For years, McAfee & Taft attorneys have warned employers of the financial consequences of misclassifying independent contractors. Businesses which improperly classify employees—whether intentional or not—may be responsible for back employment taxes, state tax withholding, unpaid workers’ compensation and unemployment insurance premiums, and penalties for noncompliance with wage and hour laws. In addition, independent contractors who are misclassified may also be eligible for employer-sponsored health and retirement benefits, including paid time off.
Still not convinced of the risks? Under the new health care reform law, many employers who misclassify just one employee run the risk of being hammered with a “play or pay” penalty assessed on the size of their entire workforce beginning in 2014.
For some employers, the penalties could be crippling.
In this one-hour webinar, employment attorney Charlie Plumb, employee benefits attorney Brandon Long, and tax attorney Keith Peters take a comprehensive look at all the issues and risks that come into play when misclassifying independent contractors and what practical steps businesses can do to take corrective action now. Topics include:
- Workplace trends using independent contractors
- Properly identifying and classifying workers
- Status of enforcement
- How government agencies are working together to share information
- Risks and exposures – how the penalties add up
- IRS relief available for employers who reclassify their workers
Watch this webinar — Originally broadcast December 5, 2012 | Click here to view in larger HD player
Many of our listeners asked about what circumstances they should take into account when deciding whether a particular individual who works for them is an independent contractor or an employee. The IRS has dedicated a section of its website to helping employers answer this important question, which you can find here. If you click on the “Behavioral”, “Financial” and “Type of Relationship” headings listed under “Common Law Rules”, you will find the IRS’s list of factors for employers to consider.
The following are answers to common questions submitted by participants during the webinar’s live broadcast.
Please note that these answers are being provided for informational purposes only and do not provide specific legal advice and are not intended to create a lawyer-client relationship. Readers should not act upon the information provided below without seeking professional counsel. Additionally, we are not able to provide answers to fact-specific inquiries in this forum.
Q: While the IRS’ 11-factor test provides general direction, it doesn’t provide employers with clear-cut answers. What additional guidance can you offer to help companies make the proper worker classification determination using the 11-factor test regarding control?
A: Despite the 11-factor test sometimes used by the IRS to determine whether a worker is an employee or independent contractor, the factors that have been considered by the courts and the IRS in published cases and rulings actually number at least 29, making the determination difficult. Altogether, these factors can be organized into six major groups:
- Details of work performance (e.g., instructions, training, work schedule, skill level, labels)
- Expenses of work performance (e.g., who pays for work expenses, furnishes tools)
- Compensation for work (e.g., ability to realize a profit or loss, payment schedule)
- Duration of position (e.g., length of relationship, ability of both parties to terminate)
- Structure of position (e.g., right to offer services to others, right to delegate duties)
- Location of work performance
The first three groupings tend to carry the most weight, and the overriding question is whether the employer has the right to control the worker. To boil it down, ask yourself whether you, as the employer, have the ability not just to specify what task the worker is to accomplish, but how, when and where the task should be completed. If you can control the “how, when and where,” then the worker is probably an employee.
Q: Does the way in which a worker is paid – for example, hourly, salaried or by the project – play any role in determining whether that person is classified as an employee or an independent contractor?
A: Yes. Paying a worker you have classified as an independent contractor in the same fashion you pay employees increases the chances they could be held to be your employee. (Please see point #3 in the answer to the question above regarding “compensation for work.”) You are safer paying on a task or project basis, where the independent contractor bears the risk of a profit or loss for performing work.
Q: Do the same determination tests and rules apply if it is the worker, not the employer, who requests a change in status from employee to independent contractor? For example, say you have a full-time employee who wants to work part-time from home so that she can spend more time with her family. She knows you don’t allow part-time status for his position, so she asks to be an independent contractor instead.
A: No, it does not matter who requested or caused the change in employee classification. The same rules apply in either situation.
Q: Do the rules that govern worker classification apply to non-profit organizations?
A: Yes, the same determination test, rules and penalties apply to non-profit organizations.
Q: Are schools and universities subject to these same worker classification rules as it pertains to part-time positions such as adjunct professors, substitute teachers, and temporary employees?
A: Yes, the same determination test, rules and penalties apply.
Q: Is a worker who is leased or hired through a personnel agency considered an employee or an independent contractor? Who’s liable for making that determination – the employer or the personnel agency?
A: If you are employing individuals through a leasing or personnel agency, the same determination test, rules and penalties apply. Although both organizations will have problems if a determination is made that leased or temporary workers are your employees, ultimately the employer will have the lion’s share of liability and problems.
Q: For some of our part-time workers, ours is their second job. They are full-time employees of other organizations and work at our company as their schedules allow. Should we classify them as an employee or independent contractor?
A: Regardless of whether an individual is a part-time or full-time worker, the same determination test, rules and penalties apply. However, if a worker is providing similar services to a number of other organizations over time, it may strengthen the argument the individual is an independent contractor. (Please see point #5 in the answer to the first question regarding “structure of position.”)
Q: What information should a worker be asked to provide in order to assist us in properly classifying him or her as an independent contractor?
A: From a practical standpoint, the employer should assume responsibility for making the call whether a worker is an employee or independent contractor. After all, it is the employer who ultimately controls the working relationship and the variables. In terms of a list, please refer to our PowerPoint presentation and the answers provided to the first question.
Q: Do employers face additional liability regarding the filing of I-9s if an independent contractor is later determined to be an employee?
A: Good question. Employers are not required to complete I-9s for bona fide independent contractors. If workers you originally classified as independent contractors are later held to be employees, Immigration and Customs Enforcement (ICE) may take the position you have been in violation all along for not have processed I-9s for those workers. So … take a hard look at who you have classified as independent contractors, and if an independent contractor is later found to be an employee, immediately process an I-9.
Q: Who is liable if a third party service provider misclassifies its own workers – the entity with the misclassified workers, or the company that contracted with the third party service provider?
A: Generally, the IRS will pursue any misclassification claim against the entity that is paying the worker directly. So, if an organization pays for services provided by a third party entity and that entity has misclassified its workers as independent contractors, the IRS would typically assess the third party entity for failing to classify its workers properly rather than assessing the organization that contracted with the service provider.
Q: As an employer, are we better off to send a 1099 to every company that provides a service or labor to our business, regardless of the company classification they have marked on their Form W-9?
A: Even if a business is not required to send a 1099 to an entity that has provided services, doing so may help that business qualify for relief provisions in the event the IRS were to claim that the workers providing the services to the business on behalf of the third party entity were actually employees of the business. The more likely scenario is that the IRS would claim the workers are employees of the third party entity, but issuing a 1099 to that service provider would offer some level of protection for the business. The third party entity may not be thrilled to receive the 1099, but as long as it is properly reporting and paying tax on the income, it shouldn’t make a difference in the amount of the entity’s tax liability.
Q: I’m concerned that my company may be at risk for the $2,000 per employee “play or pay” penalty because of misclassified employees. Can my company afford to wait until January 2014 when the penalty goes into effect to remedy the situation, or should we take action now?
A: No. You need to take action now to make sure you have properly classified your employees and that you are tracking their hours in 2013 to determine whether they are a full-time employee for purposes of 2014.
Q: If I am an “applicable large employer,” how does the “play or pay” penalty work or apply with respect to employees classified as part time but may at times work over the allowed 30 hours per week?
A: IRS Notice 2012-58 provides certain safe-harbor methods that employers may use through the end of 2014 to determine when these kinds of employees must be treated as a full-time employee for purposes of the play or pay penalty. The safe-harbor methods are fairly complicated, and I would encourage you to get with your benefits counsel to help apply the rules to your specific situation. Very generally, an employer determines certain employees’ full-time status by looking back at their hours during a “standard measurement period” in 2013. For example, an employer could choose a standard measurement period of 12 months beginning January 1, 2013, and ending December 31, 2013, or the employer could choose a shorter standard measurement period beginning January 1, 2013, and ending October 15, 2013.
If the employer determines that an employee averaged at least 30 hours per week during the standard measurement period, then the employer treats the employee as a full-time employee during a subsequent “stability period” (e.g., January 1, 2014 – December 31, 2014), regardless of the number of hours during the stability period, so long as the employee remained an employee.
If the employer determines that the employee did not work full-time during the standard measurement period, the employer would be permitted to treat the employee as not a full-time employee during the stability period that follows (but is not longer than) the standard measurement period.
Again, I strongly encourage you to get with your benefits counsel to help apply the rules to your specific situation. The guidance permits different measurement periods depending on whether the employee is an “ongoing employee” or a newly-hired “variable hour employee.”
Q: Can you please share the language we should look for in our 401k plan document to help prevent independent contractors who are later reclassified as employees form being retroactively entitled to benefits under the plan?
A: Here is an example of the language. This might either be in your plan’s definition of an employee or where the plan defines the classes of individuals who are excluded from eligibility:
Any person who has been classified by the Employer as an independent contractor and has had his compensation reported to the Internal Revenue Service on Form 1099 but who has been reclassified as an “Employee” (other than by the Employer) shall not be considered as an eligible Employee who can participate under this Plan; provided, if the Employer does reclassify such worker as an “Employee,” for purposes of this Plan, such reclassification shall only be prospective from the date that the Employee is notified by the Employer of such reclassification.
Q: Oklahoma law currently allows educational employees such as teachers and support personnel to opt out of the health plan (in exchange for money) without showing proof of any other medical coverage. How will this impact these employees in 2014 once the “play or pay” option kicks in?
A: Given the case-specific nature of this question, you should consult with your benefits counsel. In general, though, health care reform requires applicable large employers to provide full-time employees and dependents the opportunity to enroll in minimum essential coverage under an employer-sponsored health plan. The law requires that this obligation is satisfied, not that the employee accept the opportunity.
This webinar was pre-approved for 1.0 (General) recertification credit hours toward PHR, SPHR and GPHR recertification through the HR Certification Institute. Registration prior to the live event is required to receive HRCI credit for this webinar. For more information about certification or recertification, please visit the HR Certification Institute website at www.hrci.org.
The use of this seal is not an endorsement by the HR Certification Institute of the quality of the program. It means that this program has met the HR Certification Institute’s criteria to be pre-approved for recertification credit.
- IRS Resource Page: “Independent Contractor (Self-Employed) or Employee?”
- McAfee & Taft’s Labor and Employment Group
- McAfee & Taft’s Employee Benefits Group
- McAfee & Taft’s Tax Group
- Charlie Plumb’s professional biography and contact information
- Brandon Long’s professional biography and contact information
- Keith Peters’s professional biography and contact information