Worker Classification: Getting It Right The 1st Time
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Worker Classification
Getting It Right The 1st Time
Part 2
2
Lesson Outline
 Properly classifying workers
 3 Categories of classification
 What are the various classes of workers
 Penalties for misclassification
 Case studies
 Form SS-8 and it’s importance
 Federal vs. state law
 Industries with classification issues
 Voluntary Classification Settlement Program (VCSP)
 Section 530 Safe Haven Protection
3
Independent Contractor or Employee
 Which one should it be?
 How do you determine proper classification?
 What affect does improper classification have on
employer and worker?
4
So How Do You Get It Right?
 Do you know how to properly classify workers?
 How do you determine if your workers are employees,
or independent contractors?
 What factors should you use to make the proper
classification?
5
3 Categories For Classification
Worker classification facts are based on three main
categories
1) Behavioral Control
2) Financial Control
3) Relationship of the Parties
6
3 Categories For Classification
Must consider all facts in the case
Each case has different facts and circumstances
No single fact provides the answer
Misclassification can have major ramifications on
employer and worker if you get it wrong
7
Behavioral Control
These facts show if there is a right to direct or control
how the worker performs the work
A worker is an employee when the business has the
right to direct and control the worker
Business doesn’t have to control the way work is done
– can direct and control the work
8
Financial Control
These facts show whether there is a right to direct and
control the business segment of the work
Does the business or the worker control financial
elements such as expenses?
9
Relationship of The Parties
These facts show how the business and the worker
perceive their relationship
Does the business perceive the worker as an
independent contractor?
Does the worker think he/she is an employee?
10
So Where Do We Go From Here?
The worker perceives employee status,
The business perceives independent contractor
status
Who is right and who is wrong?
How do you proceed now?
11
Employees Under Common Law
A worker is usually an employee if the business can control
what will be done and how it will be done
If business has ability to control the details of how the
services are performed it indicates an employee-employer
relationship
Workers in business for themselves are not employees
12
Who Are Independent Contractors?
 Accountants
 Doctors
 Lawyers
 Veterinarians
13
Who Are Employees?
 Food servers
 Bartenders
 Receptionists
 Office managers
14
Statutory Employees
A Statutory Employee is a worker who cannot be
classified as an employee under the Common Law
rules
But is an employee for payroll tax purposes due to
specific statutory requirements (Social Security and
Medicare)
15
Who Are Statutory Employees?
An Agent or Commission Driver (Food and beverage
delivery driver – “No Milk”)
Full-Time Life Insurance Salesperson (Sells primarily for
one company)
Homeworker (Works from home using materials furnished
by business)
16
Who Are Statutory Employees?
Traveling or City Salesperson (Full-Time – Works for One
company taking customer orders)
Corporate Officers (One who provides No services or Minor
services and is not entitled to receive payment)
17
Who Are Statutory Employees?
Statutory Employees must have Social Security and
Medicare taxes withheld if the Three Tests are met
18
3 Test For Statutory Employees
1)
Service contract states or implies that almost all services
will be performed personally by employee
2)
The employee has little or no investment in the equipment
and property used to perform the services
3)
Services are performed on a continuing basis for the same
company
19
Statutory Non-Employees
Two Categories of Statutory Non-Employees
If worker falls into either category they can be
classified as Independent Contractors
Statutory Non-Employees are responsible for federal
income taxes, and self-employment taxes
20
Who Are Statutory Non-Employees?
 Direct Sellers - (Must meet Three Factors to qualify)
 Real Estate Agents – (No property managers)
21
Direct Sellers 3 Factors
1) Salesperson sells consumer goods in the home, or
at a place of business other than a permanent
retail establishment
2) Sells consumer products to any buyer on a buy-sell
basis, deposit commission basis, or any similar
prescribed by the regulations
3) Substantially all of payment made to direct seller
must be directly related to sales output, or
performance or service output (Can’t Be Paid For
Hours Worked)
22
Direct Seller Requirements
To obtain direct seller’s exemption there must be a
Written contract between direct seller and company
Stating that direct seller will not be treated as an
employee for federal tax purposes
23
So Who Are Direct Sellers?
 Door-to-door salespersons
 Home demonstration persons
24
Statutory Non-Employees
 Real Estate Agents
 Need to be a qualified and licensed agent
 Output should be based on sales and not on hours
worked
 Written contract stating they are not an employee
for federal tax purposes
25
Real Estate Agents
Provide services such as
 Advertising
 Showing real estate property
 Acquisition of a lease to real property
 Recruitment, training, and supervision of other real
estate persons
26
Real Estate Agents
 Property Management services are NOT included
 Property Managers are not classified in the real
estate agent category
27
Statutory Non-Employees
 Statutory Non-Employees are not employees for
federal tax purposes, but
 Can be an employee for other purposes such as state
worker’s compensation, and tort liability
28
Penalties of Misclassification
 Employers are required to collect withholding taxes
 Can ask for abatement of liability for employee
portion of taxes if employee has paid the taxes
 Use Form 4670 to request relief of tax liability
 Employee’s statement submitted using Form 4669
29
Failure to File Return Penalty
 5% of balance due for each delinquent month
 Maximum penalty – 25%
30
Failure To Collect Tax Penalty
 Business that “Willfully” fails to collect and pay trust
fund taxes will be assessed
 100% penalty of tax due
31
What Are Trust Fund Taxes?
 Federal income taxes and FICA taxes required to be
withheld from employee’s wages
 Trust fund taxes do not include employer’s FICA
portion
32
Trust Fund Penalty
100% Penalty if Two Requirements are Met
1) Must be responsible person
2) Responsible person must have “Willfully” failed to
collect or pay the trust fund taxes
33
What Is Willful?
Willful is defined as
 Intentional
 Deliberate
 Voluntary
 Reckless
 Knowing
34
Case Study 1
 Business misclassifies employees as independent contractors
and does not withhold federal and FICA taxes
 Should responsible be assessed the 100% penalty for failure
to collect and pay trust fund taxes?
 Is there reasonable basis for not collecting and paying?
 Crowd Management Services, Inc. DC Ore, 95-1 USTC
35
How Far Back Can IRS Go?
 Statute of limitations is based on filing date of Form
941 and 940
 3 Years from filing date
 If forms are never filed, statute never expires
 If fraud is involved, there is NO statute of limitations
for reclassifying workers
36
Form SS-8
 Form SS-8 (Determination of Employee Work Status for
Purposes of Federal Employment Taxes and Income Tax
Withholding)
 Can be submitted to IRS by worker
 Can be submitted to IRS by employer
 Can be requested by IRS examiner
37
Form SS-8
 SS-8 is a restatement of 20 Common Law questions
 It’s an excellent self-audit tool
 Business should use it when drafting independent
contractor agreement
38
Federal vs. State Law
 Every state has different laws for determining
independent contractor status
 Most states base it on “Employment”. Do worker’s
services constitute employment?
 Employment for state unemployment purposes is
defined as “any services performed for remuneration
or under contract for hire, written or oral, express or
implied”
39
Federal vs. State Law
 Services for remuneration are considered
“employment” unless the ABC Test is met
 If ABC Test is met worker is not an employee for
state unemployment purposes
 Burden of Proof falls on the business
 Some states require that only One or Two of the
conditions are satisfied
40
ABC Test
A.
The worker is free from control of direction of the
performance of the work
B.
The service is either outside the usual course of business
for which the service is performed, or it is performed
outside of all the places of business of the enterprise for
which the service is performed
C.
The worker is customarily engaged in an independently
established trade, occupation, profession, or business
41
ABC Test
 Some states use ABC Test
 Other states use the Common Law IRS 20 Factor Test
 Other states use a variation of tests
42
States With ABC Test
Alaska
Louisiana
New Jersey
Arkansas
Maine
New Mexico
Connecticut
Maryland
Rhode Island
Delaware
Massachusetts
Tennessee
Georgia
Nebraska
Vermont
Hawaii
Nevada
Washington
Illinois
New Hampshire
West Virginia
43
States Using Common Law 20 Factor Test
Alabama
Kentucky
North Dakota
Arizona
Minnesota
South Carolina
California
Mississippi
Texas
District of Columbia Missouri
Florida
New York
Iowa
North Carolina
Utah
44
Variations of State Unemployment Insurance Tests
State
Colorado
Idaho
Indiana
Kansas
Michigan
Montana
Ohio
Test
AC
AC
A – Part of B – C
AB
Economic Reality Test
AC
A – Part of B – C
45
Variations of State Unemployment Insurance Tests
State
Test
Oregon
AC
Pennsylvania
AC
South Dakota
AC
Virginia
AB or AC
Wisconsin
Unique 8 Factor Test
Wyoming
AC
46
Possible Industries With Worker
Classification Issues
 Building and construction industry
 Trucking industry
 Computer industry
 Automobile industry
 Legal industry
 Taxicab industry
47
Construction Industry Case Study 2
 Facts
Jared Jones – Experience tile setter
Oral agreement with corporation to perform full-time services
at construction sites
Uses his own tools and performs services in order designated
by the corporation
Corporation supplies all materials, makes frequent inspections
of work
48
Construction Industry Case Study 2 (Cont)
Facts
 Jared gets paid on a piecework basis
 Company carries workers compensation on him
 He doesn’t have a place of business
 Performs similar services for other customers
 Either party can terminate the services at any time
49
Construction Industry Case Study 2 (Cont)
 What is Jared Jones?
 Employee or
 Independent Contractor
50
Construction Industry Case Study 3
Facts
 Freddy Thomas is an electrician who submitted a job estimate
to apartment complex for electrical services
 $16 per hour @ 400 hours
 He will receive $1,280 every 2 weeks for 10 weeks
 Not considered payment by the hour
51
Construction Industry Case Study 3 (Cont)
Facts
 Freddy can work more or less than 400 hours to get job done.
He will receive $6,400 for the job
 He performs electrical services for other companies obtained by
advertising
52
Construction Industry Case Study 3 (Cont)
 What is Freddy Thomas?
 Employee or
 Independent Contractor
53
Auto Industry Case Study 4
Facts
 Susan Bachman performs auto repair services for auto sales
agency using their space
 She uses her own tools, equipment, and supplies
 She seeks out business from insurance adjusters and other
individuals and does all of the work that comes to the sales
agency
54
Auto Industry Case Study 4 (Cont)
Facts
 Susan hires and discharges her own helpers
 Determines her own and her helpers working hours
 Quotes prices for repair work, makes all necessary
adjustments
 Assumes all losses
 Receives as compensation for her services, a large percentage
of the gross collections from the auto repair shop
55
Auto Industry Case Study 4 (Cont)
 What is Susan Bachman?
 Employee or
 Independent Contractor
56
Auto Industry Case Study 4 (Cont)
 What are Susan’s workers?
 Employees or
 Independent Contractors
57
Taxicab Driving Industry Case Study 5
Facts
 Dexter Manning rents a cab from Speedy Cab Co for $150 per
day
 He pays all costs of maintaining and operating the cab
 Dexter keeps all fares that he receives from customers
58
Taxicab Driving Industry Case Study 5(Cont)
Facts
 Dexter uses Speedy Cab’s two-way radio communication
equipment
 Speedy Cab’s dispatching services
 Speedy Cab’s advertising
 These items benefit both Speed Cab Co. and Dexter Manning
59
Taxicab Driving Industry Case Study 5 (Cont)
 What is Dexter Manning?
 Employee or
 Independent Contractor
60
What Triggers An IRS Worker Classification
Examination?
The employee (worker) files Form SS-8 requesting a
ruling
The business issues an “extraordinarily high number”
of 1099-MISC forms
The business issues 1099-MISC forms with “high
dollar” amounts
61
What Triggers An IRS Worker Classification
Examination?
 The state unemployment agency conducts an audit
and shares information with IRS
 IRS performs “project audits” on a certain industry
 Informant tips off IRS or DOL and provides audit lead
(Be cautious of disgruntled former employees or vengeful
competitors)
62
2 Types of Worker Classification Audits
 Employment tax exams
 Income tax exams
63
Examination Location
 IRS wants to conduct audit at taxpayer’s place of
business
 Taxpayer’s representative wants it off the business
premises
 Never allow examiner to conduct exam on business
premises! Easy to “misinterpret” events
observed/overheard
64
Voluntary Worker Classification Settlement
Program
 VCSP allows employers to voluntarily reclassify
workers as employees for future tax periods
 Provides partial relief from federal employment taxes
 Nearly 1,000 employers have applied as of February
2013
65
Who May Qualify for VCSP?
 Businesses, tax-exempt organizations, and
government entities may qualify
 Must currently be treating workers (or a class or
group of workers) as independent contractors or
other nonemployees
 Must have consistently treated workers as
independent contractors or other nonemployees
66
Who May Qualify for VCSP?
 Must have filed all required Forms 1099 for workers
the previous three years (temporarily waived thru 6/30/13
– See Announcement 2012-46)
 May not currently be under employment tax audit
by IRS, or under classification audit by DOL or State
agency
 Taxpayer previously audited for classification must
be in compliance with audit results
67
Who May Qualify for VCSP?
 May not currently be contesting the classification of
workers in court
 If you qualify apply using Form 8952, Application for
Voluntary Classification Settlement Program (at least 60
days before you want to begin treating workers as employees)
68
What Does It Cost for VCSP?
 Accepted employers will pay an amount equaling to
just over 1% of wages paid to reclassified workers for
the past year
 No interest or penalties will be due
 Employer will not be audited on payroll taxes related
to these workers for prior years
69
What Does It Cost for VCSP?
 Employers applying for VCSP under the temporary
relief program (Announcement 2012-45) may qualify
even if Forms 1099 were not filed
 Will pay a slightly higher amount than 1%, plus some
penalties, and must file any unfiled Forms 1099 for
workers that will be reclassified
70
Section 530 Safe Haven Protection
 Section 530 of the Internal Revenue Act of 1978 provides a
“safe haven” for companies who use independent contractors
 Passed in 1978 – To provide relief for businesses that used
independent contractors in good faith
 Intended to last only one year until Congress evaluated and
passed legislation defining independent contractors. 35 years
later Congress is still evaluating the matter!
71
Section 530 Safe Haven Protection
 Section 530 provides the new IRS Classification
Settlement Program (CSP)
 CSP establishes procedures for early and timely
resolution of cases, reducing taxpayer burden
 It is “Mandatory” that examiner offer a CSP to
taxpayer if they qualify for Section 530 relief
72
3 Qualification Requirements For Section
530 Relief
1) Reporting Consistency
2) Substantive Consistency
3) Reasonable Basis
73
Reporting Consistency
 All federal tax returns and information returns must be filed
by the business on a basis consistent with the business’
treatment of the individual worker not being an employee.
 Test must be applied to each worker separately since Form
1099-MISC may be filed for one worker in a class, but not
another worker in same class. Treat these workers as separate
classes.
74
Substantive Consistency
 Business must have consistently treated similarly
situated workers as independent contractors.
 If business or predecessor treated a similarly
situated worker as an employee, Section 530 relief is
not available.
 Test must be applied to each class of workers.
75
Reasonable Basis
 Business must have some reasonable basis for not
treating workers as employees
 Reasonable basis can consist of reasonable reliance on
several items
76
Reasonable Basis
 Judicial Precedent
 Published Ruling
 Private Letter Ruling
 Technical Advice Memorandum
 Results of past audits
 Long standing recognized practice of a significant
segment of the industry
77
Are Section 530 Requirements Met?
 If business clearly meets the reporting, substantive
consistency requirements, and satisfies the reasonable
basis test
 Section 530 requirements are fully met and business is
eligible for “Safe Haven” relief
78
Are Section 530 Requirements Met?
If the business does not meet Section 530 relief
provisions, the IRS examiner will proceed to determine if
workers are independent contractors or employees using
the Common Law rules (20 Factor Test)
79
When Does CSP Get Offered?
 If examiner determines that a reclassification issue
does exist, examiner will consider whether or not CSP
applies.
 If examiners proposal is to reclassify workers as
employees and business has timely filed Forms 1099
 Examiner should make a CSP offer to taxpayer
80
When Does CSP Get Offered?
 It is mandatory that examiner present a CSP offer if
all requirements are met
 Taxpayer can accept or decline offer
 Businesses that have not filed the required
information returns are not entitled to CSP offer
81
Cases Qualifying for CSP
 Form 941/940 Non-Filers – Eligible for CSP if Forms
1099-MISC were filed
 Statutory Employees – If business timely filed Forms
1099-MISC
 Household Employees – If employer timely filed Forms
1099
 Corporate Officers – If business treats corporate officer as
IC and timely filed Form 1099-MISC
82
Cases Excluded From CSP
 Cases with Other Issues - CSP only available for worker
classification. Not available for dividend or wages issues with S
Corp reasonable compensation
 Prior Closing Agreement – Taxpayer who has entered
into a prior CSP is not eligible
 CSP Non-Compliance – Business that isn’t in compliance
with existing closing agreement
83
Cases Excluded From CSP
 Prior Coverage – Not available to a business that
incorporated after the closing agreement was signed by
principals, owners of the prior business that had worker
classification issues.
 Three Party Arrangements – No CSP is available if
the correct employer can’t be identified
84
Cases Excluded From CSP
 Information Returns other than Forms 1099 Not
available for any returns beside 1099s. Not available for K-1s if
workers were treated as partners
 Wage Issues – Not available for officer - shareholder
compensation issues
 Administrative or Judicial Proceeding – If prior year
employment tax returns are part of an administrative or
judicial proceeding No CSP
85
Cases Excluded From CSP
 Litigation – No CSP offer available if worker classification
issue is resolved through litigation
 Criminal Investigation – No CSP if tax return is part of an
on-going investigation
 Claims – No CSP for settlements available for cases closed
prior to CSP implementation
86
Cases Excluded From CSP
 Government Employers – CSP not available to state and
local government employers
 Taxpayer No Longer in Business – CSP is only available to
taxpayers still in existence. Closed business don’t qualify
87
Taxpayer’s Rights To CSP Offers
 Taxpayer participation in CSP is voluntary
 Taxpayer can accept or reject offer at any time during
the examination process
 Declining to accept CSP offer allows taxpayer to retain
all rights to an administrative appeal and all rights to
judicial review
88
Conclusion
 IRS audit process is designed to select returns with a
high probability of error for audit
 Being selected for audit does not indicate there is a
problem
 A “No Change” in a worker classification examination
is possible
89