Misclassified? The Fight Against Independent Contractors Christine E. Reinhard August 15, 2014 All Rights Reserved Schmoyer Reinhard LLP If It Looks Like a Duck 1 Questions of the Day Why are independent contractors a target? Why even worry about misclassification? How can a misclassification be discovered? How do you decide between classifying an individual as an independent contractor or an employee? What can you do if you discover a misclassification? 2 1
Why are independent contractors a target? 3 Why are independent contractors a target? With independent contractor, a company does not: Pay employment taxes Provide workers compensation insurance Abide by wage and hour laws Protect from unlawful discrimination and retaliation Comply with immigration requirements Supply health insurance or other employment related benefits Comply with union bargaining requirements 4 Who is targeting independent contractors? IRS State employment agencies Department of Labor EEOC and state anti discrimination agencies Employee advocate groups Unions Independent contractors, consultants, and other 1099 workers who feel unfairly treated 5 2
Why worry about a misclassification? 6 Why worry about a misclassification? Title VII ADEA ADA FMLA FLSA ERISA NLRA IRCA ACA DOES NOT INCLUDE STATE LAWS 7 Why worry about misclassification? Assume Modern Co. engaged the services of a consultant, Phil Dunfee, starting January 1. Phil is classified for accounting purposes as a 1099 independent contractor. Under his written agreement with Modern Co., he is paid a flat fee of $5,000 per month. Throughout the year, Phil works on average 45 hours per week for Modern Co. He also incurs approximately $5,000 in medical expenses that would have been covered under Modern Co. s benefit plan. What is Modern Co. s exposure if it turns out Phil should have been classified as an employee? 8 3
Why worry about misclassification? Income Withholding 1.5% $ 900.00 FICA Social Security 7.44% $ 4,464.00 FICA Medicare 1.74% $ 1,044.00 $ 6,408.00 Assumes 1099 filed Assumes misclassification not intentional Cannot recover tax liability from individual or offset with individual s payment of taxes Does not include interest or penalties 9 Why worry about misclassification? FUTA 6% of $7,000 $ 420.00 SUTA 7.41% of $9,000 $ 666.90 $ 1,086.90 Not allowed 5.4% credit towards FUTA because not report wages Excludes interest or penalties May have tax relief under Section 530, 3402 or 6205 10 Why worry about misclassification? Overtime $43.28 * 260 hours $11,252.80 Liquidated Damages $11,252.80 $22,505.60 Excludes interest Does not include civil penalty (up to $1,100 each) Does not include criminal penalties (fines up to 410,000 and prison time up to 6 months) 11 4
Why worry about misclassification? Assume Modern Co. has 100 full time employees and is an applicable large employer under the ACA Assume also that 95 of the 100 full time employees are offered appropriate coverage With John s misclassification, Modern Co. is only offering coverage to 94% of employee, which triggers annual penalty Total penalty would be $2,000 multiplied by 71, total number of employees (101) less first 30 = $142,000.00 12 Why worry about misclassification? Federal Payroll Taxes $ 6,408.00 Unemployment Taxes $ 1,086.90 FLSA Damages $ 22,505.60 Medical Expenses $ 5,000.00 $ 35,000.50 Plus Possible ACA Penalty $142,000.00 $177,000.50 13 How can a misclassification be discovered? Random audit Audit based on complaint Unemployment claim Wage claim Injury related claim Demand letter from attorney EEOC charge of discrimination Lawsuit by claimed independent contractor 14 5
How can a misclassification be discovered? Misclassification Initiative Instituted in 2011 MOU between DOL and IRS for the two agencies to work together and share information DOL Wage & Hour Division also has MOU with 14 states to share information and coordinate enforcement efforts otexas not one o States include California, Colorado, Connecticut, Hawaii, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, Montana, New York, Utah, and Washington $14 million in FY 2014 Budget to combat misclassification 15 Economic Realities Test Employment relationship exists if, as a matter of economic reality, worker is dependent on recipient of services for livelihood Five factors considered: Degree of control exercised by alleged employer Extent of relative investments by each party Degree to which worker s opportunity for profit and loss is determined by alleged employer Skill and initiative required to perform job Permanency of relationship 16 ERISA Darden Factors: Skill required Source of tools & equipment Location of work Duration of relationship Tax treatment of hired party Whether hiring party can assign additional projects Method of payment Provision of employee benefits Extent of hired party s discretion over timing and duration of work Hired party s ability to hire and pay assistants Whether work part of regular business of hiring party Whether hiring party in business 17 6
Texas Workers Compensation Act defines independent contractor as a person who contracts to perform work or provide a service for the benefit of another and who: Is paid by the job and not by the hour or some other timemeasured basis; Is free to hire as many helpers as desired and may determine the pay of each helper; and Is free to, while under contract to the hiring contractor, work for other contractors or is free to send helpers to work for other contractors 18 IRS replaced prior 20 Factor test with 3 Factor Test Behavioral Control Does the service recipient have the right to control the behavior of the worker? Financial Control Does the service recipient have financial control over the business activities of the worker (e.g., method and frequency of compensation) Relationship of Parties Do the parties operate within the typical employer employee relationship, or is the worker free from any binding relationship with the service recipient? 19 TWC still employs 20 Factor Test 1. Instructions o Employees receive instructions about when, where, and how work is to be performed o Independent contractors do job their own way with few instructions as to details and methods of work 2. Training o Employees are trained by more experienced employees or required to attend meetings or take training courses o Independent contractors use their own methods and thus need not no training 20 7
3. Integration o Employees are merged with overall business operation o Independent contractors are separate from client s daily business operations 4. Services Rendered Personally o Employees must render services personally and cannot hire substitutes or delegate work without approval o Independent contractors can assign another to do the job 5. Hiring, Supervising & Paying Helpers o Employees do not pay for assistance o Independent contractors select, hire, pay, and supervise any helpers used and responsible for results 21 6. Continuing Relationship o Employees works month after month, year after year, for same employer o Independent contractors are hired for one job or limited duration and have no expectation of continued work 7. Set Hours of Work o Employees work on call or during hours/days set by employer o Independent contractors are masters of their own time and works whenever they choose 8. Full Time Required o Employees devote full time service, with no priority to another o Independent contractors cannot work for one firm exclusively 22 9. Location Where Services Performed o Employees are told where to report by employer o Independent contractors can work from wherever they choose 10. Order or Sequence Set o Employees performs services in order and sequence set by employer o Independent contractors is concerned only with finished product and can achieve it in whatever order or sequence desired 11. Oral or Written Reports o Employees are required to submit regular oral or written reports about work in progress o Independent contractors need not report formally on progress of services 23 8
12. Payment By Week, Hour, or Month o Employees are paid at regular, pre determined intervals o Independent contractors are paid per job at negotiated rate 13. Payment of Business & Travel Expenses o Employees seek reimbursement if expenses not paid directly by employer o Independent contractors pay all of own business and travel expenses without reimbursement 14. Furnishing Tools & Equipment o Employees are furnished everything they need to do the job o Independent contractors provide all their own tools and equipment needed to complete the services 24 15. Significant Investment o Employees are economically dependent on employer o Independent contractors have substantial investment in separate, independent business 16. Realize Profit or Loss o Employees are paid for services, with no profit or loss realized o Independent contractors can realize profit or loss performed, depending on their own management of expenses and revenues 17. Working For More Than One Firm At a Time o Employees can be prohibited for working for another o Independent contractors are not subject to non competition and regularly work for more than one firm at any given time 25 18. Making Service Available to Public o Employees cannot make same services available to public o Independent contractors advertise, carry their own business cards, or operate a separate incorporated business 19. Right to Discharge Without Liability o Employees can be discharged at any time for any reason o Independent contractors cannot be fired without liability for breach of contract if work meets contract terms 20. Right to Quit Without Liability o Employees can quit at any time o Independent contractors are legally responsible for job completion and can be in breach of contract if not 26 9
Modern Co. provides telecommunication services to residential customers. Because of an increase in customer turnover, Modern has retained Cameron Tucker as an independent contractor to help with collecting Modern s equipment and past due monies from discontinued customers. As part of his contract, Cameron must provide his own vehicle, auto insurance, ladder, tools, safety equipment, and cell phone. He also can visit customer locations in any order he wishes, although he must complete all assignments within a 7 day window. He also must adhere to certain appearance guidelines and provide at least 24 hours notice if not available for assignment. Cameron has no prior experience in this line of work, so he before setting out he shadows one of Modern s employees for three days. Is Cameron appropriately classified as independent contractor? 27 DO: Analyze factors at outset When in doubt, classify as employee Enter into written agreement and ensure subsequent compliance Consult with attorney DO NOT: Rely on industry practice or standard Automatically assume independent contractor Depend solely upon written contract or agreement 28 Industries Under Attack in Texas 29 10
Texas Specific Considerations Texas unemployment statute recognizes landmen can be independent contractors, but only if: Engaged primarily in negotiating mineral rights or agreements pertaining to the exploration and development of minerals; Remuneration received is directly related to the completion of specific, contracted for tasks, not number of hours worked; and Written contract exists that specifically identifies the individual as an independent contractor, not an employee. 30 Texas Specific Considerations TWC conducts cross match of its wage reports with the new hire database maintained by Child Support Division of Texas Attorney General s Office Employer found to have misclassified new hire as non employee and failed to report new hire is liable for $25 per employee penalty for violating new hire reporting law 31 Texas Specific Considerations New Texas statute took effect January 1, 2014 Applies to any person who contracts with a governmental entity to provide a service as defined by Tex. Gov t Code 2155.001 Requires state contractor to properly classify any individual retained and compensated to provide services in connection with the government contract Provides for penalty of $200 for each misclassification 32 11
Texas Specific Considerations Texas Department of Insurance has a form, DWC Form 83, that allows a hiring contractor to designate whether subcontractor is considered: Independent contractor entitled to no workers compensation coverage through hiring contractor OR Employee but only for purposes of workers compensation coverage Applies only to construction industry 33 What do you do if misclassified? Consult with an attorney Determine extent of misclassification by conducting enterprise wide risk analysis Examine potential tax liability and take corrective measures Consider how to restructure, taking into account timing and communication needed Design and implement comprehensive compliance program 34 What do you do if misclassified? Establish internal team to monitor compliance Re examine written contracts and benefit plans for changes needed Consider whether to disallow contracting with nonbusiness entities Educate front line personnel Conduct periodic internal audits Create avenue for raising classification concerns 35 12
QUESTIONS & ANSWERS 36 13