Independent Contractor Compliance Blog

Last September, the Internal Revenue Service (IRS) announced a new program for employers to voluntarily reclassify and report workers, previously considered independent contractors (IC), as employees. Under the program, eligible employers can obtain partial relief from federal payroll taxes they theoretically owe for past misclassifications, if they prospectively treat these workers as employees.

To be eligible, an employer must:

• Have consistently treated the workers in the past as non-employees
• Have filed all required Form 1099s for the workers for the past three years
• Not be under audit by the IRS, the U.S. Department of Labor, or a state agency concerning the classification of these workers

Interested employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program (VCSP), at least 60 days before they want to begin treating the workers as employees.

The IRS announcement offered a bitter-sweet carrot while brandishing the threat of an audit stick to encourage businesses to participate. The press release states: “This new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.”

How much must you pay under this program?

The IRS states that employers accepted into the program will pay an amount effectively equaling just over one percent of the wages paid to the reclassified workers for the past year. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years.

The downside would be a longer exposure to a possible audit. To be accepted, the employer is required to sign a waiver of statute of limitations for six years (normally only three years), which allows the IRS more time to audit for other workers not covered by the agreement.

Other Federal or State agencies are not bound by this agreement. Once you treat an individual as an employee for the IRS, employee programs required by other state and federal laws will kick in, such as overtime, health benefits, retirement programs, etc.  These other agencies will also expect you to treat these workers as employees.

These agencies are not barred from auditing, making assessments, or charging penalties and interest because of the agreement.  For example, state unemployment agencies are likely to identify and target these businesses for audits when the federal Form 940 is reconciled with state reporting (a standard process each year). Also, once you begin to report these workers as employees there is no going back.

If you have been properly qualifying and documenting your ICs and contingent workers, there is no need to participate in this plan. Even if you are considering participation, it is unlikely that all your ICs are misclassified. I recommend a risk assessment before taking any action. Finally, you should consider reclassifying your workers without the IRS’ assistance.

To make the right call, you need an expert to review and qualify your non-employee workers and make recommendations as to who should be converted and who should not.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

I recently read an article that cited a survey of more than 1,400 CFOs from U.S. companies that have twenty or more employees on staff. These CFOs were asked: “What common mistake do companies make most in managing their employees?”

Here are the three top responses:

• Lack of communication between staff and management

• Lack of recognition and praise

• Lack of training, development, and/or educational opportunities

The article went on to give advice on how to better communicate with, provide recognition to and train staff.  As good as this advice may be for managing your employees, from an independent contractor (IC) compliance point of view, doing this with your ICs puts you at risk of converting them into misclassified workers. Here’s why:

• Communication: Insuring your ICs are in the “company’s communication loop” for such things as staying abreast of organizational information, changes in company policies, updates on the company’s financial performance, and new initiatives not related to their project or about other group projects not related to theirs tends to draw them deeper into your company family and into your control. This information is usually distributed in company-wide internal e-mails or during staff meetings. Treating contractors the same as your employees tends to make them look and feel more like your employees. This opens the path to misclassification.

Asking employee-staff: “Do you have the right resources to perform your work effectively?” is another good practice, especially if you then try to provide it.  ICs, however, are ideally supposed to provide their own resources to accomplish the job. Providing ICs with resources (tools, supplies, equipment and workspace) tends to make them look like an employee.

• Lack of recognition and praise:  The article recommended you take time to praise workers who go above and beyond, call attention to their successes and contributions during staff meetings or via company-wide e-mails, and be sure to copy relevant managers. Doing this for employees is an excellent method of motivating your best workers. However, doing this for you ICs is the path to misclassification. ICs need to receive timely payment for a completed job and possibly receive a good recommendation for their next potential client when the job is successfully completed. These should be praise enough for a true independent contractor.

•  Training:  The lack of training, development, and/or educational opportunities will definitely create an unhappy employee. It doesn’t take much management experience to know providing these opportunities for your staff will improve morale and increase productivity. However, providing these opportunities to your ICs is a major step towards misclassification.

The courts have viewed training as a method of instructing the worker how to perform the details of the work, which is viewed as evidence of the right of direction and control — the primary deciding factor in common law employment determinations.

The underlying tenet here is that employees and ICs are mutually exclusive sets.  Almost without exception, you cannot have them doing similar work under the same environment and consider them to be different under common law. You just cannot treat your ICs the same way you treat your employees. It makes them look like your employees and usually ensures creating misclassified workers.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.  

You may ask: Why would I want to change an independent contractor (IC) into an employee?  Over the years, I’ve encountered numerous companies that engage the perfect independent contractor and slowly, inadvertently convert him/her into a misclassified employee.

Here are some “best practices” of these misguided companies.  You may use them to either follow their lead or, better yet, to avoid their mistakes.

“Best Practices” to convert a bona-fide independent contractor into a misclassified employee:

1. Have a project description with goals and deliverables that are vague, confusing or non-existent, so it is not clear what the successfully completed project looks like, or when it will end.

2. Keep the IC, originally engaged for a three-month project, working indefinitely.  You can draw up a “new contract every six months,” making changes in the project description and deliverables, to give the appearance that a new project or new relationship has been created.

3. Encourage the consultant to drop all other clients and work exclusively for you.  This will insure the consultant becomes financially dependent on you.

4. Insist the consultant works full-time for you.

5. Watch over the consultant’s shoulder, as often as you wish, and provide detailed instructions about what tasks to perform next and how they should be performed. (The goal here is to control the consultant’s activities and time, not the end results).

6. Require the consultant to perform other duties occasionally, especially tasks that are not directly related to the original project.

7. Require regular activity reports to account for the time spent working for you.

8. Provide the consultant with supplies, equipment and workspace.

9. Require that the consultant performs the work at your business location, even if it could logically be done elsewhere. 10. Insist the consultant attend your routine employee staff meetings and other company functions, especially if they are not related to the project.

I’ve probably missed a few things you could do, but it doesn’t matter, since no single item on its own is sufficient to make the difference.  Also you don’t need to do all of these things, but of course the more of them you practice the more likely you are to convert your IC into a misclassified employee.

The reason this list applies is because it does not matter if you sign a contract and call the consultant an IC as much as how you treat the consultant on the job and the nature of the project’s day-to-day working environment.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

Last week, we addressed how Collabrus helps clients determine the proper classification for projects and consultants. If you recall, when our example CPA had four corporate clients, plus several friends and family clients for year-end income tax service, she was considered an independent contractor (IC). However, when she converted to a single, full-time corporate client, even though she still provided year-end tax services for friends and family, she became an employee of the single corporate client.

Why did she become the employee of the corporate client?

Although there were other factors that helped tip the decision, the primary factor was she gave up her financial independence when she began working full-time for a single client.  The year-end tax services she performed for her friends and family are probably not sufficient to keep her IC status year-round.

Would the services for friends and family still be considered IC?

Yes, most likely she was an IC for her extracurricular work during tax season and an employee for the full-time corporate client.  That is, if we assume:

• She performs the extracurricular work on her own time

• Her friends and family pay her directly

• Her full-time employer has no part of the extracurricular transaction

Could the single client company be the employer even for the friends and family clients at the end of the tax year?

Let’s pretend our CPA works full-time for a CPA firm as an employee.  Her duties are to manage and complete income taxes of the firm’s clients.  She does friends and family taxes each year on her own time; however, she uses the CPA firm’s billing system to bill her friends and family.  The friends and family pay the CPA firm for the service, which in turn, pays her (know, I wouldn’t do it that way either, but we’re just pretending).

This completely changes the picture.  She no longer has financial control over her extracurricular work and since the employer is an accounting firm, the work is integral to the business.  Therefore, the payments she receives for doing it will most likely be considered employee wages paid by the CPA firm. The slope is slippery. Many times, one or two facts can change the outcome.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

At Collabrus, we review working relationships and help clients determine the proper classification for projects and consultants:  independent contractor (IC) or employee?  If the consultants are ICs, we file the necessary reporting forms.  If they are employees, we can put them on our temporary employee payroll and provide a full-range of benefits and protections.  We also maintain a compliance file for later use if the qualification is ever challenged.

Of course, you may choose to complete these tasks on your own, but you’ll need to ask yourself whether you can do it more accurately or cost-effectively than a company that is geared to do it as their area of expertise. Also, think about whether you will make the right call and then be able to prove you were right, if challenged later.

Pop quiz: can you make the correct call?

A consultant performs services as a certified public accountant (CPA).  She normally does quarterly reconciliations, year-end accounting close-outs and income tax returns for her clients. Briefly,

• Her standard fee for all clients is $125/hour
• She does the work at the client’s location, working when they are open for business
• She uses the client’s computers and equipment
• She is paid expenses if she incurs them
• She has a B.S. in Accounting, is a CPA, and is an enrolled agent with the IRS
• She determines the method, details of her work, and the format of her final report based on her professional judgment, standards of the State Board of Accountancy, IRS requirements, and requirements by other regulatory agencies
• She currently has four corporate clients and prepares personal income tax returns for several individuals during tax season each year
• She has no employees of her own. She performs all the work personally
• She carries her own Errors & Omissions/Liability Insurance
• She has not formed a corporation, operating as an individual
• She markets her services to gain new clients by word-of-mouth and a professionally constructed website

Although you may have picked out factors that point both ways, it is a pretty safe call that she has established her own business and can safely be treated as an IC.

OK, that was an easy call.  How about if we change a few facts? Let’s see how the picture could change.  Let’s assume everything above stays the same except the following:

Simply making these changes is probably enough to change her status from IC to employee.  The slope is that steep – and that slippery!

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

It’s time to file taxes, and there are special advantages and special requirements if you’re an independent contractor (IC).  An IC is a small business by definition, and as a small business enjoys tax breaks in the form of deductions for expenses employees do not.

Deducting business expenses before you pay taxes ICs are entitled to most of the same deductions larger businesses take for necessary business expenses.  These expenses are deducted up front from your revenue (gross income) to reduce your taxable income. A few examples are:

• Business travel (not reimbursed by your clients)
• Cost of equipment
• Cost of supplies
• Cost of rent for office space
• Advertising and marketing
• Some types of entertainment for clients or prospective clients to gain new business
• If you have employees their wages are expensed against your income
• The costs of fringe benefits for your employees such as health insurance
• The taxes you pay on your employee’s wages such as:
• The employer’s share of FICA and Medicare taxes
• Federal and state unemployment taxes

Most ICs carry their own liability insurance to protect themselves and their clients against errors.  The cost of this insurance is also a tax deduction.

Did you lose money after paying these expenses? Although not a bright prospect, a bona fide business is subject to the risk of loss.  It is possible for an IC to actually lose money.  If so, these losses can be deducted against your income to reduce or eliminate any taxes due.  If the losses exceed income for the year, some of the year’s losses may be carried over to the next year.

An IC also has some added responsibilities As a self-employed individual you are required to file and pay quarterly estimated tax deposits.  This is an area that some small businesses, both sole proprietorships and corporations, fail to do — at least initially.  Failure to pay quarterly estimated taxes can result in costly penalties and expose you to some hard collection procedures by the IRS.

Most people consider quarterly estimated tax deposits a complicated area because they are not familiar with the requirements.  The estimated deposits may include:

• Your estimated income taxes and self employment taxes (Social Security and Medicare)
• If you had employees it also includes the employee’s share of FICA, Medicare and personal income taxes withheld
• If you are operating with employees in California, there is employee withholding of State Disability Insurance

As an employer you also pay an employer’s share of Social Security, Medicare and unemployment insurance taxes There’s more… The list of advantages and responsibilities of having your own business is much more than what is covered here.  Being an employee is relatively simple.  Show up, do the job, and get paid.  An IC, on the other hand, must be aware of and follow many other legal requirements.  You may need an expert to help you meet these requirements.  Many leave meeting these requirements to a CPA, whose cost of service is also a tax deduction.

Good luck with your taxes this year!

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as either tax or legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

California’s seasonally adjusted unemployment rate was 10.9% in February 2012, unchanged from the rate in January.  The national unemployment rate for February was 8.3%, unchanged from January.

The California Employment Development Department (EDD) reported the following industries added jobs in February:

• Information (9,300)
• Manufacturing (6,200)
• Educational and health services (6,100)
• Professional and business services (2,800)

What does this have to do with IC compliance?
Each time the unemployment rate increases so does the funding level for tax enforcement agencies like EDD.  So when private companies are letting people go the government is hiring more people.  That’s because government agencies, like EDD, are funded in part by the number of people who file unemployment insurance claims.  The more claims filed the more funding.  On the other hand, once the government hires a permanent employee they almost never let them go.

Also, more claims put a larger number of businesses on the EDD Audit Radar.  That’s because whenever someone who was not reported as an employee files a claim for unemployment insurance (UI) benefits there is an investigation.

In addition, when the EDD is choosing industries to focus their audits on, they are likely to look closely at those who have the more dynamic worker environments — those who are both terminating and engaging workers (either as employees or ICs).

EDD is seemingly biased to finding misclassified workers.
People who file a UI claim are more commonly held to be employees.  Why? So they may receive benefits.  In my experience, whenever an EDD auditor encounters someone classified as an IC who files a UI claim, he will make an extra effort to determine misclassification.  Generally speaking, the EDD believes “where there’s smoke there’s fire.”

If EDD decides your former consultant or other IC was not properly classified the next action is typically to set the company up for an employment tax audit.  EDD’s theory is, “where there’s one there are many,” and EDD wants them all covered as employees.  Once an audit is arranged, usually every IC in your company will be looked at for the past three years.

Then the IRS steps in…
Since the IRS and EDD have a written agreement to share the results of these audits, the IRS will most likely be knocking on the door within a few months.  The combined liability can be an additional 52% or more of the original gross payments made to your ICs.

If California’s Department of Industrial Relations (DIR) joins in the stakes can go even higher.  The EDD also shares information with California’s DIR, which has a new penalty: they can levy of $5,000 to $25,000 per misclassified worker.

Lesson?  The time to fix misclassifications is before the claim is filed; it’s too late and too expensive once the EDD, or another enforcement agency, knocks on your door.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

There are two identical bills pending in New York’s Senate and Assembly (S4129-2011 and A6698-2011).  The legislation would grant independent contractors the same rights and remedies for payments on earnings an employee receives for wages.  The proposed law would grant New York’s Labor Commissioner the authority to: • Investigate complaints by ICs • Make claims for compensation on behalf of ICs • Assess damages, civil penalties and criminal penalties on behalf of ICs • Award and collect attorney fees • Charge and collect interest on any amounts due from this action At this time, the unions in New York do not appear to be resisting the bill, indicating a higher likelihood of passage.

Severe criminal charges possible
The legislation provides that, “…Officers and agents of any client who knowingly permit the client to violate this [law]… by failing to pay compensation of any of its independent contractors…shall be guilty of a misdemeanor for the first offense and upon conviction…shall be fined not less than five hundred nor more than twenty thousand dollars or imprisoned for not more than one year…”

Upon a second violation the bill provides, “… [Officers and agents of any client who knowingly permit the client to violate this bill] shall be guilty of a felony…fined not less than five hundred nor more than twenty thousand dollars or imprisoned for not more than one year plus one day…or both”  which means they can be both fined and imprisoned.

These fines and prison sentences are for each violation.

Other provisions
The protections extend to both expenses and compensation for time worked.  The bill places the burden of proof on the client — not the contractor — to prove if the money is owed or not. The bill would require that the IC be paid “…not later than the last day of the month following the month in which the compensation is earned…”

The law would apply to any IC who is owed $600 or more, the same as the requirement to file a Form 1099 for ICs.  Also, the law would require all jobs costing $600 or more be covered in a written contract — verbal contracts would be illegal under this law.

Six year statute of limitations
The bill requires the written contract must be maintained on file, available for inspection by the Labor Commissioner, for at least six years.  The bill also allows ICs a six year statute of limitations for filing complaints and collecting money owed.

Why this bill?
The stated purpose of the bill is to give New York’s Labor Commissioner the same remedies he currently has to enforce employee pay laws, so he may insure an IC is properly paid for work.  This proposed law would also make collecting payment much simpler for ICs.  Currently, if an IC believes s/he was not properly paid for a project the recourse is to sue the client in civil court.  Under this proposed law the IC only needs to make a claim with the Labor Commissioner.

The law would go into effect immediately when passed.  If this bill becomes law in New York, you can expect to see “me, too” bills in other states.  California comes to mind as a likely “me, too” state, since both states have similar employee and IC enforcement laws.

Also, if this law is successfully implemented, it is not difficult to imagine other laws, involving IC working conditions, minimum earnings guaranteed per hour, workers comp insurance coverage for ICs, and mandatory withholding for state income taxes.

We’ll certainly monitor the progress of this legislation!

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

The IRS recently announced the extension of the 2011 reduced payroll tax rate.  The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extends the two percent reduction of Social Security tax withholding on employees’ wages.  The rate is temporarily reduced from 6.2 percent to 4.2 percent through Feb. 29, 2012.  The IRS announcement states, “This reduced Social Security withholding will have no effect on employees’ future Social Security benefits.”

There is an offsetting income tax withholding increase for higher income workers.
The law also includes a “recapture provision;” a two percent increase for income tax withholding on wages in excess of $18,350 (up to $110,100) to offset the tax break they receive in Social Security during the two-month period.  This “recapture tax” is an additional income tax liability not eligible for reduction by credits or other deductions.  The “recapture tax” will be added to the employee’s income tax for 2012.

For some workers the break may be extended for the whole year.
There is a possibility that Congress will extend the payroll tax reduction for the entire year; however, workers who earn more than $110,100 (the 2012 Social Security taxable wage limit) will still be subject to the “recapture tax” provision under the version currently being considered.  The IRS states that it plans to issue additional guidance, including revised employment tax forms, instructions and information on the “recapture provision.”

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.

In 2012 both state and federal governments are turning up the pressure on employers that misclassify workers.  Governments need money and view the additional taxes, penalties and interest for violators as a way to get it.

At the Federal level

Obama’s 2012 budget provides for increased worker misclassification enforcement. These paragraphs were taken directly from President Obama’s budget website:

Under the Department of Labor section:
“Detect and Deter the Misclassification of Workers as Independent Contractors. When employees are misclassified as independent contractors, they are deprived of benefits and protections to which they are legally entitled, such as overtime and unemployment benefits. Misclassification also costs taxpayers money in lost funds for the Treasury and in the Social Security, Medicare, and Unemployment Insurance Trust Funds. The Budget includes $46 million to combat misclassification, including $25 million for grants to States to identify misclassification and recover unpaid taxes and $15 million for personnel at the Wage and Hour Division to investigate misclassification.”

Under the Department of Treasury section:
“…The Administration also proposes more than $240 million for a targeted set of new, revenue-generating tax enforcement initiatives aimed at closing the tax gap—the difference between taxes owed and taxes paid. When fully in place by 2014, these new efforts are expected to yield about $1.3 billion a year in additional tax revenue.”

In California

Almost every state is struggling to collect more revenue, but California is especially strapped and has begun implementing some of the most aggressive actions in the nation.

In October 2011, Governor Brown signed Senate Bill 459 into law that makes the “Willful Misclassification” of employees as independent contractors illegal.  The law gives California’s Labor Workforce Development Agency authority to assess very high civil penalties and take severe actions against a person or employer violating this new law.

Specifically;

• This law allows California’s Labor Commissioner, or a court, to levy a civil penalty of $5,000 to $15,000 for each violation found to be “willful” (a single misclassified individual is one violation).
• If the agency, or a court, determines there is a pattern and practice of these “willful misclassifications,” a civil penalty of $10,000 to $25,000 for each violation may be imposed.
• These fines are in addition to any other assessments, penalties and fines that may be imposed under other laws.

These fines will be levied against business who are determined to “willfully misclassify” workers.

“Willful misclassification” is defined in the new law as “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.” 

Courts have generally defined “knowing” in this context as including constructive knowledge, which can mean what an employer purportedly should have known…

This law also requires violators to post a letter

The law requires that an employer, who violates this law, post a letter:
“…prominently for one year on its Internet Web site, in an area accessible to all employees and the general public, or, in the absence of an Internet Web site, to display in an area that is accessible to all employees and the general public at each location where a violation occurred, a notice signed by an officer that contains all of the following:

(1) That the Labor and Workforce Development Agency or a court, as applicable, has found that the person or employer has committed a serious violation of the law by engaging in the willful misclassification of employees.
(2) That the person or employer has changed its business practices in order to avoid committing further violations of this section.
(3) That any employee who believes that he or she is being misclassified as an independent contractor may contact the Labor and Workforce Development
Agency. (The notice must include the mailing address, e-mail address, and telephone number of the Agency.)
(4) That the notice is being posted pursuant to a state order.

Senate Bill 459 is California law, effective January 1, 2012.

It doesn’t take an IC Compliance expert to see that both state and federal governments are planning to turn up the heat on compliance this year.

Disclaimer: Given the general nature and context of this article, the material presented should not be relied upon or construed as legal advice. For specific information on recent developments, the effects of particular factual situations or of a particular law in regards to your business, or before making decisions based upon this presentation, you should obtain the opinion of a qualified expert.