boards and state unemployment insurance agencies notify the settling company that its “Special Agents” were also misclassified employees under state laws. If the “Special Agents” were not ICs under those state laws, kgb USA would have been required to have made state unemployment insurance tax payments on behalf of the “Special Agents” and covered them under applicable state workers’ compensation laws for several years in the past. If these state agencies pursue enforcement, they are likely to seek past unpaid unemployment taxes and workers’ comp premiums as well as interest, penalties and fines.
Likewise, it would not be surprising if the IRS made an assessment against the settling business for back payroll taxes including Social Security and Medicare (FICA) payments that had not been made on the earnings of the “Special Agents” it treated as ICs and paid on a 1099 basis instead of treating them as W-2 employees.
The “Special Agents” themselves may also pursue other types of legal claims, including class action claims for employee benefits.
2. Companies can minimize or eliminate worker misclassification liability, even those with at-home workers in Internet-based businesses, by enhancing their IC compliance before being challenged by a government regulatory agency or a plaintiffs’ class action lawyer.
Companies that rely on ICs as one of their key sources of manpower or simply to supplement their existing workforce can take steps to minimize misclassification liability by ensuring that their relationships with such ICs are properly structured, documented, and implemented. Bona fide IC relationships are permitted in virtually all states but one in the U.S., although state law tests for IC status often vary from one state to another.
As described in detail in our White Paper, businesses that rely on ICs should consider engaging in a form of IC Diagnostics™ to avoid or minimize exposure to IC misclassification liability. This starts with an assessment of the company’s current level of IC compliance on an IC Compliance Scale™, using all applicable federal and state IC tests and an examination of each of the “48 Factors-Plus” found by the courts and administrative agencies to be relevant to a determination of IC status. Some businesses need little if any restructuring of their IC relationships, while others, including some Internet-based companies, are likely to benefit from moderate to substantial restructurings to enhance the likelihood of a successful defense to an IC misclassification challenge.
Regardless of whether a business’s IC relationships need restructuring or not, documentation of the IC relationship can be critical under most state and federal laws governing the status of workers. Many IC agreements have not been updated since the crackdown on IC misclassification began or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status, is an essential aspect of IC Diagnostics™.
Alternatives to restructuring and re-documentation include reclassification and redistribution of ICs, as described in our White Paper.
Many companies utilizing ICs are well aware that they may not be in compliance with laws affecting ICs, but find themselves in a form of corporate paralysis, unaware that there are a number of ways they can minimize or avoid IC misclassification liability. Indeed, for most of those businesses, IC compliance is readily attainable.
Your comments are invited.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Input by Janet Barsky
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, IC Diagnostics, Independent contractor misclassification, misclassification
This month there have already been two cases in the staffing and workforce solutions industry that highlight the risks posed to that industry and their clients where the workers being referred are paid on a 1099 basis. One case arose in New York and involved workers referred to clients holding marketing events that required extra staff for promotional work. The other case arose in California and involved customer service and technical workers referred to AT&T and Apple.
Many staffing and workforce solution companies refer only W-2 employees to their clients or send only 1099ers who are bona fide independent contractors (ICs). There are, however, a number of staffing and workforce referral companies that send misclassified common law employees to their clients but pay them as if they were ICs. That creates substantial exposure for misclassification liability for the referring companies and their clients – exposure that can be minimized or eliminated.
The New York Case:
On January 3, 2013, the New York State Unemployment Insurance Appeal Board issued identical decisions in 35 separate cases holding that the workers supplied by a staffing company to a client to perform promotional work for a marketing event were employees and not independent contractors. See, e.g., Matter of Appeal Board No. 556309. Each of the 35 cases involved claimants who sought unemployment benefits despite being treated as 1099ers.
The Appeal Board was not persuaded that the workers were independent contractors simply because they could decline assignments and could work for other agencies. In ruling that all 35 workers had been misclassified, the Appeal Board relied on five other administrative and court cases where workers in the promotional and event marketing industry were found to be misclassified as ICs:
- one case involved a “promotional staffing company,”
- another case ruled against a company that “provided models for trade shows and other ‘events’ where promotional materials were handed out,
- the third case involved a promotional “marketing company,”
- a fourth case dealt with misclassified appliance demonstrators, and
- the fifth case involved a staffing agency “which provided models to stores for make-up demonstrations and sales promotions.”
As a result of the January 2013 decision, the staffing company was held liable for contributions for all similarly situated workers.
The California Case:
On January 9, 2013, customer service and technical support service workers reportedly referred to AT&T and Apple settled their class action IC misclassification lawsuit with Arise Virtual Solutions for $1.25 million. On that date, a federal district court in California granted preliminary approval of a class action settlement alleging that Arise, which refers to itself as a “provider of virtual business process outsourcing and contact center services” for the financial services, retail, technology, e-commerce, telecommunications, travel, and hospitality industries, misclassified over 200 service providers as independent contractors instead of employees.
The original lawsuit had sought damages against Arise, AT&T, and Apple for unpaid overtime, failure to reimburse workers for required business expenses, and failure to provide meal periods and rest periods under state law. After considerable motions and the filing of new complaints only against Arise, the parties settled. The $1.25 million settlement is subject to a fairness hearing scheduled before the court in May 2013. Perry v. Arise Virtual Solutions, No. C 11-01488 YGR (Jan. 9, 2013) (N.D. Cal.).
The settlement was reached after extensive discovery was taken including depositions and the exchange of over 81,000 pages of documents in response to over 300 document requests. AT&T and Apple are not parties to the settlement. Arise denied any wrongdoing in the settlement papers.
This case is one of a number of “class action” type cases filed against Arise for worker misclassification.
In October 2012, a lawsuit was filed against Arise in federal court in Florida alleging that it violated the federal minimum wage law. Dowell v. Arise Virtual Solutions, No. 12-cv-61947 (S.D. Fla.). That lawsuit alleged that Arise failed to pay its “individual business owners,” “virtual service corporations,” “client service professionals,” “partners,” and other independent contractors for time spent in extensive training teaching them to become customer service representatives for specific customers of Arise and for time they were on call time waiting for work. The lawsuit alleges that those independent contractors are employees under the federal Fair Labor Standards Act (FLSA) because they are trained, directed, and controlled in the manner in which they performed their work. In addition to required training, the customer service representatives were allegedly required to follow scripts when speaking on the telephone to customers for Arise’s clients, which are cited as American Automobile Association, Apple, Disney, and Carnival Cruise Line. This case was recently withdrawn “without prejudice” to any party after Arise filed a motion seeking to arbitrate the claims pursuant to an arbitration clause in its agreements with the customer service representatives or their corporate entities.
Another lawsuit was filed against Arise in the same federal court in October 2012 with similar allegations: the customer service representatives retained by Arise are not independent contractors but rather employees who are directed and controlled in the manner in which they performed their work, yet they were not paid for required training courses and other time worked without compensation – all allegedly in violation of the FLSA. These customer service representatives provided services for Carnival Cruise Lines and AT&T, the complaint alleges. Otis v. Arise Virtual Solutions, No. 12-cv-62143 (S.D. Fla.). No answer or motions have yet been filed by Arise.
Analysis and Observations:
1. IC misclassification claims create an array of legal proceedings. These types of cases represent two of the many types of legal proceedings that staffing and workforce solution companies are increasingly facing when the personnel they refer to clients are not treated as W-2 employees. As noted above, there is no legal prohibition on such companies referring to their clients workers treated as 1099ers where those individuals meet the tests for ICs under applicable federal and state laws. However, administrative proceedings and lawsuits alleging IC misclassification are more prevalent, and more likely to create liability for the workforce management/staffing company and/or the client, where there is considerable direction and control allegedly exercised by the staffing company, or its client, over the manner and means by which the workers perform their services. Other types of IC misclassification proceedings besides unemployment administrative matters and class action lawsuits include governmental audits – by the IRS, workers compensation boards, and/or the federal and state Labor Departments.
2. The corporate status of the IC does not eliminate misclassification liability. These cases also show that IC misclassification claims are not eliminated simply by entering into a service contract with a corporate entity. In the first of the two cases against Arise in Florida, the lawsuit claimed that the corporate status of the customer service representatives were allegedly a sham to disguise Arise’s alleged IC misclassification. Lawsuits for worker misclassification continue to be brought even where the worker has created a business corporation and is providing services through his or her company. Staffing companies and other businesses that enter into IC and other types of agreements with corporate entities operated by individuals are not immune from worker misclassification lawsuits. Indeed, a number of state laws and court decisions disregard the corporate form of the IC and focus on whether the business can establish that the worker meets the applicable IC test.
3. Three costly observations. First, as one can imagine by the extraordinary amount of discovery that transpired in the California case involving Arise Virtual Solutions, the legal fees incurred in defending class action-type lawsuits are extraordinary and can be even more costly, in some instances, than the damages sought or the amount of a settlement, even a 7-figure settlement as in the Arise case.
Second, client companies can suffer as well from IC misclassification lawsuits , even when they are not the primary target. In the Arise cases, the client companies were likely to have incurred or continue to incur substantial legal costs themselves and may be subject to further legal claims. Moreover, where the client company itself directs or controls the workers found to be misclassified as ICs, it may be found to be a joint employer with the workforce management/staffing company or even the sole employer of the workers. In either instance, client companies run the risk of joint and several liability with the company providing the workers, or liability on its own, for violation of labor laws or for failure to withhold taxes and pay for unemployment and workers compensation coverage. Indemnification clauses do not offer complete, or sometimes any, protection to corporate clients, especially where the staffing/workforce management company does not have the financial resources to make the client whole or where the indemnification clause language favors the referral company. In contrast, where an indemnification clause favors the client, it can create potentially sizeable exposure for a staffing or workforce solutions company, even if it exercises little or no direction or control over the workers, if they are directed and controlled by the client company to such an extent that they may succeed in showing that they are not ICs.
Third, the unfavorable decision by the New York Unemployment Insurance Appeal Board, described above, may lead to the issuance of additional notices to that staffing company from affected state and federal agencies. The staffing company involved should not be surprised if, within the next 12 months, it receives an assessment for penalties and interest from the state unemployment office, an assessment of penalties and interest charges from the state workers compensation board, and an assessment from the state tax commissioner and/or the IRS. If the promotional workers also claim that they regularly worked more than 40 hours per week, overtime claims may also be asserted by the state or federal Labor Departments or by the workers themselves in the state or federal courts. A lawsuit may also be filed by the workers claiming they should have been covered under the employee benefit plans or fringe benefit programs of the staffing and/or client companies, now that they have now been re-characterized by the Appeal Board as employees.
Takeaways:
As noted in our White Paper, the current regulatory landscape involving IC misclassification has become far more unfriendly to those businesses that are based on an IC-model or rely on the use of ICs to supplement their workforce. Congress has yet to pass any IC misclassification legislation despite introducing bills each year since 2007; however, in each of the last five years, more and more states have passed laws designed to curtail the misclassification of ICs. The number of states has now reached 24. The U.S. Department of Labor and IRS have joined forces in a Misclassification Initiative and by increased enforcement, while state governments have formed task forces to crack down on businesses that should, but do not, pay state payroll or unemployment taxes or fail to provide workers comp coverage for workers who qualify as “employees” under the state labor, tax, and workers comp laws.
IC misclassification liability, though, can be eliminated or minimized through IC Diagnostics™ and other compliance tools that provide businesses with the means to assess and enhance their level of IC compliance. As noted in our White Paper on the subject, businesses have alternative means to minimize or eliminate exposure: restructuring, re-documentation, reclassification, or redistribution - and all but the last alternative are available to companies in the staffing industry.
Cases like those reported above in New York and California are a clarion call to those companies in the staffing, workforce management, and workforce solutions industry that have yet to take meaningful steps to reduce or eliminate this manageable risk. Clients of such companies should likewise take heed that redistribution of their workforce to such staffing or workforce solution companies that are not IC-compliant may not be a sound business option. Further, use of an IC-compliant staffing or workforce management firm does not, by itself, eliminate IC misclassification exposure for client companies unless they, too, take steps to enhance their own IC compliance in relation to the workers referred to them by a staffing company.
This blog post was updated on February 2, 2013.
Richard Reibstein, Lisa Petkun, and Andrew Rudolph.
Filed under: IC Compliance | Tags: Court Cases/Decisions of Significance, IC Diagnostics, Independent contractor misclassification, misclassification liability
Buried in the Federal Register on January 11, 2013 is a proposal for the U.S. Department of Labor to conduct a study to “better understand employees’ experience with worker misclassification” by “measur[ing] workers’ knowledge about their current job classification, and their knowledge about the rights and benefits associated with their job status.”
The proposed study defines worker misclassification as “the practice, intended or unintended, of improperly treating a worker who is an ‘employee’ under the applicable law as [being] in a work status other than an employee (i.e., an independent contractor).”
The Department of Labor is soliciting comments concerning its proposal to collect this information. The study is budgeted to conduct extended interviews with 10,060 workers. In contrast, the study will survey only 100 “executives” and conduct in-depth interviews with only 20 of them.
This worker classification study is part of the continuing focus by the U.S. Department of Labor to crack down on independent contractor (IC) misclassification, which (according to the proposal) allows employers who misclassify workers “to achieve significant administrative and labor cost reductions, giving them a profound advantage over employers that properly classify their workers as employees.”
The Department of Labor’s proposal also notes that misclassification results in a loss in overall unemployment insurance revenue due to underreporting of at least $200 million dollars annually, as well as unpaid revenues to the federal government of more than $2.7 billion dollars per year in unpaid Social Security, unemployment insurance, and income tax. The proposal notes that a study conducted for the Labor Department in 2000 found that 10 to 30 percent of businesses audited for state unemployment insurance had one or more of its employees misclassified as independent contractors, and that, since 2009, Wage and Hour investigators have collected over $29 million in back wages for over 29,000 employees who were not paid in compliance with federal law because they were misclassified as independent contractors.
Comments to the Labor Department’s proposed survey may be submitted by interested members of the public or by counsel on their behalf by March 12, 2013. Comments are being sought on whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; the validity of the methodology and assumptions used; and the quality, utility, and clarity of the information to be collected. The publishers of this blog post can assist those interested in registering their comments on the proposed study.
Analysis:
This proposed study is the latest in a series of crackdowns by the U.S. Department of Labor on IC misclassification. Other initiatives include:
- A “Right to Know” rule-making initiative included in the Department’s Regulatory Agenda in 2010 and re-issued on December 21, 2012 that would update the recordkeeping regulations under the federal Fair Labor Standards Act “in order to enhance the transparency and disclosure to workers of their status as the employer’s employee or some other status, such as an independent contractor.”
- A “Misclassification Initiative” to coordinate enforcement and information sharing with state workforce agencies. To date, 13 states have signed Memorandums of Understanding with the U.S. Department of Labor: California, Colorado, Connecticut, Hawaii, Illinois, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, Montana, Utah, and Washington. New York has reportedly agreed to enter into its own Memorandum of Understanding with the Wage Hour Division of the Labor Department.
- A joint undertaking with the Internal Revenue Service, pursuant to a Memorandum of Understanding with the IRS signed on September 19, 2011. The agencies have committed to coordinate their law enforcement efforts aimed at businesses that misclassify employees as ICs.
This new proposed study by the Labor Department appears to be most closely related to the proposed “Right to Know” rule that the Department has included on its Regulatory Agenda.
The Department’s focus on workers’ understanding of their classification as employees or independent contractors, to the virtual exclusion of employers’ misunderstanding of the confusing array of tests for independent contractor status under both federal and state laws, seems to be a profound misapplication of the budgeted funds for the survey. Even the Government Accountability Office has stated that “[t]he tests used to determine whether a worker is an independent contractor or an employee [at the federal level] are complex, subjective, and differ from law to law” (see GAO Report No. 06-656 at 25). The tests used by state regulatory agencies in enforcing state laws are even more diverse than the federal tests, leaving both businesses and employees equally confused.
Takeaway:
Most companies with business models that are IC-dependent or simply make use of multiple ICs are aware that they are at risk of IC misclassification liability if they have not properly classified these workers. Recognizing which tests will be applied to the workers in question by the most relevant federal agencies and the applicable state agencies is one of the first steps, using the 48 Factors-Plus™ analysis, in determining where a business falls on the IC Compliance Scale™.
Once a company’s level of compliance is so measured, it can then enhance its IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers, using IC Diagnostics™ as described in our “White Paper” on minimizing IC misclassification liability.
Richard Reibstein, Lisa Petkun, and Andrew Rudolph.
Filed under: IC Compliance | Tags: IC Diagnostics, Independent contractor misclassification, misclassification liability
Many due diligence reviews in mergers, acquisitions and investments have ignored the issue of independent contractor (IC) misclassification liability. This is a difficult exposure to identify unless the legal team digs below the information typically provided by the seller or available in public records. In view of the crackdown by federal and state governments on the misclassification of employees as ICs, an increase in state misclassification legislation, and a steady stream of class action lawsuits claiming that certain workers have been disguised as ICs, due diligence efforts should not overlook this often hidden exposure.
What should be examined during due diligence? And why?
IC agreements should be closely examined; they can often reveal a material IC misclassification exposure. It may also be prudent to request Form 1099s from a seller for at least the past 2-3 years. An abundance of Form 1009s may indicate there is the potential for substantial IC misclassification liability, especially where IC agreements, once examined, appear to have been drafted by lawyers insufficiently familiar with the nuanced legal distinctions between ICs and employees under applicable federal and state laws. Indeed, some IC agreements have been used by government regulators and plaintiffs’ lawyers as their “Exhibit A” to prove IC misclassification or to help obtain certification of a class action.
An absence of 1099s may not necessarily indicate that there is no IC misclassification liability. Some companies may not be issuing Form 1099s to single-member LLCs, as required by law, if a Form W-9 was not properly completed by the LLC member. Further, where independent contractors have been required to incorporate by the service recipient, no 1099s are likely to be issued; however, some administrative agencies and courts treat requirements imposed by the hiring party upon contractors to incorporate, or to become franchisees or owners of the business for which they are performing services, as illusory or a sham designed to circumvent tax and labor laws. Such business requirements imposed on contractors have also been treated by regulatory agencies and courts as an exercise of control over the worker that can be used to “pierce the IC veil.”
It is also prudent in an acquisition context to ask the seller to list all its IC relationships including those with LLCs, C or S corporations, and partnerships, and the amount paid to such entities over each of the past 2-3 years. Such information can better illuminate the extent of any IC misclassification.
How can you determine if a contemplated acquisition involves exposure to IC misclassification liability?
Due diligence in this area can start with the same IC Diagnostics™ tools used when companies examine their own IC misclassification exposure. This should include an assessment of the risk using the 48 Factors-Plus™ analysis and a designation of the risk using the IC Compliance Scale™. The number of ICs and the states in which the ICs work can also be critical inasmuch as a concentration of ICs in a particular state may require a re-determination of the risk assessment on the IC Compliance Scale.™ Moreover, some states have quirky IC statutes, while others may use the common law test in some legal contexts (such as wage laws) but not in other contexts (such as workers’ compensation laws). It is fair to say that some states are relatively hospitable to the use of ICs while a few are downright inhospitable – both by statute and enforcement practices of state workforce agencies. Familiarity with all of these state-specific nuances is indispensable to determining a company’s IC misclassification risk, especially if the ICs are located in multiple jurisdictions.
After the necessary documents have been requested and properly examined by the prospective purchaser, there may be a need for pinpoint follow-up inquiries and requests for further documentation to determine the degree of risk, extent, and potential cost of any IC misclassification. In an acquisition, the assessment of this exposure may prompt the negotiation of special indemnification provisions or representations and warranties protecting the purchaser.
Likewise, in the context of a contemplated investment by a hedge fund, private equity firm, or other institutional investor in a company determined to have significant exposure to IC misclassification liability, this type of due diligence may lead the investor to “pass” on the contemplated investment.
A post-closing use of due diligence
Any company that acquires another without having engaged in pre-closing IC misclassification due diligence should consider conducting its diligence post-closing, especially if it learns that there are a multitude of ICs being paid from the accounts payable ledger. While it is more advantageous to discover this risk in advance of entering into the transaction, discovery through post-closing diligence is far better than remaining in the dark.
Sometimes, pre-closing due diligence reveals only a part of the risk and the full extent of any IC misclassification cannot be fully determined until after the transaction has closed. This is where post-closing diligence can be most useful, inasmuch as the purchaser will then have full access to all pertinent information.
Where a significant risk of IC misclassification liability is revealed using IC Diagnostics™ during pre- or post-closing diligence, a purchaser has a valuable opportunity to take affirmative steps to minimize or eliminate misclassification liability on a prospective basis. As discussed in our White Paper, IC relationships can be restructured to enhance the level of IC compliance. Whether or not restructuring is needed, most IC agreements require considerable revisions and should be re-documented with state-of-the-art IC provisions. Other alternatives to minimize IC misclassification liability include reclassification (voluntarily or through a government program) or redistribution of ICs. Which alternatives are most suitable often depends on the risk assessment measured on the IC Compliance Scale™ and the particular needs of the service recipient.
As a matter of timing, these and other types of post-closing changes are not uncommon events for recently acquired businesses. They should be accomplished in a thoughtful manner with suitable communications to affected workers soon after new ownership takes over. These types of insightful adjustments to existing IC relationships can substantially diminish the likelihood that any past IC misclassification exposure will become an issue in the future.
Richard Reibstein, Lisa Petkun, and Andrew Rudolph.
Filed under: IC Compliance | Tags: Federal and State Agency Programs and Publications, Independent contractor misclassification
The IRS earlier this week temporarily expanded the Voluntary Classification Settlement Program (VCSP), which was the subject of a prior post, to permit taxpayers who do not meet all of the conditions for the original Program to reclassify independent contractors as employees for federal employment tax purposes. The expanded program (the “VCSP Temporary Eligibility Expansion”) is available through June 30, 2013.
Who is Eligible for the Expanded VCSP?
The VCSP Temporary Eligibility Expansion is available to taxpayers who meet all of the conditions to participate in the original VCSP, except that they have not previously filed all required Forms 1099 consistent with non-employee treatment for workers proposed for reclassification. The other eligibility conditions include the following:
(1) The taxpayer must have consistently treated the workers as non-employees.
(2) Neither the taxpayer nor any other member of its affiliated group is currently under employment tax audit by the IRS.
(3) If the taxpayer was previously audited by the IRS or the Department of Labor concerning the classification of workers proposed for reclassification, the taxpayer has complied with the results of that audit and is not currently contesting the classification in court.
What are the Initial Costs of Participation in the VCSP?
Whereas the settlement payment under the original VCSP is 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509 of the Internal Revenue Code, the settlement payment under the VCSP Temporary Eligibility Expansion will be 25% of that amount. In addition, the taxpayer must pay a reduced penalty for unfiled Forms 1099 for the previous three years. As under the original VCSP, the taxpayer is not liable for interest and penalties on the employment tax liability and will not be subject to an employment tax audit with respect to worker classification of the class or classes of reclassified workers for prior years.
How Does a Taxpayer Apply for the VCSP?
Taxpayers that wish to participate in the VCSP Temporary Eligibility Expansion must submit an application on or before June 30, 2013 using IRS Form 8952, with the phrase “VCSP Temporary Eligibility Expansion” inserted at the top of the Form. The original VCSP Program continues to be available for taxpayers who have timely filed Forms 1099 for workers it seeks to reclassify.
Is the VCSP a Good Alternative?
Business taxpayers who have not filed Forms 1099 for non-employee service providers may consider this reclassification opportunity as an alternative to other strategies to achieve compliance with federal tax laws governing employee classification, including bona fide restructuring of the relationship between service providers and service recipients, the use of a third party employee leasing or staffing company, and voluntary reclassification outside of any government program. Those alternatives can be analyzed using IC Diagnostics ™ and other proprietary compliance tools of Pepper Hamilton’s Independent Contractor Compliance practice. Taxpayers may also be eligible for a safe harbor from liability from employment taxes under section 530 of the Revenue Act of 1978. Additional background on these alternatives can be found in our white paper on minimizing IC misclassification liability.
We continue to hold a number of the same significant reservations about taxpayer participation in this VCSP Temporary Eligibility Expansion as we had about the original VCSP. The two leading concerns are as follows:
- Participation in the VCSP only addresses potential employment tax exposure and does not eliminate potential exposure to other enforcement actions relating to overtime, unemployment taxes, workers compensation, and state and local income taxes.
- There is a risk that participation in the VCSP will lead reclassified workers to believe that they may have been misclassified in the past, and they will then use their reclassification as a reason to assert claims before administrative agencies or in private litigation seeking overtime pay, unpaid employee expenses, and/or employee benefits that would have been available to them if they had been previously misclassified as independent contractors. It should be remembered that the seminal Microsoft case on the collateral consequences of reclassification, which settled for just under $100 million, commenced shortly after Microsoft resolved its employment tax liabilities with the IRS.
Consequently, when weighing the pros and cons of participating in the VCSP Temporary Eligibility Expansion program, business taxpayers should ask: Is it worth the price of admission? And are there better alternatives?
Your comments are welcome and can be sent to ICComplianceLegalBlog@gmail.com.
Andrew Rudolph
Lisa Petkun
Richard Reibstein
Filed under: IC Compliance | Tags: Federal IC Laws and Bills, independent contractor liability, Independent contractor misclassification
On December 12. 2012, Rep. Erik Paulsen (R. Minn.) introduced a bill that bears many similarities to a bill introduced earlier this year by 33 Democrats. The Independent Contractor Tax Fairness and Simplification Act (H.R. 6653) would, like the Fair Playing Field Act (H.R. 4123) introduced on March 1, 2012 by Democrats, eliminate prospectively the “safe harbor” that has been relied upon since 1978 by many businesses that may have misclassified employees as independent contractors (ICs).
Similarly, both bills would allow a business that has treated a worker as a IC to qualify for a form of retroactive safe harbor for purposes of past employment tax liability if the business has had a reasonable basis for not treating the worker as an employee and has consistently reported the earnings of the worker and others similarly situated on a 1099 basis.
Neither the Democrats’ earlier bill nor this new bill introduced by a Republican Congressman would, if enacted, eliminate the use of ICs; rather, the proposed “Findings” in both bills acknowledge the important role ICs play in the economy.
Key Differences
There are a number of key differences between the bills, however. The Fair Playing Field Act bill, if enacted, would require the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. On the other hand, this new bill, H.R. 6653, specifically prohibits the issuance of new regulations or Revenue Rulings by the Department of the Treasury with respect to the employment status of any individual for employment tax purposes.
While both bills expressly state that the term “employment status” shall mean the classification of an individual as an employee or IC “under the usual common law rules,” H.R. 6653 (unlike the Democrats’ bill) would codify a new form of “safe harbor” if the worker meets all four of the following factors:
- incurs significant financial responsibility for providing and maintaining equipment and facilities;
- incurs unreimbursed expenses or risks income fluctuations because remuneration is “directly related to sales or other output rather than solely to the number of hours actually worked or expenses incurred”;
- is compensated on such factors as percentage of revenue or scheduled rates and not solely on the basis of hours or time expended; and
- “substantially controls the means and manner of performing the services” in conformity with regulatory requirements, or “the specifications of the service recipient or payor and any additional requirements” in the parties’ written IC agreement.
Analysis
This bill puts forth a new safe harbor that appears to be limited to a defined segment of ICs who bill for services on the basis of scheduled rates, such as truckers and messenger couriers. Thus, the bill would exclude from this safe harbor many legitimate ICs that are traditionally compensated on an hourly rate, such as professionals (including sole practitioner lawyers, accountants, architects, designers, and interpreters) as well as sole proprietors in the skilled trades (including electricians and plumbers). It would also exclude legitimate ICs who have little or no expenses or equipment, such as freelance editors and writers. Other legitimate ICs would undoubtedly also be excluded under the four-factor test.
The bill also appears to have a misclassification escape clause that has not been recognized by the courts and administrative agencies as indicative of IC status. In the fourth factor, a service recipient may direct the service provider by inserting into the parties’ IC agreement its “specifications” or “any additional requirements” without creating an employment relationship. Generally, requirements imposed by the service recipient as to how the work is to be performed are taken into account in determining if the hiring party exercises control or direction over the means and manner by which the services are performed. Such direction and control is typically indicative of employee status. In contrast, specifications and requirements as to the end-product of the services, i.e., what the services the individual is being hired to perform, are not indicative of employee status inasmuch as all ICs must be told what they are being retained to do.
The scope of both bills are limited. Neither bill would have any impact on whether a worker is an IC or employee under the federal Fair Labor Standards Act (FLSA), which governs minimum wages and overtime. The determination of whether a worker is an IC or employee under that labor law is based on a variation of the common law standard frequently referred to as the “economic realities” test. Thus, a worker that may qualify for IC status under H.R. 6653 may not qualify for IC status under the FLSA.
State labor, unemployment, and workers compensation laws would not be affected by either bill. Some of those laws are not based on the common law but rather contain a different statutory scheme that have a list of factors that must be met in order to qualify for IC status.
Takeaway
Most companies with business models that are IC-dependent or simply make use of multiple ICs are aware that they are at risk of IC misclassification liability if they have not properly classified these workers. Businesses can enhance IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers, using IC Diagnostics™ as described in our “White Paper” on minimizing IC misclassification liability.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: IC Diagnostics, Independent contractor misclassification, misclassification liability
The last four years started out with expectations that the federal government would enact legislation to curtail misclassification of employees as independent contractors (ICs). Yet, not a single bill was enacted despite strong support by President Obama for Congressional action in the area of IC misclassification. Federal regulators, though, were undaunted by the legislative gridlock, as both the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) implemented initiatives seeking to address IC misclassification.
ANALYSIS
What will the legislative landscape look like over the next four years?
Legislative action is expected in the area of IC misclassification if, as most Americans hope, Congress begins to operate on a bipartisan basis to address matters affecting the nation’s tax revenues. Curtailing IC misclassification arose as a federal priority in large measure because it deprives the federal treasury of billions of dollars of tax revenues. An oft-quoted 2006 Report from the Government Accountability Office (GAO) estimates that this type of misclassification resulted in an estimated $2.62 billion tax loss annually. Yet, instead of focusing on the need to raise tax revenues and reduce our increasing “tax gap,” bills were introduced in Congress repeatedly that infused politics into IC misclassification. Because raising tax revenues is likely to be a priority for many in Congress, regardless of party affiliation, IC misclassification legislation will most likely become the subject of several bills in the coming year, but whether one or more of these bills becomes law depends on the level of cooperation that will be exhibited by Congressional leaders.
As readers of this blog will recall from past blog posts, Democrats introduced two bills in particular over the past four years that did not enjoy bipartisan support. The first was the Employee Misclassification Prevention Act (EMPA), first introduced in 2008, then re-introduced in 2010 and again in 2011. This bill did not directly address the tax gap; instead, it focused on the labor and employment aspects of IC misclassification. EMPA not only would have made IC misclassification a federal labor offense under the Fair Labor Standards Act (FLSA), but also it would have imposed an array of increased penalties on businesses that misclassified employees and subjected businesses to new notice and paperwork obligations, even those that did not even use ICs. Thus, this bill was destined for defeat in Congress, as it was the antithesis of a bipartisan legislative endeavor. Indeed, EMPA was regarded by U.S. businesses and Republicans in Congress as akin to “throwing the baby out with the bathwater.”
What would a bipartisan labor bill do – and not do?
It would retain IC misclassification as a federal labor offense but would eliminate any additional notice and paperwork provisions, which typically create partisan disputes, and do away with the treble damages provision in the 2010 and 2011 EMPA bills. Currently, the FLSA imposes liquidated damages that would double any lost wages resulting from a “willful” violation of that law. A bipartisan bill would likewise limit damages to double (not treble) any actual losses for “willful” misclassifications. Because the test for determining whether workers are independent contractors or employees is so ill-defined, varies from law to law, and is often confusing to both employers and workers, a bipartisan EMPA bill would more likely be enacted if it would limit violations to willful misclassification of employees as ICs. This is precisely the legislative compromise that was enacted in California when that state’s legislature passed the Independent Contractor Willful Misclassification Law, where violations are limited to “avoiding employee status for an individual by voluntarily and knowingly misclassifying [an] individual as an independent contractor.”
What would a bipartisan tax bill do – and not do?
The other bill that was introduced in Congress during the President’s first term was the “Fair Playing Field Act.” That bill, first introduced in 2010 and then again in 2012, would have addressed a portion of the tax gap by prospectively eliminating so-called “safe harbor” in the federal tax laws relied upon by some businesses that for years may have consistently misclassified employees as independent contractors. It would also have required the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. Although this bill did not contain provisions that, on their face, would likely have been objectionable to Congressional Republicans, it was merely referred as a matter of course to the House Ways and Means Committee and was thereafter ignored – perhaps because of the bill’s title and the fact 2012 was an election year and misclassification of ICs had already been turned into a political issue.
A bill repealing the safe harbor provision in the federal employment tax laws would more likely be regarded as bipartisan if the bill did not bear a name that was not as politically charged as the “Fair Playing Field Act” and if a member of the current Cabinet was not issuing regulations or prospective guidance on the status of individuals for employment tax purposes. The legislation could simply utilize the definitions of “employee” and “independent contractor” in court cases and Revenue Rulings that are based on the common law definition of those terms. While there may be less certainty about who is and who is not an independent contractor, there are few positions whose status should automatically be treated as either “employee” or “independent contractor.” Court decisions and administrative rulings make it clear that the determination of independent contractor vs. employee status is very fact dependent and may vary from one instance to another where the facts are different – even when the titles or positions are alike or similar. Indeed, many individuals treated as ICs but who have been re-characterized by the courts and the IRS as employees can legitimately be re-classified as ICs if one or more key indicia of direction and control had been adjusted by the parties in the past or if such adjustments are made going forward.
What regulatory initiatives are we likely to see in the next four years?
As reported in earlier blog posts, the President has included funds in his most recent budget for the DOL to “detect and deter” companies from misclassifying employees as independent contractors. President Obama committed $14 million in 2013 for misclassification prevention, including $10 million for grants to States to identify misclassification and recover unpaid taxes, and $4 million for personnel at the Labor Department to investigate misclassification.
The DOL has engaged in a variety of enforcement efforts, which we can expect to continue in the next four years.
- First, the DOL has begun to share information with the IRS about suspected misclassification
- Second, the DOL has entered into information sharing agreements and coordinated enforcement agreements with state workplace agencies in 13 states.
- Third, the DOL has sought to focus its enforcement activities in industries where misclassification is regarded as prevalent.
- Fourth, the DOL announced in 2010 that it would propose new “Right to Know” rules updating the recordkeeping regulations of the FLSA to presumably protect workers’ entitlement to wages that they have earned and bring greater transparency and openness to the workplace. The proposed rule would require employers to conduct classification analyses of their workers and notify workers of their status (either as an employee or independent contractor) and whether that person is entitled to the protections of the FLSA. To date, these proposed regulations have yet to be issued.
We fully expect that the first three initiatives will continue with renewed vigor in the next four years and that more states will sign agreements with the DOL to share information about suspected IC misclassification. This will enable states to piggyback on the federal initiatives and the DOL to re-double state enforcement actions.
The IRS has also been active in regulatory enforcement matters in the past few years. In September 2011 the IRS instituted a voluntary classification settlement program in the form of reduced payments for those businesses that are willing to acknowledge they have misclassified employees as ICs, and it also signed an agreement with the DOL to coordinate federal enforcement actions against companies that are believed to have misclassified employees as ICs.
Takeaways:
Federal regulatory action to curtail IC misclassification is likely to increase substantially in the next four years. The President has made misclassification of ICs a priority each time he has announced a budget, and the opportunity to turn this issue into a bipartisan initiative to address the tax gap is likely to be viewed by the Administration as one way to reduce the deficit. IC misclassification has been and will also remain a principal focus of the IRS Commissioner and the Secretary of Labor. The DOL is expected to finally seek to implement its “Right to Know” misclassification rules through proposed regulations, which have been the subject of over two years of work to date. It is reasonable to assume that they will be issued in 2013.
These types of federal initiatives will likely increase public awareness of this issue, thereby causing more workers to question if they have been misclassified and are owed moneys – whether as a result of overtime hours worked, employee benefits they have not been offered, and/or lack of coverage for unemployment and workers compensation. Such workers may seek relief through the DOL, or through class action lawyers, or by simply filing a Form SS-8 with the IRS. That form, entitled “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” may only take a worker under an hour to complete but can affect not only the specific worker but all other similarly situated workers classified as ICs by a business – if the classification is subject to scrutiny.
While this blog post is limited to federal misclassification initiatives, many states have cracked down on IC misclassification, and more are expected to join in if they have yet to do so or if they wish to stiffen their laws against misclassifying employees as ICs. In 2012, eight states passed substantive legislation to curtail misclassification – both states that had already enacted legislation to curtail IC misclassification and states that had not previously enacted legislation in this area. Now, close to half of all states have enacted IC misclassification laws since 2008.
Best practices:
Businesses that rely on ICs as one of their key sources of manpower or to supplement their existing workforce can take steps to minimize exposure to misclassification liability by ensuring that their relationships with such workers are properly structured, documented, and implemented.
Those companies that have yet to be targeted by federal or state regulators or class action lawyers may wish to consider a form of IC Diagnostics™ to avoid or minimize such exposure. This starts with an analysis of all applicable federal and state IC tests and an examination of each of the dozens of factors found by the courts and administrative agencies to be relevant to a determination of IC status. Some businesses may need little if any restructuring to their IC relationships, while others can benefit from more substantial changes to enhance the likelihood of a successful defense to any challenge to their use of ICs.
Documentation of the IC relationship can be critical under most laws governing the status of workers – and many IC agreements either have not been updated or were never drafted in a manner that minimizes IC misclassification liability. Thus, re-documentation of the IC agreement, including use of state-of-the-art provisions keyed to the relevant legal tests for IC status, is typically an essential aspect of IC Diagnostics™.
Some companies risk exposure to IC misclassification liability simply because their use of manuals, guidelines, policies, or procedures are either drafted in a manner inconsistent with the structural framework of the IC relationship or were drafted in a noncompliant manner with applicable IC laws. These are documents that are oftentimes ignored, but not by the regulators or class action lawyers.
Your comments are invited.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
Filed under: IC Compliance | Tags: IC Diagnostics, Independent contractor misclassification, misclassification liability, Underground Workforce
The lead story in today’s front page of the Texas Tribune reports on a hearing before the Texas Workforce Commission where the testimony focused on the intersection of undocumented aliens and independent contractor misclassification. The hearing was held in advance of the Workforce Commission’s preparation for its upcoming legislative agenda. Texas is no different than many states that are cracking down on misclassification of employees as independent contractors (ICs). But unlike most articles on the subject of IC misclassification, this article discussed the testimony of those who complain about the underground hiring of workers who are not paid on a W-2 or Form 1099 basis but rather under the table, either to undocumented aliens or to those willing to be paid in cash.
Some of those that support legislative bills designed to curtail IC misclassification frequently advance the argument that proposed new laws are needed to eradicate this “underground workforce.” While some regulators and employee rights organizations refer to cash payments as a form of IC misclassification, it is not really misclassification at all but rather a form of illicit conduct. IC misclassification, on the other hand, results when companies classify workers as ICs and report compensation on a Form 1099 for one or more workers that may be “employees” under state or federal law. These businesses do not withhold taxes from such workers’ pay, or make any contributions for Social Security and Medicare, or cover the workers for Unemployment and Workers Compensation, or pay any required overtime – none of which is required unless the company has failed to properly classify such workers as employees.
What should companies do that are using underground labor and not reporting that compensation? And what should businesses do that are reporting compensation on a 1099 basis for workers they have classified as ICs?
For companies that are involved in the “underground workforce,” it’s rather simple. They would be wise to cease using undocumented aliens and terminate all cash payments including to workers who are authorized to work in the U.S. If they continue to employ workers with proper work authorization, they should classify them as “employees” and pay them on a W-2 basis. Alternatively, they can outsource them to a staffing company that will employ them, withhold state and federal income taxes, and accord them the protections of state and federal labor and employment laws. Those companies should also consider taking any necessary corrective steps with state and federal tax and workforce authorities.
In contrast, companies that use 1099ers but wish to avoid being swept up in the IC misclassification crackdown can often retain their 1099ers, provided their IC relationships are properly structured, documented, and implemented. Many states have laws that require a showing that individuals classified as ICs must be “free from control or direction in the performance of the service, both under contract and in fact.” Even in the absence of such state laws, many state workforce agencies and tax commissions are actively seeking to detect companies that are paying workers on a 1099 basis but improperly exercising direction and control over the manner or means by which the workers perform their services. Government regulators are even targeting companies that have properly structured their IC relationships but have simply failed to document those relationships in their IC agreements in a manner consistent with IC laws.
For those companies paying workers on a 1099 basis who are concerned that they may be misclassifying employees as ICs, their level of IC compliance can be considerably enhanced by (a) determining where they fall on the IC Compliance Scale™ in light of applicable state and federal IC laws, and (b) where necessary, restructuring, re-documenting, and/or re-implementing their IC relationships consistent with those laws. Some companies that wish to minimize their IC misclassification liability have done so using tools such as IC Diagnostics™, as described in a White Paper also published on this site.
Regulators such as those in the Texas Workforce Commission and agencies in other states are increasingly equating businesses involved in the “underground workforce” with those that may be doing nothing more than failing to dot their i’s and cross their t’s in their IC agreements with workers providing services though legitimate IC relationships. Businesses using 1099ers that wish to stay ahead of the IC misclassification curve should examine their exposure to this form of liability and take steps promptly to enhance their IC compliance in those states that permit IC relationships.
Your comments are invited.
Richard Reibstein
Lisa Petkun
Andrew Rudolph
