IS A DREADED IRS AUDIT COMING TO A SCHOOL NEAR YOU?

Transcription

1 IS A DREADED IRS AUDIT COMING TO A SCHOOL NEAR YOU? TASPA Summer Conference July 17, 2014 Presented by: Laura Rodriguez McLean lmclean@wabsa.com & Shellie Hoffman Crow scrow@wabsa.com E. Huntland Dr. Suite 600 Austin, TX (512) E. 3 rd Street Weslaco, TX (956) N.E. Loop 410 Suite 900 San Antonio, TX (210) Marquette, N.W. Suite 1360 Albuquerque, NM (505) Decker Court Suite 600 Irving, TX (214) Richmond Ave. Suite 750 Houston, TX (713)

2 Is a Dreaded IRS Audit Coming to a School Near You? INTRODUCTION Classification of a worker as an independent contractor or employee is an important issue with significant tax and possible audit implications. As part of the federal government s efforts to strengthen the economy, many federal agencies, including the IRS, are focusing their attention on the issue of misclassification of workers. As a result, employers who classify workers as independent contractors may face increasing scrutiny. The IRS and U.S. Department of Labor have stepped up their enforcement efforts to address misclassification of employees as independent contractors. The last few years have brought additional enforcement personnel focused on misclassification, as well as an increased number of random audits of school districts and other local governments by the IRS. There is also pending legislation known as the Payroll Fraud Prevention Act of 2014, which might become the first ever "independent contractor vs. employee law at the federal level. All of this means that the issue of misclassification of workers is and will be getting a lot more scrutiny. Districts should take great efforts to ensure that they are classifying workers correctly. A. Classification as an Employee or an Independent Contractor When a district hires someone to do a job or provide a service, the district must determine whether to classify the individual as an employee or an independent contractor. If the individual is classified as an employee, the district is typically responsible for withholding federal income tax, and withholding and paying over Social Security, Medicare, and unemployment taxes. Most employees are also covered by the Teacher Retirement System of Texas (TRS). Employers report payments made to an employee, as well as the taxes paid and withheld, on a Form W-2. If the individual is classified as an independent contractor, however, no withholding is required. Employers report payments made to independent contractors on a Form-1099 MISC but are not required to pay over any portion of the individual s taxes. Furthermore, independent contractors generally are not entitled to certain benefits and legal protections to which employees are entitled, such as workers compensation, sick days, TRS benefits, and insurance. For these reasons, the classification of a worker as an employee or an independent contractor has significant financial and legal implications for both the individual and the employer. B. Occurrences of Misclassification Misclassification is a term used by the IRS to describe when an employer wrongly classifies an employee as an independent contractor. If the IRS determines that the district has misclassified a worker, the district may be liable for back taxes, interest, and penalties. If pending legislation on this topic becomes law, districts could also face hefty fines from the Walsh Anderson 2014 Page 2 of 15

3 Department of Labor. In addition to the federal tax implications, the employer could also owe back payments for unpaid leave, overtime, or other benefits to workers wrongly classified as independent contractors. Misclassification occurs for a number of reasons, including confusion about how to classify a worker, mistaken beliefs about classification in general, or the desire to avoid paying taxes or providing benefits. For Texas schools, there can also be significant pressure in some situations to classify individuals as independent contractors because of the rules governing the employment of retirees under the TRS. Finally, many school district employers might also mistakenly believe that a contract describing a worker as an independent contractor is enough to establish the relationship as it is stated. As discussed in further detail below, however, whether the worker is an employee or independent contractor depends on the amount of control and nature of the relationship, not the label given to the worker. PART ONE: DETERMINING WHETHER AN INDIVIDUAL IS AN INDEPENDENT CONTRACTOR OR AN EMPLOYEE A. IRS Determination of Worker Status The IRS defines employee as an individual who performs services for the employer, and who is subject to the employer s control regarding what will be done and how it will be done. If the employer retains the right to direct and control the means and details of the work, then the worker is an employee. An independent contractor, on the other hand, is an individual who performs services for the employer, but who is not subject to the employer s control. An employer has the right to direct and control an employee, but not an independent contractor. When discussing classification of workers, you will frequently hear the phrase right of control. Sometimes it is difficult to determine whether a worker is an employee or an independent contractor. The IRS uses several common law factors to determine whether an employer has the right to direct and control a worker, thus making that worker an employee. These factors are generally divided into three categories: 1) behavioral control, 2) financial control, and 3) type of relationship. B. Factors for IRS Determination The IRS will examine the relationship and will look for factors indicating the right to direct and control, or the absence of those factors. Many factors may apply to both employees and independent contractors, so the IRS tries to look at the big picture to determine whether the right to direct and control exists. The factors are analyzed with the following criteria: 1. Behavioral Control: Does the employer have the right to control the behavior of the individual related to the job? In other words, does the school district have the right to control how the job is done? Walsh Anderson 2014 Page 3 of 15

4 The key factors under this category are training and instruction. An employer probably has behavior control over a worker if the following exist: Specific instruction. This can cover a wide range of instruction provided by the district about how to do the work, including dictating when and where to do the work, what tools or equipment to use, where to purchase supplies and services, what order or sequence to follow, and who to hire or assist with the work. Degree of instruction. The more specific or detailed the instruction given to the worker, the more it indicates that the district wants the job done a certain way. Absence of detail in instruction reflects less control. Training protocols and procedures. If the district provides the worker with training on how to do the job, this indicates the district wants the job done in a particular way. The more intense and/or frequent the training, the more it indicates employer control. Evaluation systems. If the evaluation measures how the work is performed, this indicates an employee. If the evaluation measures just the end result, this could indicate an employee or an independent contractor. When looking at behavioral control, the emphasis is on the employer s right to control, not whether the employer actually exercises that right. Just because the district chooses not to exercise control over a worker does not, by itself, make that worker an independent contractor. 2. Financial Control: Does the employer have the right to control the economic and business aspects of the individual s job, or does the individual have this right? The key factors of this inquiry focus on whether the individual faces independent financial loss or gain related to the job (signs of independent contractor) or has more fixed, steady work (signs of an employee). This inquiry frequently focuses on the individual worker rather than the employer. The IRS looks at the following factors: Significant investment. Typically, an independent contractor, not an employee, has a significant investment in the equipment he or she uses to perform the job. Reimbursed expenses. If an employer reimburses a worker s expenses, this points to financial control. Typically, independent contractors are more likely to have unreimbursed expenses. However, teachers often purchase their own supplies without being reimbursed, and teachers will almost always be considered employees. Opportunity for profit or loss. When an employee does a job, there is usually no opportunity for profit or loss, there is just a paycheck at the end of the workday. Independent contractors, on the other hand, may have significant opportunity for profit or loss independent of the employer. Walsh Anderson 2014 Page 4 of 15

5 Services available to the market. An independent contractor is generally able to seek out business opportunities even while under contract with an employer. Independent contractors advertise and are available to the market, whereas employees are typically bound to their employer. If the district prevents the worker from working anywhere else, the worker is probably an employee. Method of payment. As a general rule, employees are guaranteed a regular wage based on hourly, weekly, or other period of time. An independent contractor is usually paid by a flat fee for the job done. However, some independent contractors are paid hourly, such as the district s attorney. 3. Type of Relationship: Do the employer and the worker appear to have an employee/employer relationship? The key factor here is how the worker and employer interact and treat the relationship, not how they label the relationship. Drafting a contract that states that an individual is an independent contractor and will pay his or her own taxes will not protect you if the IRS determines the parties have an employee/employer relationship. This inquiry focuses on the following factors: Written contracts. Be aware that the IRS is not bound by the terms of a contract calling a worker an independent contractor! Employee benefits. Independent contractors typically do not receive sick days, vacation days, insurance, or retirement plans from an employer. However, the lack of these benefits does not necessarily mean the worker is an independent contractor. Permanence of the relationship. If you hire someone with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally evidence of an employer-employee relationship. Services provided are a key activity of the business. The more integral the services are to the employer, the more likely the individual is an employee of the employer. Teaching is an integral part, or key activity, of schools. Thus, teachers are almost always going to be classified as employees. Characterization of similar relationships. If other individuals in the position have been considered an employee, it is likely that all future individuals in that position will be considered employees. Likewise, if other districts typically classify that type of worker as an employee, the worker will likely be considered an employee. State laws or state agency rules may characterize a worker as an employee for purposes of various benefits, but remember that the IRS is not bound by state laws. A worker may not be considered an employee under certain state laws or rules, but if the district has the right to control the worker, the IRS would likely consider the worker a district employee for federal tax purposes. Walsh Anderson 2014 Page 5 of 15

6 C. Categories of Workers Commonly Analyzed by IRS As a general rule, teachers, principals, superintendents, administrators, librarians, school nurses, coaches, and bus drivers are almost always considered employees of the district because the district has the right to control these workers, whether the district exercises that right or not. Anyone who performs a function similar to that of a teacher or other district employee will most likely be considered an employee by the IRS. For example, the IRS would very likely consider a tutor an employee because a tutor performs the same function as a teacher. On the other hand, a school district s attorney will almost always be an independent contractor, unless the attorney is an employee of the district as the district s general counsel and subject to the district s control. There are other professionals that a district may hire that will be considered independent contractors, not employees. These may include engineers, landscapers, accountants, or certain providers of related service to students with disabilities. The key inquiry is whether the district has the right to control the worker, and is dependent on the specific facts and circumstances. In recent audits, the IRS has also considered almost any position that works exclusively with students and/or provides educational services as being in a position that is integral to the business of the employer and has weighed that factor very heavily in its analysis towards classifying the worker as an employee. Therefore, positions that have often been categorized as independent contractors in the past, such as Occupational Therapists, Physical Therapists, Speech Therapists, and Orientation and Mobility Specialists, may be at risk of being categorized as employees, depending on the totality of the circumstances in a school district or cooperative. D. TRS Coverage Impact on IRS Classification Whether the employee is covered or not covered by TRS does not affect whether the IRS would classify the individual as an employee or an independent contractor. Many part-time or brand new employees may not be covered under TRS, but they are still considered employees for federal income tax purposes. Remember, a worker is considered an employee by the IRS if the district has the right to direct and control that worker. Some school districts may have Section 218 Agreements with the Social Security Administration, in addition to TRS coverage for their employees. If an individual is covered under a Section 218 agreement, federal law dictates that the individual will be considered an employee for federal income tax purposes. E. Examples Employee or Independent Contractor? 1. Joann - the part-time or substitute teacher. Joann is hired by the district as a part-time or substitute teacher. The district tells Joann when to arrive, what subjects to teach, and which classes to teach. The district does not train Joann, but it could provide training if necessary. The district has the right to control Joann s behavior, even if it does not exercise that right. The district provides a Walsh Anderson 2014 Page 6 of 15

7 regular paycheck, most of her supplies, and shared office space. Joann is likely an employee. 2. Rick - the basketball coach. Rick is hired by the district as an assistant basketball coach. The district does not intend to tell Rick how to coach the team, nor does the district intend on training Rick. However, the district has the right to control Rick s behavior, even if it doesn t exercise that right. Additionally, Rick is not free to coach at any other school while he coaches in this particular district. Rick is likely an employee. 3. Hank - the retired principal. The district recently hired Hank, a retired principal, on an interim basis while it searches for someone to fill the position permanently. Even though Hank was hired on an interim basis, he will still receive employee benefits and he is providing a key activity to the district. The district has the right to control how Hank s job is done, even if it does not exercise that right. Furthermore, individuals in the position of principal are typically characterized as employees. Hank is likely an employee. 4. Mike - the landscaper and tree-trimmer, and occasional janitor. The district hired Mike s Lawn Service to landscape the local schools. Mike mows the grass, trims trees and bushes, and tidies up the grounds. Occasionally he cleans up around the school and the parking lots. The district has some control over Mike s behavior related to the job, but little to no financial control. Mike owns his own business, Mike s Lawn Service, and he uses all his own equipment. He gets paid a flat fee, and he is available to the market. Mike is likely an independent contractor. 5. Susan the orientation and mobility specialist. Susan is a licensed professional orientation and mobility specialist, who works seven students each week. She provides her availability and coordinates her schedule with the school to schedule her hourly sessions with the school district. She also works for four other school districts. She must comply with state and federal law, as well as local policies and the students IEPs. However, she determines her own methods during each of her sessions with the students to attempt to achieve the goals outlined in the IEPs, and in fact, many of her sessions take place off campus. She bills the school district by the hour, at her hourly rate, and charges the school district reimbursement for her mileage. She keeps a log of the time she spends with each student, but does not provide a summary of each of her sessions to the school district. Is she an employee or an independent contractor? Walsh Anderson 2014 Page 7 of 15

8 PART TWO: WHAT TO EXPECT IF THE IRS GETS INVOLVED A. How and why does the IRS get involved? The IRS may get involved for a number of reasons, such as a random audit of the district, selection for audit based on certain red flags, at the request of a third party, or at the request of the district itself. 1. Random Audit: As mentioned in the introduction, the federal government is devoting more time, money, and efforts to examine worker classification and other non-compliance issues. The IRS may conduct a random audit in which it reviews the district s tax returns for missteps, including worker misclassification. 2. Selection for Audit: School districts may get selected for audit based on a number of issues related to inconsistency. The IRS considers certain things to be red flags that may warrant examination of a district s tax returns. These include: District employees receiving both a W-2 and a Form in the same year; District employees receiving a W-2 one year and Form-1099 in another year; Withholding social security from some workers, but not others. (The IRS would likely inquire as to why some workers are covered by TRS, but others are not.) Superintendents or other administrators receiving unreported income in the form of fringe benefits such as using a district vehicle for personal use. 3. Request by Third Party: Sometimes the IRS gets involved at the request of an individual hired by the district. A worker who expected to receive a W-2, but instead received a Form 1099, may contact the IRS to request tax relief or report that he or she was wrongly classified as an independent contractor, rather than an employee. The worker would file a Form 8919 with the IRS explaining why he or she believes that the misclassification occurred. It is not uncommon for an individual to contact the IRS or the Social Security Administration office if he or she believes she was misclassified. 4. Request by the district: If the district is concerned about misclassifying a worker or group of workers, the district can submit information to the IRS and request that the IRS make a determination about the proper classification. This is done by filing a Form SS-8, Determination of Worker Status. By filing this form with the IRS, the district can explain the nature of the business and relationship and get a determination from the IRS as to whether the worker or group of workers should be classified as independent contractor or an employee. Walsh Anderson 2014 Page 8 of 15

9 Be aware that a response will usually take about six to eight months, including the audit process. If the district disagrees with the IRS s determination, the district cannot appeal the decision, but it can submit additional information for reconsideration. If the district hires several of a certain type of worker and would like clarification over the group, a Form SS-8 can be very helpful. B. Notice of an IRS Audit If the IRS is examining or auditing the tax records of the district or the individual worker, the IRS will typically notify the district first by telephone, and follow up with a letter or notice. The notice is called an Information Document Request, or IDR. The notice should describe what issue is being examined, what records or documents the IRS would like to examine, what additional information the district may provide to help the IRS make its determination, who the IRS may want to interview, and what additional resources the district can contact for assistance. If your district receives such a notice, it is wise to contact your attorney to help you respond. There may be factors or information about the nature of the relationship that would support the district s classification, but that the district may not know to provide. If the IRS doesn t have all the information, the IRS may disagree with the district s classification. C. IRS Process for Classification Determinations During Audit The IRS will apply the factors discussed in Part One, above. The IRS agent auditing the district will take into account the information provided by the district and may conduct interviews to determine if the district has the right to direct and control the worker. In some circumstances, the IRS will agree with the district s classification after the facts and circumstances are jointly reviewed. If the district has classified workers as independent contractors, it should have documentation reflecting the common law factors, applying the factors to the specific circumstances, and explaining how the factors support its classification decision. Not only does the District need to have contracts with the independent contractors that reflect the relationships, but the invoices from the providers should also match and verify the same kind of relationship and show further proof. Additionally, for independent contractors providing any kind of services with students, the IRS will ask to see examples of work product to determine the degree of independence and autonomy exercised by the independent contractor with respect to the student services. The better the documents that reflect the work product of the provider, the better able the district will be to prove that the relationship was an independent contractor. The better the documentation overall, the better chance the IRS will agree with the district s classification decision. Walsh Anderson 2014 Page 9 of 15

10 D. IRS Determination of Misclassification If the IRS determines that the independent contractor should have been classified as an employee, the IRS will reclassify that worker or group of workers. If the workers are reclassified, the district could be liable for all of the employment-related taxes for each misclassified employee for each year that the employee was misclassified, plus interest and possible penalties. Penalties can be particularly burdensome because of the increase in financial obligation. For example, the penalty for failure to file a return can be as much as 20% of the back taxes owed, on top of the back taxes, plus interest. Because this can be a tremendous financial burden, the IRS allows districts some relief in certain circumstances. If the district can show that it meets the requirements of Section 530 of the tax code, known as the Safe Haven provision, it may be relieved from this financial obligation. E. The Safe Haven Provision and Effect on Tax Obligations The Safe Haven provision is found in Section 530 of the tax code. If the employer who misclassified a worker meets certain requirements, the provision relieves the employer from its obligation to pay back taxes. The employee may still be liable for his or her portion, however. The district must meet the following three requirements to receive relief under Section 530: (1) Reporting Consistency; (2) Substantive Consistency; and (3) Reasonable Basis for the decision. 1. Reporting Consistency: This means that the district has filed all required federal tax returns on a consistent basis. An employer must file Form W-2s to report payments made to employees and Form 1099-MISC to report payments made to independent contractors. To show reporting consistency, a district would show that it has consistently filed Form 1099-MISC for the worker classified as an independent contractor. Districts cannot show reporting consistency if: The worker received a W-2 in one year, and 1099 in another year; Workers of the same type receive different forms (for example, some received W-2s, but one received 1099); No form was filed even though the worker performed a service (for example, the district did not provide a 1099 last year to the worker, but did provide one this year). 2. Substantive Consistency: This means that the district has treated all workers in similar positions the same. A district (and other districts) must classify workers of a certain type consistently in order to meet this requirement. Districts cannot show substantive consistency if: Walsh Anderson 2014 Page 10 of 15

11 The district employs several workers to perform a similar service, yet classifies some as employees and others as independent contractors; The district classifies a certain worker as independent contractor, but most other districts classify the same type of work as an employee; The district classified the worker as an independent contractor, but classified the same worker as an employee in the past. 3. Reasonable Basis: This means that the district has a reasonable basis for not treating the worker as an employee. This can be established by showing that the district reasonably relied on a court case with very similar facts, an IRS ruling issued to the district on the same issue; common practice of the industry; or written advice of the district s lawyer or accountant who knew the facts about the employment relationship. Districts cannot show reasonable basis if: The district classified a certain worker as an independent contractor, but knew that other districts classify the same type of work as an employee; The district was previously informed by the IRS or another agency that the worker was misclassified; The district has no explanation for why it classified the worker as an independent contractor other than to avoid paying taxes, benefits, or insurance to the worker. Final note on the Safe Haven provision: This provision does not apply to misclassification of a worker who is covered under a Section 218 Agreement. Federal laws dictate that individuals covered under Section 218 Agreements will always be treated as employees for federal income tax purposes, thus, there is no reasonable basis to believe otherwise. PART THREE: PRACTICAL ADVICE TO AVOID MISCLASSIFICATION AND SOME EXAMPLES A. Analyze All Positions and Classify Correctly First, you should go through the factors and determine whether or not the district has the right to control the behavior of the individual related to the job, the right to control the financial aspect of the job, and whether the nature of the relationship indicates employee status. If you determine that the district has the right to control the worker, the worker is an employee and must be classified as such. Second, don t assume that the IRS is bound by state definitions of employee or by contractual language stating that a worker is an independent contractor. Whether a worker is a covered employee for purposes of TRS has no basis on whether the IRS would classify the worker as an employee. Walsh Anderson 2014 Page 11 of 15

12 B. Don t Convert Employees into Independent Contractors Finally, don t convert a legitimate independent contractor into an employee by exerting too much control. For example, if the district needs security for an athletic event and intends on hiring independent contractors, ensure that the district does not treat these workers like employees by dictating what they wear and how they do their job. If the district is treating the worker like an employee, the district must report and withhold taxes through a W-2, just like any other employee. C. Examples of District Classifications 1. Mike - the landscaper and tree-trimmer. Let s say that Mike, who we discussed in Part One, used to be the district superintendent. He retired and is now living his dream of owning his own lawn service. He doesn t make much money at it, but he has his TRS retirement account. In the example under Part One, Mike was considered an independent contractor because the district lacked financial or behavioral control. The same analysis applies here, and Mike would still likely be considered an independent contractor. Remember that for TRS retire/rehire staff, it does not matter whether the employee is covered or not covered by TRS. While Mike used to be a district employee, he was not rehired to the same position. If the IRS questioned the district about Mike s classification, the district could explain that Mike was not rehired in the same capacity as his former position, and that the district lacks the right to direct and control this worker in his current position. 2. Lisa - the English teacher and occasional softball scorekeeper. Lisa teaches English at the middle school and receives a W-2 as a district employee. She also loves sports and attends all the home games. The district recently hired her to work softball games as the scorekeeper and announcer. The district plans to treat Lisa as an independent contractor and issue a Form-1099 for her work at the games. The IRS would likely determine that Lisa has been misclassified. Although her scorekeeping duties are separate and distinct from her teaching duties, the district still has the right to direct and control Lisa while she works the games. Lisa would be considered an employee and her income from the games should be reported on a W-2 as additional wages. Note: This is a big area of confusion for some districts. If the district pays a teacher, parent, or member of the community to work at an extracurricular or athletic event, the IRS will almost always consider that individual to be an employee of the district, not an independent contractor. The only exception is people who are in the business of working these events, such as referees. Walsh Anderson 2014 Page 12 of 15

13 3. Juan - the police officer. The district has had problems with students fighting at some of its extracurricular activities. The district hires Juan, a local police officer, to work for the district when he is off duty. The district does not intend on him becoming a district employee. If the district controls Juan, the IRS may consider Juan to be an employee. Does the district tell Juan what to do, where to be, and how to do his job? Does Juan wear his police uniform, or a t-shirt with the district s logo? Is Juan paid directly, or through a contract with the local police department? Finally, is Juan working exclusively for the district, or does he advertise his off-duty security to the general public? If the district classifies Juan as an independent contractor, it should ensure that it does not have the right to control Juan, and can provide documentation if the IRS later requests it. 4. Alejandro, Jesse, and Vickie - the football game security officers. Rather than hire Juan, the district contacted its local police or sheriff s department and contracted directly with the department for off-duty officers to provide security. The officers wear their uniforms, they are not subject to the district s control (other than being told when and where to provide security), and the district pays the department, not the workers, through a contract. Alejandro, Jesse, and Vickie are independent contractors. 5. Felicia - the tutor. Felicia is hired by the district as a tutor. The district tells Felicia when to arrive, what subjects to teach, which students to tutor, and what results it expects. The district does not train Felicia, but it could provide training if necessary. The district has the right to control Felicia s behavior. The district may, however, lack the right to control the financial aspect of the job. Felicia advertises her tutoring services, and she intends on tutoring other clients while she tutors for the district. Behavioral control points to employee, but financial control points to independent contractor. In this type of situation, the IRS would likely look to the third factor, type of relationship. Tutoring would likely be considered a key activity of the school since it is equivalent to teaching. Other tutors in the district are treated as employees, and tutors in other districts are probably treated as employees as well. Based on all these factors, the IRS would likely determine that Felicia is properly classified as an employee, not an independent contractor. 6. Heather - the physical therapist. Heather is a physical therapist hired by the district to provide services to certain special education students. The district tells Heather which students to serve and when to provide the physical therapy. However, the district does not (and cannot) train Heather on how to provide the therapy, nor can it provide detailed or specific instruction as to how deliver the therapy. Heather advertises her services as a physical therapist and is available to the public. Some districts classify their physical therapists as employees, but many classify theirs as independent contractors. Walsh Anderson 2014 Page 13 of 15

14 Because there are factors indicating both types of worker status, the IRS would need additional detail before it could determine if Heather was correctly classified as an independent contractor. Additional evidence that the district could provide would include the contract between the parties showing that she was free to work for others, and that the district lacked the right to direct and control Heather s work. Heather might have to explain her role as a physical therapist to the IRS and why she believes she acts as an independent contractor. This type of situation can get very murky and, as stated above, the IRS has recently leaned towards the general determination that positions in schools that work with students should almost always be classified as an employee. The documentation related to this relationship will be very, very important in proving the actual nature of this working relationship. PART FOUR: THE FEDERAL GOVERNMENT S CONTINUING CONCERN REGARDING THE ISSUE OF MISCLASSIFICATION A. The Payroll Fraud Prevention Act of 2014 The Payroll Fraud Prevention Act of 2014, first introduced in 2011, was introduced into Congress on May 8, If enacted, the Act would make misclassification of employees as independent contractors a new federal labor offense. It would expand the Fair Labor Standards Act (which currently addresses minimum wage, overtime, and child labor laws) to cover a new category of workers non-employees and make it a special prohibited act to "wrongly classify an employee as a non-employee." One of the most significant provisions of the bill is the obligation for every employer or business to provide a classification notice to all "non-employees" and "employees". Every business would be required to provide a written notice to all workers performing labor or services (a) stating that they have been classified by the business either "as an employee or nonemployee," (b) directing them to a U.S. Department of Labor website for further information about the rights of employees under the law, and (c) informing them to contact the Labor Department if they "suspect [they] have been misclassified." All businesses would be affected by the Payroll Fraud Prevention Act of 2014 if it passed, even those that do not use any independent contractors or other non-employees. Each employer or other business would be required to issue such notices to all its employees within six months following passage of the law for incumbent workers and, with respect to new employees and independent contractors, at the commencement of the new worker's employment or independent contractor relationship. Any business, even one not using any non-employees or one with properly classified independent contractors would be subject to heavy fines for violations of the new notice rule if the business failed to provide the new notice. The civil penalties listed for failure to provide a Walsh Anderson 2014 Page 14 of 15

15 notice is a specified amount "for each employee or other individual who was the subject of such a violation" in an amount of $1,100 for a first offense and up to $5,000 for a second offense or a "willful" violation. The language of the bill may arguably suggest that if an employer or enterprise neglected to provide the required notice to a large number of workers, the penalty may be considerable $1,100 (or up to $5,000 if a second offense) multiplied by the number of employees or non-employees who did not get the required notice or did not receive it in a timely manner. Another significant penalty for failure to give the required notice is the creation of a presumption that a "non-employee" is an "employee" if the business fails to provide the worker with the prescribed notice or does so in an untimely fashion. The bill further provides that the presumption of employment can only be rebutted by "clear and convincing evidence that a covered individual... is not an employee.... B. Federal Assistance Regarding Proper Classification The first place to go for additional information and guidance is often the IRS itself. The IRS s website has lots of good information that is available to the public. The website is There is a special division of the IRS known as Federal, State and Local Governments (FSLG) that ensures governmental entities, such as school districts, comply with federal employment tax laws. FSLG is the division of IRS that reviews and examines school district activities, and it also provides educational programs. FSLG agents work with other state agencies, such as TASBO, to help school districts comply with federal tax laws. FSLG has many great resources online at including: Webinars on topics such as fringe benefits, misclassification, and rehire/retire issues Compliance Self-Assessment Toolkit Phone numbers to your local FSLG compliance office. Upcoming seminars and events Additional publications and pamphlets on topics specific to governmental entities. *The information in this handout was prepared by Walsh, Anderson, Gallegos, Green & Treviño, P.C. It is intended to be used for general information only and is not to be considered specific legal advice. If specific legal advice is sought, consult an attorney. Walsh Anderson 2014 Page 15 of 15