Continuing a trend in Congress to limit employers’ use of independent contractors, on April 22, 2010, Rep. Lynn Woolsey (CA) and Senator Sherrod Williams (OH) introduced the Employee Misclassification Prevention Act (H.R. 5107, S. 3254) (“EMPA”) in the House and Senate respectively.
The EMPA would amend the Fair Labor Standards Act (“FLSA”) and render worker misclassifications a violation of federal law. Employers would be required to maintain records reflecting hours worked and wages paid for employees and non-employee workers. They also would be required to provide workers a “notice” that identifies:
- The worker’s classification
- A yet to be created, Department of Labor website (containing an on-line complaint link)
- Contact information for the applicable Department of Labor office
- Other additional information as prescribed by regulation.
For workers classified as non-employees, the Notice would be required to state:
Your rights to wage, hour, and other labor protections depend upon your proper classification as an employee or non-employee. If you have any questions or concerns about how you have been classified or suspect that you may have been misclassified, contact the U.S. Department of Labor.
Employers who violate the notice and/or record keeping requirements or misclassify a worker would be subject to a civil penalty of up to $1,100 per worker for a first offense and up to $5,000 per worker for willful or repeated violations. Employers who misclassify workers and violate the minimum wage and overtime requirements would be subject to
treble damages (3X). The proposed legislation also contains broad anti-retaliation/discrimination provisions.
To enforce the Act’s provisions, the Department of Labor would be directed to perform targeted audits focusing on employers in industries that frequently misclassify employees. The Department of Labor and Internal Revenue Service would be permitted to refer incidents of misclassification to each other. The states would be directed to increase their own penalties for worker misclassification, conduct audits for the purpose of identifying employers who misclassify workers, and report the results of the audits to the Department of Labor on a quarterly basis.
While the EMPA is in the earliest stages of consideration by both houses of Congress, its introduction is significant because it follows introduction of the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (“TRAC”) (H.R. 3408, S. 2882), which would revise the Revenue Act of 1978’s safe harbor provision (the safe harbor provision allows an employer to treat a worker as a contractor if certain requirements are met), make it more difficult for employers to classify workers as independent contractors, and significantly increase employer penalties in the event of misclassification. It also follows President Obama’s proposed budget for 2011, which includes significant funding for the U.S. Department of Labor’s Wage and Hour Division to increase the Division’s number of investigators, train investigators to detect misclassification of workers, and focus on industries where misclassification is most prevalent. In sum, the EMPA serves as a reminder that curtailing employers’ use of independent contractors remains a significant issue in Congress. Employers who have not yet done so would be well-advised to review their independent contractor relationships and ensure that they are on the up and up before the Department of Labor and/or a corresponding state agency does it for them.
Most of us are aware of the past actions to Microsoft and more recently UPS and FedEx in the IRS's pursuit of tax revenue via misclassified worker investigations. 
But if misery loves company, these firms have lots of friends.
Here are some that have line up as their closest "friends":
- Hewlett-Packard (Marks v. Hewlett Packard Company)
- Time Warner Inc. (Herman v. Time Warner Inc.)
- Allstate Insurance Company (Equal Opportunity Employment Commission v. Allstate Insurance Company/Romero v. Allstate Insurance Company)
- S.G. Borello & Sons, Inc. (S.G. Borello & Sons, Inc. v Department of Industrial Relations)
- ...and many more have suffered the consequences of worker misclassification.
Perhaps FedEx Corporation’s legal battle will become the newest landmark case, with approximately 30 state class action suits and an Employee Retirement Income Security Act (ERISA) class action filed against the company; settlements are estimated by some to be $1 billion.
Already a California appeals court decision in August 2007 ruled in favor of the plaintiff and FedEx lost its appeal of a $5.3 million verdict. The verdict resulted from a class action that claimed FedEx treated its independent contractors as if they were employees but did not provide them with payment and benefits that full-time employees would receive. The ruling proved that the workers in question, delivery drivers for FedEx Ground, were in fact employees of FedEx and not independent contractors due to the level of control that the company exercised over them.
And if all of the recent legislative action, lawsuits and case studies aren’t eye-opening enough, employers now have more to be concerned with, as current data analysis tools on the market, already in use by several State Unemployment Insurance agencies, allow users to easily analyze the IRS 1099 abstract file with technology that searches and identifies triggers for an audit.
With this technology, a user can establish criteria for queries and can target employers for an audit if, for example, a worker received only one IRS Form 1099 within one year but is paid what the agency views as high-level income. In this case, the agency might suspect that the employer was concealing full-time employment in order to avoid paying unemployment taxes. In the event that an independent contractor is reclassified to employee status during an audit, the employer is responsible for all back taxes, including employer and employee contributions and of course, applicable penalties and fines.
As the IRS has reported asking for significant funds to increase their agents in an effort to go after several new revenue opportunites, including misclassified 
workers. The tensions between parties has heated up again on Capitol Hill over actual numbers and costs. Here is an excerpt from an article titled, "Debate brews over expansion of Internal Revenue Service's workforce". click for full article
Republicans lawmakers are warning the law would put as many as 16,000 new Internal Revenue Service agents and workers on the streets. They claim Democrats tucked dozens of new departments and boards into the bill. And Sen. Jim DeMint (R-S.C.) predicts a massive expansion of the federal work force.
“There are going to be tens of thousands, maybe hundreds of thousands, before this is all over,” DeMint told POLITICO. “We are going to be looking for the real truth of what this means. Just on something as simple as having 16,000 IRS agents chasing them around, that is going to open a lot of eyes.”
There’s just one problem: Experts say the figures are highly speculative.
Administration aides, who were cognizant that creating massive new bureaucracies would be bad politics, have sought to minimize the potential for a major expansion, sources said.
But the Obama administration has done little to quiet this tempest, as the key players who will implement the new law have provided few specifics on how it may increase the federal payroll.
With the loss by the Republican's on the Obama Healthcare Bill you can bet this will be one of their next stands against Obama and the Democratic Party. Misclassification of employees will continue to be at the forefront of human resource management services.
Interested in a free Risk/Reward, evaluation on your current program? Please click below and be directed to our Assessement area.
President Obama has signed into law the Hiring Incentives to Restore Employment (HIRE) Act, which is focused on accelerating the hiring of unemployed workers.
The HIRE Act has many provisions that impact employers, including a payroll tax exemption, and increased tax credits for employers that meet certain eligibility requirements. The legislation immediately enhances employers’ cash flow by permitting employers to retain the employer portion of the Social Security tax ordinarily remitted.
Social Security Tax Exemption
The 6.2% Employer Social Security Tax exemption applies to previously unemployed individuals hired after February 3, 2010 who have worked less than 40 hours during the 60-day period prior to employment and whose 2010 earned wages after March 18, 2010 and before January 1, 2011 do not exceed $106,800.*
- Employers can save the 6.2% Employer Social Security Tax, whether they hire a $40,000 worker, or a $90,000 worker. Employers, including nonprofit organizations, and colleges and universities, would not have to wait until 2011 to benefit from this tax relief because savings would accrue with each payroll processed.
- The legislation also encourages businesses to hire workers earlier in the year because the tax benefit will be greater. For example, a $60,000 worker hired on April 1 saves an employer about $2,800 in taxes. Delaying the hiring until June 1 would reduce savings to about $2,200.
- This exemption has no cap or limit as to the total amount of tax benefits that can be claimed by an employer. Employers can save up to $6,622 per qualifying worker, whether they hire one worker or hundreds of new workers.
Tax Credit
Employers will receive an income tax credit, which is either $1,000 for each qualifying worker hired after February 3, 2010, and employed for at least 52 consecutive weeks, or 6.2% of wages paid to the qualifying worker over the 52-week period, whichever is less. Wages during the last 26 weeks must be at least 80 percent of wages paid for the first 26 weeks.
- Any new hire must certify "by signed affidavit," under penalties of perjury, that he/she has "not been employed for more than 40 hours during the 60-day period ending on the date such individual begins such employment."
- Neither the 6.2% Employer Social Security Tax exemption nor the retention tax credit is permitted if a person is hired to replace another employee "unless such other employee is separated from employment voluntarily or for cause."
The information on this site is provided solely as a courtesy and should not be construed as legal advice. Your legal counsel should be consulted for updates on law and guidance that may have an impact on your organization and the specific facts related to your business.
* The 6.2% Employer Social Security Tax exemption applies to previously unemployed individuals hired after February 3, 2010 who have worked less than 40 hours during the 60-day period prior to employment and whose 2010 earned wages after March 18, 2010 and before January 1, 2011 do not exceed $106,800. If an otherwise qualifying individual earns more than $106,800, then the Employer Social Security Tax exemption only applies to the first $106,800 of qualifying wages. Other conditions may apply.
Additional Details: To qualify for the $1000 business tax credit, an employee must be hired after February 3, 2010 and employed for at least 52 consecutive weeks. Other conditions may apply. Wages paid to otherwise-qualifying individuals prior to enactment of the HIRE Act are still subject to the Social Security Tax. As part of this calculation, it is assumed that all February wages and half of March’s wages are subject to the Social Security Tax. Actual results may vary and may depend on when the HIRE is finally passed into law.
Everybody is buzzing about the historic passing of the Obama Healthca
re reform in the United States. Whether a Republican or a Democrat, you will agree that this legislation will go down as a historic event for many reasons.
Many individuals, companies and industries will be impacted by this new legislation. One that we would like to look at are the possible implications to the Professional Employment Organization (PEO) Industry. The PEO companies provide services used by small and medium sized businesses (SMB) to outsource their payroll and human resources administrative departments. PEO's are also used by large corporations to provide an outsourced form of management for independent contractor and other various recruitment activities.
The Negative
One of the biggest markets that the PEOs provide services to is the SMB Market. Many companies have utilized the PEO industry to gain greater buying power for various employee benefits and outsource the various HR "Administrivia" that SMB's don't have the time or resources to focus on. However, now that the SMB market may have access to a healthcare alternative for their employees, or now even get a tax benefit for offering there own benefits, the PEO industry may find itself losing a large part of their market share to the National Healthcare Option. One need only to look at the PEO market in our Northern neighbor, Canada. The demographics on the PEO industry are a fraction, on a prorated basis, of the industry here in the US. Canadian Small and Mid Size businesses do not have to rely on PEO's due to the National Healthcare system currently in place. There has been growth in the larger client size deals for the Canadian PEO Industry but, like in the US, this has primarily been to mitigate risk and improve the management of large independent contractor populations.
The Positive
With the National Healthcare option, there have been studies alleging that many full time workers will leave their corporate jobs to pursue more independent type of positions now that an alternative option is available. This may cause a larger growth in the ranks of independent contractors working in the market driving organizations to pursue the use of PEO organizations, as in Canada, to mitigate tax and co-employment risks by the centralization of these resources managed by a third party.
While definitely still to soon to tell and with many more aspects of the legislation and the PEO industry to consider, we will continue to welcome your insights and options and continue to report on this industry changing movement.
Please share your views with us. Also, take a moment to complete our Risk/Reward assessment and let us help you determine what opportunities for savings and/or potential risks you might have.
by Maria Ricci
I have a strong belief that whether you are a small, medium size or large corporation, a tenure policy will definitely be one of great benefit to you. Although it is not obligatory for an enterprise to have one, it plays an important role in the proper management of your 
independent contractor community, it is a highly contributing factor toward the mitigation of co-employment risk and it also promotes cost saving opportunities.
The benefits are not easily acquired. Here are some items to consider when establishing the policy:
- Establish a limit that coincides with the recommended time line present in your labor law standards based on your province or state of business.
- Ensure that the proper resources are in place to monitor-audit the policy.
- Select a vendor management tool that will assist with the quality control of the established policy.
- Seek legal advice to ensure validity and protection of the established policy.
- Create a clear “exception” process because there will be some.
Benefits of voting “Yea”:
- Will reduce the risk of an independent contractor claiming employee status due to length of service.
- The obligation to recruit for new talent in order to comply with the established tenure will assist the corporation in obtaining a more contemporary workforce.
- All of the above will assist the corporation in achieving their cost saving objectives. This will occur with the acquisition of new talent through positive turnover. Through attracting a contemporary workforce wanting to share their gained experience versus being paid top dollar for the experience they have gained through the years working for the same corporation.
- Decreases the financial risks of a negative legal ruling.
Risks of voting, “Nay”:
- Will increase the risk of having to offer a permanent position to an independent contractor due to length of service.
- Will increase the risk of having to incur unnecessary legal fees to debate the hiring of an independent contractor due to length of service.
- Will increase the risk of not engaging the best talent to get the job done.
- Will increase the risk of paying out of market rates in trying to retain a contractor who has already been there past ideal tenure.
I vote Yea!!
TRUE STORY: A client of ours terminated a contractor who had been with the company for 15 years. Yes, 15 years. The contractor sued the corporation for back severance for the 15 years and other fringe benefits not received. While not yet through the court system yet, the ruling which will most likely be in favor of the employee will be approximately $1.2MM in severance, benefits and taxes.
Please share your thoughts…….
As we have been reporting over the past month on the heightened interest in the Tax Authorities' pursuit of misclassified workers, here is a recent ruling from Massachusetts last week on why the IRS feels that there is an opportunity to generate rev
enue in this arena.
BOSTON, MA-Two former owners of a temporary employment agency in Stoughton were charged today with paying more than $24 million dollars in unreported cash to employees of their temporary employment agency as part of a conspiracy to avoid paying more than $7 million dollars in taxes, and hundreds of thousands dollars in workers compensation insurance premiums.
(Media-Newswire.com) - BOSTON, MA—Two former owners of a temporary employment agency in Stoughton were charged today with paying more than $24 million dollars in unreported cash to employees of their temporary employment agency as part of a conspiracy to avoid paying more than $7 million dollars in taxes, and hundreds of thousands dollars in workers compensation insurance premiums.
United States Attorney Carmen M. Ortiz; Susan Dukes, Special Agent in Charge of the Internal Revenue Service, Criminal Division – Boston Field Office; Warren T. Bamford, Special Agent in Charge of the Federal Bureau of Investigation – Boston Field Office; and Anthony DiPaolo, Chief of Investigations for the Insurance Fraud Bureau of Massachusetts,
announced today that MICHAEL POWERS, age 45, of Wesport, and JOHN MAHAN, age 46, of Stoughton, were charged with one count of conspiracy to defraud the Internal Revenue Service ( IRS ) and their workers compensation insurers, one count of mail fraud, and two counts of false tax returns, all arising out of their operation of a temporary employment agency.According to the Indictment, between 2000 and 2004, POWERS and MAHAN owned and operated Commonwealth Temporary Services, Inc. It is alleged that in order to avoid paying employment taxes, such as Social Security and Medicare, and to fraudulently reduce the businesses’ insurance premiums, POWERS and MAHAN arranged to pay more than $24 million of their payroll in cash, under the table.
Commonwealth Temporary Services, Inc. supplied hundreds of temporary laborers to businesses throughout Eastern Massachusetts. The amount an employer pays in payroll taxes ( FICA ) and workers compensation insurance premiums is largely dependent on the size of their payroll. POWERS and MAHAN allegedly lied to both the IRS and their insurers about the size of their payroll, and paid the majority of their employees in cash to make their fraud more difficult to detect.
If convicted, POWERS and MAHAN each face a maximum of five years in prison, three years of supervised release, and a $250,000 fine on the conspiracy charge; 20 years in prison, three years of supervised release, and a $250,000 fine on the mail fraud charge; and three years in prison, one year of supervised release, and a $250,000 fine on the tax fraud charges.This case was investigated by the Internal Revenue Service, Criminal Investigation – Boston Field Office and the Federal Bureau of Investigation – Boston Field Office, with assistance from the Insurance Fraud Bureau of Massachusetts. It is being prosecuted by Assistant U.S. Attorney Sarah E. Walters of Ortiz’s Economic Crimes Unit.
The details contained in the indictment are allegations. The defendants are presumed to be innocent unless and until proven guilty beyond a reasonable doubt in a court of law.
In our series on how to be prepared in the various aspects of Independent Contractor risks, we came accross this article from a the CPA firm of
Habif, Arogeti & Wynne, LLP in Atlanta.
We trust you'll find these Audit proceedures helpful.
IRS Employment Tax Audit InitiativeBy Frank Ciaburri
Last fall, the IRS announced a major audit program targeting underpayment of employment taxes by companies. Over the next three years, they expect to conduct approximately 6,000 audits of randomly selected employers for employment tax compliance. A broad cross-section of businesses are targeted, including tax exempt employers. To ramp up for this initiative, the IRS has trained 200 to 300 experienced agents to handle the workload. Starting this month, the IRS will be sending letters to employers selected for audit. Once selected, a company should expect the audits to be very detailed and time consuming. In addition, the audit may expand into other aspects of company operations.
The audits are part of the National Research Program, which is structured to gather statistical information about compliant and noncompliant employers. This information will be used to help determine whether enforcement or legislative changes will be necessary to address evasion of employment tax schemes. The goal is to test how much of an estimated $15 billion gap in employment taxes actually exists and how to close it. Of course, collecting revenue from non-compliant employers is an important aspect.
Audit Focus
The expectation is that the audits will be thorough and will address areas perceived to be issue prone:
- Worker Classification
- Fringe Benefits
- Owner/Officer/Executive compensation
- Reimbursed Expenses
- Non-Filers
The audits will begin with the examination of federal employment tax returns and in larger companies will typically impact functions other than payroll, including benefits, legal and tax.
Of the issues being examined, employer misclassification of workers as independent contractors has the greatest collection potential for the IRS, as the employer could be liable for employment taxes even if the misclassified workers have paid their employment taxes. For fringe benefits, the audit focus will be on the proper treatment of fringe benefits and per diems as tax free rather than as compensation. For compensation of owners and other highly paid employees such as officers and executives, the IR will consider whether compensation is reasonable in amount and will include deferred compensation, stock options, and other perks. Expense reimbursements will be reviewed for compliance with the accountable plan rules to exclude them from compensation.
How to Prepare for a Potential Audit
To make sure your company is ready for an audit, consider taking the following actions:
- Ensure that past employment tax returns and supporting records are available and have been reviewed for compliance with applicable rules. This includes reviewing past employment tax notices and ensuring that they have been resolved.
- Perform a self-audit of your company's employment tax practices and procedures, focusing on the areas the IRS would audit if your company were selected. If issues are discovered in this process, consult with tax counsel to determine the appropriate corrective action.
If Your Company is Selected for Audit
If your company is selected for audit, designate the person that will manage the audit. This may be an internal resource and/or outside tax counsel. In larger companies, an audit may be handled by the payroll and/or tax departments, as they have experience in dealing with IRS audits.
Smaller enterprises, whether they prepare their own payroll or use a payroll services provider, generally should consider having their tax counsel manage the audit, as tax counsel regularly handles IRS audits.
In the PSC Train Blog this week we have been discussing "prevention" steps for Independent Contractor risks. Today we are going to address a seemingly innocent operational convenience that can have deep legal and cost consequences.
We encounter many times when organizations find out, after the fact, that a independent contractor is working on premise without the proper corporate documentation. When this occurs the company works to get the proper paperwork in place after the assignment has begun. Sometimes due to the urgency of the work, the contractor is engaged immediately with the promise of paperwork to follow. So, what's the big deal?
Well it turns out that when a contractor is asked to complete and execute paperwork outlining terms and conditions of their assignment after they have been engaged, that documentation can be deemed null and void by the courts because it was completed after the engagement took place. The contractor could contend that it was signed under duress. Meaning that if they didn't sign it they might have lost that the assignment and the revenue. They could contend that some of the terms and conditions, like non-compete, non-disclosure, were unknown to them and therefore unenforcible by law. There are a slew of exposures that can be caused by operationally putting the "kart before the horse". So, what's the solution?
First, don't let this happen. Create a policy whereby a contractor cannot be engaged or arrive to perform any work until all paperwork is completed and verfied. This isn't always optimal but it might be better than the legal and cost alternative. Educate offenders of this policy.
Secondly, you can provide the contractor "consideration" for signing the document. While the laws vary by state, provice and federal jurisdictions. Most legal advice will direct that by paying the contractor a nominal sum of money in consideration for signing the contract post assignment, the effect is that the contractor was compensated for the contractual considerations and therefore, the contract is valid and thus the terms enforcible.
As with many things in life, something so simple or small can be very dangerous.
Check in with us next week while we explore more news and prevention strategies in the world of employer of record services.
NOTE: We strongly recommend that you consult your legal counsel on the proper activities before your institute any of the recommendations in this post. These are merely operational guidance.
In our series this week about preventative measures organizations can take to mitigate risks and costs associated with the use of Contract Labor, we wanted to address the first line of defense...Be prepared.
Like the Boy Scouts mantra of "Be Prepared", there is no better way of mitigating the risks you might have if your firm were to be pulled into a tax audit for the misclassification of employees. As a basic in Human Resource Management, your firm should work with HR and Legal to craft the company's general position on the usage of independent contractors. That policy should include, but not be limited to:
- How to Engage a Contractor?
- What are the Legal Requirements?
- What is the Tenure Policy?
- What Information do I need to Gather?
- Who do I Need to Contact?
In addition to the policies, create an educational FAQ that can be accompanied to the policies and demonstrate that your organization has take the proper steps to protect, document, and educate its company.
Remember, if you do all these things you won't prevent an tax audit nor will you avoid potential penalties, but having these items in place and documented will demonstrate to the courts and the auditors that you took the right actions to try and "prepare" yourself as best as you could.
If you want help in getting prepared, don't hesitate to take our free Risk/Reward Assessement to determine what exposures your firm might have.