Fair Playing Field Act of 2010: The End of ‘Safe Harbor’ for Businesses Misclassifying Employees as Independent Contractors

In the past three years, 16 states have passed legislation seeking to curtail the misuse of the independent contractor classification. Yet, despite congressional studies finding that misclassification contributes to the federal and state tax gaps and deprives misclassified employees of workplace protections, Congress has not made independent contractor legislation a national priority until this year.

Now, the second of two bills has been introduced in Congress this year that will not only discourage businesses from continuing to issue Form 1099s to workers who are not legitimate independent contractors, but also will impose obligations on businesses to inform individuals they treat as independent contractors how to challenge their classification.

While the other shoe may be about to drop on companies that may be misclassifying employees as independent contractors, Congress has tempered this latter bill by including a limited form of amnesty for businesses that have had a reasonable basis for past misclassifications.

Neither of the two federal bills, if enacted, would legislate an end to the use of independent contractors; rather, businesses may continue to use independent contractors if they satisfy the legal tests for independent contractors under federal and state laws. As set forth in a forthcoming blog post on this site, businesses can avail themselves of timely alternatives to the costly and often unacceptable alternative of reclassifying independent contractors as employees.

The Fair Playing Field Act of 2010

The latest bill, The Fair Playing Field Act of 2010, was introduced on September 15, 2010, in both the Senate (as S. 3786) and House (as H.R. 6128). The bill would close what the sponsors of the legislation, Sen. John Kerry (D-Mass.) and Rep. Jim McDermott (D-Wash.), refer to as a “tax loophole allowing businesses to misclassify workers as independent contractors.” According to Sen. Kerry, a “safe harbor” in the tax laws that has existed since 1978 “creates an unfair environment for businesses that play by the rules and an unfair environment for workers.”

The White House immediately endorsed the Fair Playing Field Act, just as quickly as it endorsed the Employee Misclassification Prevention Act, which was introduced in both houses of Congress this past April.

The so-called loophole that the Fair Playing Field Act seeks to close is Section 530 of the Revenue Act of 1978. 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.

This safe harbor was reportedly used most recently by FedEx in escaping a $319 million back tax assessment by the IRS related to FedEx’s classification of its Ground Division drivers as independent contractors. Although the IRS concluded that such drivers were common law employees, it withdrew its assessment based on the protection afforded FedEx under Section 530.

In its findings, the bill recognizes that “many workers are properly classified as independent contractors,” but “in other instances, workers who are employees are being treated as independent contractors.” After noting that Section 530 was intended to be an “interim measure,” the findings state that this safe harbor had become permanent. Therefore, “in the interest of fairness and in view of many service recipients’ reliance on current section 530,” the Fair Playing Field Act would direct the Secretary of the Treasury to issue guidance to workers and businesses on a prospective basis only.

Going forward, the Fair Playing Field Act would eliminate the continued use of the Section 530 safe harbor. It would also require the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. In addition, the act would 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.”

The bill sets forth “one method of satisfying the [reasonable basis] requirement” – if the business acted in reasonable reliance upon (A) judicial precedent, published rulings, technical advice, or a letter ruling issued to the business; (B) a past IRS audit of the business in which there was no assessment attributable to individuals holding positions that were substantially similar to the worker in question; or (C) a long-standing recognized practice of a significant segment of the industry in which such individual was engaged. The Fair Playing Field Act defines a “significant segment of the industry” as no more than 25 percent of the industry, and clarifies the term “long-standing recognized practice” as not requiring the business to show that the practice continued for more than ten years.

The act would also:

  • eliminate the reduced penalty provisions of the Tax Code for failure to withhold income taxes and the employee’s share of FICA taxes in cases in which the business did not have a reasonable basis for treating a worker as an independent contractor;
  • require businesses who use an 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,;and
  • exclude certain skilled workers (engineers, designers, drafters, computer programmers, systems analysts, and the like), who were not eligible for the safe-harbor protection of Section 530, from the prohibition on retroactive tax assessments.

The safe-harbor provisions of Section 530 and the Fair Playing Field Act only apply to the classification of workers as independent contractors under the federal employment tax laws. The bill has no application to state tax laws or federal and state workplace laws, which would be unaffected by passage of the Fair Playing Field Act.

The Employee Misclassification Prevention Act (EMPA)

As discussed in a prior article by the publisher of this blog, Congress has also introduced labor legislation dealing with misclassification of employees as independent contractors. The EMPA bill was introduced on April 22, 2010 by the Senate (as S. 3254) and House (as H.R. 5107). 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. Once enacted, businesses can anticipate that they will be confronted with an onslaught of private actions by workers claiming they are misclassified “employees.” A more detailed analysis of EMPA can be found in the EMPA article by the publisher of this blog post.

The Senate Committee on Health, Education, Labor and Pensions (HELP) wasted little time in holding a hearing on EMPA. On June 17, 2010, HELP, headed by its Chairman Tom Harkin (D-IA) and Ranking Member Michael B. Enzi (R-WY), led a hearing by the full committee during which a high-ranking member of the Obama administration and three other panelists spoke in favor of EMPA, and one panelist spoke in opposition to the bill.

Although no further hearings are yet scheduled for the labor bill, Congress appears likely to pass both EMPA and the Fair Playing Field Act this year – unless the upcoming mid-term election changes the composition of one or more houses of Congress.

 

Written by Richard Reibstein.

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