Misclassification: 1099 Contractor or Employee

Misclassification

1099 Contractor or Employee

Agenda• Why is this a big deal for employers?

– Increased attention and resources– Fines and Penalties

• Knowing the difference isn’t always easy– What is an employee? An independent

contractor?• Tests to determine status

– IRS -20 factor test assesses degree of control– Economic Realities test

Misclassification as Independent Contractors - Serious Problem

• Affected Employees– Denied access to benefits and protections

• FMLA, minimum wage, unemployment insurance

• Employers– Fines and Penalties

• Economy– Losses to the Treasury, Social Security and

Medicare funds, Unemployment and Workers’ Compensation funds

DOL Misclassification Initiative

• Under VP Biden’s Middle Class Task Force

• Memorandum of Understanding between DOL and IRS 9/2011

• Additional MOU’s– Employee Benefits Security

Admin– OSHA– OFCCP– Office of the Solicitor– 13 States (so far)

MOU Missouri/Illinois

• The Wage and Hour Division entered into agreements with the Illinois and Missouri with the specific and mutual goals of providing clear, accurate, and easy-to-access outreach to employers, employees, and other stakeholders, and of sharing resources and enhancing enforcement by conducting joint investigations and sharing information consistent with applicable law.

2011 Misclassification Collections

300 Additional Investigators

$5 million recovered

7800 Affected workers

500% Increase since 2008

CBS Morning Show, December 2, 2011

Scope of Suggested Misclassification Areas

• 2009 Government Accountability Office studies suggest 10-30 percent of firms misclassify.

• High Risk industries sited– construction, janitorial, home health care,

child care, transportation and warehousing, meat and poultry processing, and other professional and personnel service industries

– Construction highest area sited in all studies

Committed Resources

• The administration's budget request for fiscal year 2011 included $25 million for the Department of Labor as part of this initiative, including $12 million for increased enforcement of wage and overtime laws in cases where employees have been misclassified

• The 2011 budget included 1582 FTE’s to investigate

• The 2012 budget requested an additional 107 FTE’s

Recent Penalties Assessed

• US Labor Department sues Kentucky cable, telephone and Internet installer to recover unpaid overtime wages, damages for 165 employees – Investigations found Bowlin Services LLC and Bowlin

Group LLC misclassified employees as independent contractors, falsified payroll records

– The amount of back wages and damages owed continues to accrue while the employer remains out of compliance with the law.

Recent Penalties Assessed

• US Labor Department finds Knoxville, Tenn., security company owes $62,000 in back wages to 34 guards misclassified as independent contractors – DOL found the employees were improperly

classified as independent contractors and consequently denied minimum wage and overtime wages due under the Fair Labor Standards Act.

Addition to CA Labor Code• Effective 1/1/12, additional penalties between $5,000 and

$15,000 for each violation plus civil penalties already

permitted by law.

• The misclassified employee can seek up to three years

worth of unpaid wages, unreimbursed businesses

expenses, and penalties

• California business owners may also face exposure to tort

liability for injuries suffered by employees when workers

compensation insurance was not secured, for unfair business

practices, and even potential criminal liability under Labor

Code §3700.5.

Reasons for Misclassifications

• Need to make factual determinations– Present law requires an examination of a variety of factors

that often do not result in a clear answer.

• Misclassification may also be deliberate– both for tax and nontax reasons– Worker: contribute on a deductible basis to a pension

plan or to deduct significant work-related expenses– Service recipient: avoid coverage & nondiscrimination

requirements applicable to qualified retirement plans by classifying lower-paid workers as independent contractors.

Independent Contractor Definition

• Independent contractors, by definition, – self-employed – not covered by employment, labor, and

related tax laws. • Whether or not a worker is covered by a

particular employment, labor, or tax law hinges on the definition of an employee.

IRS states that…

• Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be -

• An independent contractor• An employee (common-law employee)• A statutory employee• A statutory nonemployee

IRS states that…

• An independent contractor

– The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.

– The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.

IRS states that…

• An employee (common-law employee)

– Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

IRS states that…

• Additional IRS categories include – A statutory employee – A statutory nonemployee

• Both have their own set of criteria.

So how do you determine where your workers fall?

Common-law Rule

• Previously referred to as the 20-factor rule.• Identified over the years by the courts.• 1987 IRS developed the list• Not all inclusive• Determined on a case-by-case basis

The 20-Factors1. Instructions

2. Training

3. Integration

4. Services rendered personally

5. Hiring, supervision, and paying

assistants

6. Continuing relationship

7. Set hours of work

8. Full time required

9. Doing work on employer’s

premises

10. Order or sequence test

11. Oral or written reports

12. Payment by the hour, week, or month

13. Payment of business and/or traveling

expenses.

14. Furnishing tools and materials

15. Significant investment

16. Realization of profit or loss

17. Working for more than one firm at a

time

18. Making service available to the general

public

19. Right to discharge

20. Right to terminate

Economic Realities Test

In addition to considering the degree of control the employer exercises, it takes into account the degree to which the workers are economically dependent on the business.

Test Description Laws under which test has been applied by Courts

Common-law test (used by IRS)

Employment relationship exists if employer has right to control work process, as determined by evaluating totality of the circumstances and specific factors

• Federal Insurance Contributions Act• Federal Unemployment Tax Act• Income tax withholding• Employment Retirement and Income

Security Act• National Labor Relations Act• Immigration Reform and Control Act

Economic realities test

Employment relationship exists if individual is economically dependent on a business for continued employment

• Fair Labor Standards Act• Title VII• Age Discrimination in Employment Act• Americans with Disabilities Act• Family & Medical Leave act

Hybrid test Employment relationship is evaluated under both common-law and economic reality test factors, with a focus on who has the right to control the means and manner of a worker’s performance.

• Title VII• Age Discrimination in Employment Act• Americans with Disabilities Act

In Summary•Why is this a big deal for employers?▫Increased attention and resources▫Fines and Penalties

•Knowing the difference isn’t always easy▫What is an employee? An independent

contractor?•Tests to determine status▫IRS -20 factor test assesses degree of control▫Economic Realities test