If you haven’t heard the ever increasing buzz about worker misclassification yet, you will. The issue of whether a worker should be classified as an independent contractor or an employee is a hot topic and getting hotter all the time. Subscribers to HRSentry, can easily and quickly access our newly created online training and accompanying slides on the topic, along with a host of relevant resources. For others, the following provides key information to help you assess what you need to know and the steps you should take.
There are many parties interested in proper worker classification ranging from the IRS to the U.S. Department of Labor (DOL) to state governments to workers themselves. It’s much cheaper for employers to use independent contractors over employees because they avoid paying the following: employer portion of payroll taxes, workers’ compensation and unemployment insurance premiums, overtime payments and the expensive benefits that often go along with hiring employees.
On the flip side, there’s a growing risk if you misclassify employees as independent contractors, especially if you do so willfully. In addition to the possibility of owing back pay (if minimum wage requirements haven’t been met) and overtime, you could also face paying: back taxes, including the employee portion; penalties and interest; fines; retroactive employee benefits; costs of staff time and effort; and possible legal fees if faced with going to court. Additional costs, less quantifiable but important nonetheless, include negative publicity for your organization and possible employee morale issues.
Even inadvertent misclassification can be expensive but imposed fines and penalties grow increasingly severe the more willful the nature of the violation. Both state and federal governments are paying greater attention to this issue than in years past. The IRS and DOL have even teamed up with eleven states (thus far) to share information and resources in a joint effort to uncover violations. So there’s strong incentive these days for employers to do their best to get it right.
The IRS makes is clear that there is no magic formula or simple test as to whether or not a worker is an independent contractor. They emphasize that each case is fact specific. In general, however, the best place to start is to consider whether you, the employer, have the right to control, not just the outcome but also how the worker performs the work. Whether or not you actually exercise this right is irrelevant to the worker’s status. There are many times, for instance with highly experienced employees, when organizations provide little guidance or oversight. The real question is whether or not you have the right to do so.
How does the IRS decide upon the degree of control an employer has over how the work is performed? It comes down to looking at a number of factors that comprise three main categories: Behavioral Control, Financial Control, Type of Relationship. Remember, no one factor is decisive as circumstances differ; the totality of the situation must be evaluated. IRS guidance is abundant on their web site.
You should also take a look at the DOL’s Economic Reality Test. This test relates to whether the Fair Labor Standards Act (FLSA) applies. The seven factors it contains overlap those that the IRS looks at and likewise consider whether or not the worker has a bona fide business that does not provide services integral to yours. Be sure to familiarize yourself with all seven factors of this test in addition to IRS guidance.
So how do you prove that someone is indeed an independent contractor and not your employee? The best documentation shows that the person has a bona fide business quite separate from yours; that control over how the person does the work resides with the worker; that the work being contracted is not an integral part of what your business provides and the worker is free to make a profit or loss and be hired by others. Keep a vendor file for each independent contractor just as you would for any other vendor or supplier, such as the folks who deliver your coffee supplies or service your copier machines. Here are some important items that should be kept in that file:
A written contract—Always a good idea, the contract should outline the nature of the relationship, although saying the person is an independent contractor doesn’t make it so. Indicate the project’s expected results, the fee and date(s) of completion. Note that you don’t control how the results are achieved; the worker uses his/her own equipment/tools; is free to hire others without your approval and that the person provides liability insurance to his/her workers, and is not eligible for benefits with your company. Note that the person has their own business and tax I.D. number. Make sure it is signed by both parties and create a new contract if the worker takes on a new project for you. Each project should have a separate contract.
Proof of a real and separate business—Keep any letters on business stationery, business cards, brochures, or newspaper advertisements. With so much done electronically these days, print off a copy of an appropriate page of the worker’s web site, online advertisement of services or copies of emails detailing services offered.
Invoices—Every payment to an independent contractor should be based on an invoice. The worker should never submit expense reports to you as that would point toward the person being an employee. The worker’s mileage or purchase of equipment or supplies should be part of their own business expenses, not yours. Keep every invoice and make sure it ties in with the Form 1099 you issue to the person for that calendar year.
Form W-9—Obtain this form when hiring an independent contractor and make sure it is filled out properly. If the person does not check the box exempting him- or herself from tax withholding, you are legally obligated to withhold taxes at 28%. An independent contractor should check the box file their own self-employment taxes on their own.
Due to lots of bad practices that organizations got away with in the past, businesses may think they are classifying workers correctly when they are not. Increasing scrutiny demands that the facts of each situation be reviewed. Here are some common red flags to watch for:
After an employee terminates, you hire the person back to do work that resembles their old job, even on a temporary, project basis;
If an intern is doing actual work, not just shadowing or learning; be sure to check DOL Fact Sheet #71 for the six criteria related to interns. In order to not pay interns minimum wage and overtime, all six criteria must be met.
When you provide the equipment, supplies or office space the worker uses;
If the worker replaces one of your employees or supervises any of your employees;
If the worker receives any benefits or perks your employees receive, gets paid on a regular basis, or submits expense reports;
If the relationship is ongoing and long-term;
If a supervisor hires a worker and pays the person through Accounts Payable unbeknownst to human resources or payroll.
The last item happens more often than you might think, especially in larger organizations, but all organizations are vulnerable without proper communications and procedures in place. If the person administering payroll also issues 1099s and is thus aware of all workers, misclassification can be avoided. But if your organization is too large for that, make sure there are good channels of communication among payroll, accounts payable and human resources and train managers to get approvals from human resources when engaging any worker.
A final caveat is that state laws may differ from federal laws in important ways. It’s possible for a worker to be classified as an independent contractor for IRS purposes, yet, by state definition, require workers’ compensation or unemployment insurance premiums paid on his or her behalf. So be sure to check your state laws as well! Subscribers to HRSentry may simply search on the term independent contractor to pull up helpful federal resources and relevant state resources as well.
Previously, we discussed the importance of classifying your workers properly, whether independent contractors or employees. Greater attention is being paid by the IRS, as well as a number of states, as to whether employers are misclassifying their workers; at the same time, the IRS has created the Voluntary Classification Settlement Program (VCSP) to allow employers to come into compliance relatively painlessly. Here’s the gist of how it works:
Under the VCSP, an employer that wants to reclassify one or more workers as employees going forward must complete an application form (Form 8952) 60 days in advance of the date it wishes to make the change. Note that, to be eligible, the employer must have consistently treated the workers in question as non-employees and must have filed all required Forms 1099 for the workers for the previous three years. Additionally, the employer must not be under current IRS audit by the IRS nor can it be under audit by the U.S. Department of Labor (DOL) or a state agency regarding the classification of such workers.
If accepted into the program, the employer:
will pay 10% of the amount of employment taxes calculated under the reduced rates of section 3509(a) of the Internal Revenue Code (IRC) for the compensation that was paid to the worker(s) for the most recent tax year;
will not be liable for any interest and penalties on the payment;
will not be audited for employment tax purposes for prior years with respect to the worker classification of the worker(s.)
Note that the IRS indicates that completing Form 8952 does not trigger an audit even if you are not accepted into the VCSP. You might, of course, be audited for other reasons but should not fear that completing the application will increase your chances. (See the IRS web site for additional FAQs.) Who needs the worry of failing an IRS or other worker classification audit? The VCSP is an excellent opportunity for employers wishing to come into compliance going forward and allay those fears.
In late July, a bill was introduced into Congress that would add grieving for the death of a son or daughter as an additional qualifying reason to take Family and Medical Leave Act (FMLA) leave. Dealing with the death of a child is a painful ordeal that bereavement leave (typically only 3 days or so) cannot typically adequately cover.
Senator Jon Testerof Montana, who introduced the bill, S1358 The Parental Bereavement Act of 2011, said, “the last thing parents should be worrying about is whether they’ll lose their jobs as they deal with life-changing loss.”
If the bill passes, an eligible employee would be entitled to a total of 12 workweeks of unpaid leave during any 12-month period due to the death of a child, the same as with the birth or adoption of a child, the serious health condition of the employee or immediate family member, and military exigency leave.
The impetus for the bill was created by two grieving fathers, Barry Kluger and Kelley Farley, who started a petition to lobby Congress. During the week of September 12th, the two will travel to Washington, DC to meet with a number of members of Congress. To read more about the evolution of this bill, check out Mr. Kluger’s article on Scottsdale.com.
Should this bill pass, it will augment the current FMLA law that requires protected, unpaid leave for an employee to care for a sick child but, ironically, not if the child should die. The FMLA generally applies to employers with 50 or more employees while similar state laws may be applied to employers with fewer employees.
Have you heard of E-Verify? What is it? Will it affect you? Has it already? You are surely already quite familiar with the employment eligibility verification process using the federal I-9 form: all new employees must, within three days of hire, present one or more forms of identification from an approved list which show (s)he is legally eligible to work in the U.S. You review the documents so as to attest that they seem to be reasonably authentic; and you and the new employee complete and sign the I-9 form which you must keep on file for a specified time period.
E-Verify is an online verification system employers may participate in voluntarily with a growing number of states mandating its use. Federal agencies, federal contractors and subcontractors must participate as well. The system compares I-9 information with records held by the Social Security Administration (SSA) and the Department of Homeland Security (DHS.) The comparison usually yields an “Employment Authorized” message instantaneously but may take longer and be “in process” for up to 48 hours before authorization. Sometimes, however, there is a “tentative nonconfirmation.” When that occurs the employer must notify the employee who then has eight days within which to contact the SSA or DHS to try to resolve the discrepancy. During that period the employee may not be fired; however, if the person does not follow up with the SSA or DHS or if those agencies are unable to resolve the issue, the employer may terminate the person.
Employers wishing to voluntarily enroll in E-Verify must complete a Memorandum of Understanding (MOU), which outlines the responsibilities of the SSA, the DOH and the employer. Among other things, the employer agrees to: participate in online E-Verify training for the employer representative who will be performing the employment verification queries, prominently post required E-Verify notices, and use E-Verify to check an employee’s work authorization only after the individual accepts an offer and completes the I-9. In particular, an employer may not use E-Verify to pre-screen job applicants.
There is currently a bill before Congress that would mandate using E-Verify in all 50 states. The bill, if passed into law, would phase in participation over a three year period, starting with the largest employers. Support from different corners is varied and there is doubt that this bill could pass before summer recess in August. Still, it’s good to be aware of E-Verify as more states continue to adopt E-Verify laws and as the possibility of a nationwide law exists.
North Carolina is the most recent state to join the growing list of those requiring employers to use the E-Verify system for all new hires. E-verify is the government’s online system that compares information from an employee’s I-9 (Employment Eligibility Verification) Form to records with the Department of Homeland Security and Social Security Administration to confirm a person’s eligibility to be legally employed within the United States. There are currently 16 other states which likewise require the use of E-Verify: Alabama, Arizona, Colorado, Florida, Georgia, Idaho, Indiana, Minnesota, Mississippi, Missouri, Nebraska, Oklahoma, South Carolina, Tennessee, Utah, and Virginia.
North Carolina’s new law phases in compliance dates as follows: October 1, 2011 for all of its counties and municipalities; October 1, 2012 for employers of 500+ employees; January 1, 2013 for employers with 100-499 employees; and July 1, 2013 for those with 25-99 employees.
HRSentry® has an excellent I-9 Kit to help you comply with I-9 and E-Verify requirements including any state requirements, if applicable. Check it out under the Topic Modules section within the HR Resources tab of our web site. There’s even an excellent step-by-step guide to help you audit I-9 forms of current and terminated employees for peace of mind that you are in full compliance.
