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.

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.

There are no fool proof systems to circumvent California’s worker classification rules.

A few years ago, California put together a powerful combination of enforcement agencies to address IC compliance in the courier industry.  The task force included almost every government enforcement agency with jurisdiction in California.  This unprecedented action was primarily a result of two out-of-state staffing companies aggressively marketing a “foolproof IC system”.  They promoted an “arm’s distance” payment and administration system that would convert employee drivers to independent contractor drivers overnight.

Thinking they would save costs, many California courier companies signed up, converting their drivers to ICs.  They paid the staffing companies the driver’s wages, plus a fee for administering the program.  In turn, the staffing companies issued the drivers a “settlement check” for their services.  Since the money was channeled through a third party the belief was that neither the staffing company nor the client company could be considered as the employer.  They were wrong.

Some companies were so confident in this “fool proof IC system” that they literally converted their employee drivers to ICs overnight. The companies assured the former employee drivers everything else about their jobs would remain unchanged, and indeed, nothing else concerning the working relationship changed.

Yet California held that each courier company was still the employer of the drivers and had misclassified their workers.  These courier companies were assessed for employment taxes, penalties, interest, fines for violations of labor laws, and in some cases the corporate officers were pursued for criminal charges.  Furthermore, the state coordinated with other state and federal agencies to go after the out-of-state staffing companies for various violations of both California and federal laws.

The misclassified employees also pursued compensation from the companies.

The drivers of several client companies decided they had been wronged and filed civil class action lawsuits for expenses, overtime, and other employee rights and benefits provided under California and federal law.

Some client companies looked to the staffing company to recover damages.

The contract between the courier companies and the staffing agencies implied that the client company would be indemnified against any legal challenges.  This included misclassification from civil, employment tax or labor laws (with some restrictions).  However, when the client companies looked to the staffing companies for reimbursement of their losses, the staffing companies refused to pay.

This may seem an extreme and harsh example.

It does not matter if an employer received bad advice by a staffing company; the employer is responsible for any non-compliance and resulting delinquent taxes, fines, penalties, interest, civil suits or other legal actions.

You need to select a true expert to protect your company.

I’m not saying that staffing companies from other states cannot be trusted.  Many are very professional and offer competent services.  However, California’s worker classification laws and rules are arguably the strictest in the nation.  California’s IC compliance arena is no place for an amateur to play.

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 rates are:

• three percent for overpayments (refunds and credits)
• two percent for overpayments (refunds and credits) in the case of a corporation
• three percent for underpayments (liabilities)
• five percent for large corporate underpayments
• one-half percent for the portion of a corporate overpayment (refund or credit) exceeding $10,000

Corporations pay a higher federal interest rate for errors in reporting.
As a result of an audit, large corporate liabilities (over $10,000) would have a 5 percent interest rate, covering most assessed corporate liabilities. The IRS is after these larger corporate liabilities; they tend not to spend much effort on smaller amounts.

The State of California’s current interest rate.
California adjusts its interest rate effective in July and January of each year. California just announced its interest rates will be four percent for January-June of 2012, a rate increase of one percent from 2011.  This interest rate does not change with the size of the assessment or type of business for California.

Situations where the IRS and California charge interest, which compounds daily.
Both the IRS and California charge interest when an error is identified during the tax return process. These interest charges are incurred for intentional and unintentional, or “honest” mistakes.  Interest is also charged when there is a delinquent payment and when an income tax and payroll tax audit determines a misclassification of workers.

Interest is calculated on all liabilities owed, including other interest and penalties.  I’ve seen situations where compounded interest over a period of time doubled the amount of tax liability owed.  This is a hidden risk for which most businesses are not prepared, making it especially important to properly classify employees and independent contractors.  In the case of an audit the results can be devastating.

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.

These fines will be levied against business who are determined to “willfully misclassify” workers.
“Willful misclassification” is legally defined as “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.”  Courts have defined “knowing”, in this context, as including constructive knowledge, which can mean what an employer purportedly “should have known”. 

This interpretation opens up a very loose definition for “willful misclassification” and could expose employers who make honest mistakes to these penalties.  The initial investigator or auditor who performs the review normally makes the determination of “willful”.

Violations under this new law could lead to a series of unfortunate events.
The Department of Industrial Relations (DIR) and the Employment Development Department (EDD) are sub-entities of the California’s Labor Workforce Development Agency and have missions to uncover misclassified workers and impose assessments and fines against employers who misclassify workers:

• The EDD enforces California’s payroll taxes, including unemployment, disability, employment training, and personal income tax withholding.
• A division of the DIR, The Division of Labor Standards and Enforcement (DLSE), has the authority to issue citations/fines and orders to close down businesses, if they are found to be out of compliance with labor laws (employee misclassification, Cal OHSA rules, overtime, minimum wages, etc.).

Both agencies share information with each other.  In addition, the EDD also shares misclassification information with the IRS.

Senate Bill 459 also requires the agency to notify the Contractors’ State License Board of violating licensed contractors and require the board to initiate an action against the licensee.

Senate Bill 459 also requires employers found to be in violation to post a letter: The letter shall be posted “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”:

• 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.
• That the person or employer has changed its business practices in order to avoid committing further violations of this section.
• 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.)
• That the notice is being posted pursuant to a state order.

IC compliance regulations have become expensive and strictly enforced.
Do not wait until a state or federal agency audits your company, incurring huge fines, and exposing you to other agencies. It is time for your company to become serious about your IC compliance program and engage an expert to help you. 

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.

Not only have economic pressures and new technology changed client expectations, but they have altered the way businesses recruit permanent and temporary staff.  For example, referrals are a primary source for filling positions. Long gone are the recruiting days of classified ads in newspapers, resumes posted on job boards, and dot-com job placement services.  Businesses now prefer engaging high-end consultants referred through networking and social media by individuals they know and trust. Hitting the mainstream media is now a last resort.

Not surprisingly, technology is also changing the way the IRS plans to enforce future tax compliance.  They call their concept “the real-time tax system.”

The IRS wants to enforce compliance in real-time.
In a speech before the American Institute of Certified Public Accounts (AICPA), on November 8, 2011, IRS Commissioner Doug Shulman outlined his vision to enforce tax collection and administration for both individuals and businesses before they file their returns.

The IRS wants to leverage technology to detect and resolve non-compliance before the taxpayer files a return. Shulman states that this new technology structure would fundamentally change the way taxpayers and tax practitioners prepare and file returns.  In his most recent presentation, Shulman calls his vision “the real-time tax system” as the proposed IRS system would embed third-party information (W-2s, 1099s, etc.) into its pre-screening filters that would immediately reject any return that did not match up with the IRS’ data.

According to Shulman, the new “real-time tax system” would eliminate the need for many tax audits and reduce the risk of interest and penalties for taxpayers.

Shulman stated, “Technological innovations allow us to process large amounts of information exponentially faster than just a decade ago…I believe that this vision for a more real-time tax system for the nation is real and doable.  For the past six months, we’ve been taking those first steps down the path toward taking the vision to the next level.”

The IRS is getting more money to make this technology possible.  In his April 2011 speech, Shulman stated, “In all honesty, there was an under-investment in IRS technology over the past 20 years which left us in a very deep hole. Starting with the President’s 2011 budget proposals the trend has been reversed.”

How likely is this to occur?
Oftentimes, government agencies like the IRS run new ideas up the flagpole to gauge public reaction before officially trying to implement them.  Commissioner Shulman has been promoting his real-time tax vision before various professional organizations since the beginning of 2011.  The probability of this new technology becoming a reality increases with each presentation, but depends on the public’s reaction and subsequent funding by Congress.

The list of records and documentation requested by the EDD auditor was staggering and the company realized they were not prepared to defend their IC classifications for the previous four years. The company had standard accounting records and a standard IC contract they used for all consultants. However, when asked why the consultant had been classified as an IC, the best response they had was, “We put him on 1099, so s/he was an IC.” That was their justification for most of the ICs they classified.

The potential tax assessment was hefty.
The auditor planned a full audit. That meant not only were they reviewing the accounting records for reporting accuracy, they were also reviewing the qualifications of all the consultants who had worked for the company during the past four full years. Since many of the projects lasted more than a year, that meant finding contracts and proof of IC qualifications dating back more than four years. There were nearly one hundred consultants!

The company was most worried about proving proper qualification for every consultant. Going back over four years of consultants would be an ominous task considering they had not recorded the necessary supporting information when it was fresh. Most of the consultants had moved on from the company and also worked with several key project managers, who all had detailed information about their working relationships with the individuals.

The auditor was asking detailed, specific, and intimate questions about each consultant. My friend wanted to know what to do.

One option is to call an attorney.Even the best attorneys, assuming s/he has experience and is competent in the area of employment tax and labor law, will only be able to minimize the damage of the fiscal liability of the company.

Even with an attorney, the company cannot change the fact that:

What’s the best way to avoid all this?
Had this company addressed this properly a couple of years ago, they would be sleeping much better tonight. The best time to fix your IC qualification and documentation system is before you are targeted for an audit or a civil lawsuit. In the event you are challenged with an audit Collabrus has a proven compliance system that will provide the documentation to show you have properly classified your consultants – even four years later.

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.

Attorneys fall under the same rules as any other profession. If you are investigating the employee status of an attorney you should go down the same checklist of questions of direction and control that you would for other professionals.

Is there someone who can instruct the attorney on how to handle a case or require changes in how it will be handled? Is that person also an attorney with the expertise to critique the work? Most attorneys subscribe to the principle that only an attorney can supervise an attorney, so when that occurs, employee status is more likely.

However, don’t fall into the trap of thinking that an attorney who works for a non-attorney (the CEO of a company, for example) must be an IC. There is no shortcut. You must follow the common law factors to find the answer.

Some common law tests that could be applied to attorneys are:

Are attorneys subjects of misclassification audits or law suits?

Actually, it does occur from time-to-time (See Labor Lawsuit Against You— By Your Own Lawyer!). However, generally, attorneys are generally left alone because most auditors, other attorneys and even judges believe attorneys should know the employee common law rules and should not allow themselves to be forced into an adhesion IC contract just to get a job.

Not knowing the law and being pressured into agreeing to be an IC are primary motivations for agencies like the California EDD to be aggressive in locating non-attorney, misclassified workers. These agencies feel obligated to help protect individuals who are not educated in the law.

In most cases, attorneys wouldn’t fit that description. Unless the agency is forced to review it or the worker-attorney is making the complaint, attorneys are generally not targeted for misclassification audits. However, if they do fall into the auditor’s sights the same rules will apply.

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.

Employers whose workplaces fall under the National Labor Relations Act will be required to post the notice where other workplace notices are typically posted, including Internet and Intranet sites.

The required notice states that employees have the right to act together to improve wages and working conditions, to form, join and assist a union, to bargain collectively with their employer, and to refrain from any of these activities. A fact sheet with further information about the rule is available here.

Employees are subject to NLRB Rules—independent contractors are not.
Collective bargaining rules apply to employers and their employees – not to independent contractors. The NLRB and labor unions are aware of this, which explains union support for increased enforcement of IC compliance laws. It is not uncommon for unions to provide government enforcement agencies with audit leads for misclassified workers.

Properly qualifying your ICs and maintaining supporting documentation to prove it is the best protection against an audit challenge. The government and the unions have full time professionals who dedicate their entire careers to proving workers are misclassified. Don’t make the mistake of thinking your HR person or a busy line manager, who has IC compliance as an added duty, is equipped to handle this task. You likely need to engage an expert.

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.

Jim was an employee also working as an IC for his own employer.

I was interested and started a conversation with Jim during his break. I learned that:

For $500 he plays three hours with a ten-minute break every hour. Tips are welcome but not expected. Those were his terms.

(Interestingly, by choosing $500 for his fee no 1099 would be required by his employer. Had his fee been $600 or more, a 1099 would have been required, since he was working for a business…)

Jim is a perfect example of an employee (W-2) who also performed services for his employer as an IC on the weekend.

Then I wondered, “What if he did this every weekend for his employer, instead of different clients? What if this wasn’t a law firm, but instead a recording studio and Jim was an audio engineer during the week? Would that change his status?”
But that’s a different story…

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.