The following is an interview from the website accounting.smartpros.com. There has been a good deal of publicity lately about the changing attitudes of government interpretation of what the difference is between independent contractors and employees.
Our one sentence synopsis is: Be careful, the courts have started to re-characterize independent contractors as employees even though independent contractor agreements have been signed by both parties. See the indented section below for a more detailed explanation.
It may be time to convert your independent contractors to employees. If you’d like to discuss your particular situation, we’d be more than happy to meet with you. Just follow this link to schedule an appointment.
This July 2015 video interview transcription is from SmartPros Ltd.’s popular FMN Series.
Summary: The good news: more and more businesses, including those in the sharing and on-demand economy, are making use of independent contractors in their workforce. The bad news: the controversy over the classification of workers as employees or as independent contractors continues to be a hotbed of regulation and litigation in a wide variety of industries. In this segment, noted tax attorney Robert W. Wood highlights the measures you can institute to protect your company from attack by taxing authorities and from lawsuits by former workers.
July 2015 Segment 4
Are You Prepared for the Latest Independent Contractor Crackdown?
- Worker Classification: Regulatory and Business Environment
QUINLAN: The classification of a company’s workers – as employees or as independent contractors – continues to be viewed as a widespread issue. Just about everyone knows that the IRS, along with most taxing and regulatory agencies, does not favor independent contractor treatment. These agencies believe, sometimes correctly, that the independent contractor classification is subject to abuse. In fact, the Service is inclined to presume that most workers should be classified as employees, even if they may actually be called independent contractors. That makes sense. After all, a person who is paid as an independent contractor does not pay his or her taxes until the filing deadline the following year. In contrast, payments to employees are subject to Social Security and Medicare taxes, which are collected on wages immediately. In a similar vein, self-employment taxes paid by independent contractors have been one of the most notoriously under-collected taxes.
As a result, there are both timing and revenue differences between employee and independent contractor treatment. These lead to a great preference – by the IRS as well as by state regulators in the area of unemployment compensation and workers compensation – in treating all workers as employees and subjecting them to withholding. In an era when the front-page headlines are preoccupied with health care reform and immigration reform, we asked Rebecca Surran to find out why Robert Wood, our longtime expert commentator on independent contractor compliance and misclassification, calls this issue “the elephant in the room.”
SURRAN: Joining us is Robert W. Wood, who practices law with the firm of Wood LLP in San Francisco, and is the author of “Legal Guide to Independent Contractor Status,” now in its fifth edition. Thanks for being with us once again, Rob.
WOOD: Nice to be here. Thanks, Becky.
SURRAN: Last year, you told me, Rob, that the issue of classifying workers – as employees or independent contractors – was becoming “more pivotal than ever” for businesses. So, let me ask you: How accurate was your crystal ball? To what extent is worker classification still a “front-burner issue” for businesses and their tax advisers?
WOOD: I wish my crystal ball were more accurate. I think it has been partially true. It certainly should be a front-burner issue. I do not know if it is for many people. Very frequently what happens is that companies are so interested in growing their revenue and pushing out new products and services that they do not revisit these fundamental issues until something happens that makes them do it. It might be a lawsuit, or something else, like a government investigation. But it certainly ought to be an important topic.
SURRAN: When we covered the onset of Obamacare, you mentioned to me that the federal statute defined “full-time” employees as those who worked – on average – thirty or more hours per week. I’m curious: has that guideline had an impact on workplace practices besides health care benefits?
WOOD: I think so. I mean, every business knows that whether it is providing health coverage under Obamacare, or simply the usual tax withholdings, it is more expensive to have employees than contractors. You have all the nondiscrimination laws, typically state and federal. As a result, there are a whole bunch of reasons that it is cheaper to have independent contractors, provided that the status holds up. But you mention Obamacare and health coverage, Yes; it is true that some companies are pushing the envelope, trying to avoid having employees that they will have to cover under the healthcare rules.
SURRAN: A few years ago, Rob, you indicated that the trend toward new forms of worker classification was driven by the economy. At the time, a lot of businesses wanted to ride the recovery by hiring “temporary” workers. These days, it seems as if the latest trend involving the issue is driven as much by technology as by the economy, doesn’t it?
WOOD: Yes, absolutely. When it comes to technology, which I am not all that savvy about, we all know that there are these companies that are using enormous sort of branding power that they have. They are providing a service or a product to everyone, in a large geographic area of the country or the world. Yes, a lot of that is taking place and further pushing the envelope with worker status.
SURRAN: On one hand, we’ve got an entire alphabet soup of federal and state agencies that regulate and audit a business’ arrangements for tax withholding, health care, pension, and unemployment insurance. On the other hand, it seems as if we’re also seeing a lot of issues – including class action lawsuits – triggered by workers who signed contracts, as independent contractors, now claiming that they are employees, aren’t we?
WOOD: The way you ask the question raises a fundamental point, which is: who gets to decide? A lot of employers, sophisticated and less so, are surprised when they find that they can have a contract that is signed in ink that can be recharacterized. That is, a worker who says: “I agree, I’m not an employee. I agree, I’m an independent contractor. I agree, I’m not going to come after you, Mr. Employer, for any kind of worker benefits, no health benefits, no nothing. I know you’re not withholding. I’m going to pay my own taxes,” and all of these commitments, anything you want this person to say.
They sign it and they have their wits about them. They have contracting capacity. They might even have a lawyer that looks at such an agreement for them. The courts, the taxing agencies, like the IRS, and the Department of Labor and other non-tax entities say that contract does not necessarily mean that the worker is not really an employee. If you have a company, or work for a company, that is facing one of these types of lawsuits, the range of liabilities is staggering and it can go back a number of years. I think for a lot of employers, that they sort of shake their head and think, “How is this possible?” But it is certainly possible.
SURRAN: Thanks, Rob. We’ll return to your commentary in a minute.
- Uber and Lyft Cases
QUINLAN: This spring has been a tough season for ride-sharing start-ups Uber and Lyft. Two federal court judges in California issued separate decisions this spring in class action lawsuits brought by drivers of both companies. The drivers are alleging that Uber and Lyft misclassified them as independent contractors, instead of employees, thereby depriving the drivers of many employee rights and benefits.
Both Uber and Lyft have filed motions with the federal courts, seeking summary judgment on the grounds that they had properly classified the drivers as independent contractors. The courts in both cases denied their motions, ruling that juries would have to decide in each case whether or not the drivers are employees. But what will impact will these cases have for companies that use a “1099” business model, particularly in the so-called “on demand” economy?
SURRAN: The current court actions involve Uber and Lyft. But I suppose it’s logical for businesses in an “on demand” economy to consider these workers as independent contractors. I mean, the workers can make themselves available for work whenever they want and can accept or reject rides whenever they want, can’t they, Rob?
WOOD: I was waiting for you to mention those two companies. They have very much been in the news, and not just national or local news, but worldwide news, because they have really shaken up the industry of taxicabs and now so-called ride-sharing. Those are distinctly technology companies. If you listen to what the companies say, there are lots of drivers, some who it may be unfair to pigeon-hole into one category. There are some who work for different companies, for example, who might drive for Uber and Lyft both, some who work very little and some who work decidedly full-time occupations. So, there are a variety of liabilities, not just tax liabilities. It’s a really interesting area, and yes, I think those class actions are, as I understand it, proceeding. But I should probably mention that some of these cases – one in particular, involving Uber – are simply wrongful death cases. I do not know if “simply” is the right word, but it is a wrongful death case. So, in other words, it is not an employee class action or worker class action. There have been a lot of these cases impacting taxicabs and other types of delivery services – the delivery of people or the delivery of goods, where somebody gets injured seriously or killed. Then the question is: “Who is liable?’ Obviously the driver is liable and anybody else who may have caused the accident. But a key question here is tort liability, under the Latin term “respondeat superior,” which is an agency concept. We all know if a UPS driver, who is an employee, drives over someone, and injures or kills them, the driver is liable, but so is UPS. In the case of Uber and many of these other kinds of services, the question is: what is going to happen? The jury is still out on that case and in many cases like it. Those things, oddly enough, may end up driving – no pun intended – much of the debate on the worker status cases, because it is sort of a different legal concept. But I think it is relevant and worth watching.
SURRAN: As you say, there may be some ways that a worker is like an employee and other ways that the same worker is like an independent contractor. So, how does a court decide if the business is passing or failing the key test: do you have the right to control the manner and means of accomplishing the desired result?
WOOD: Well, the traditional answer is “facts and circumstances.” For lawyers, accountants, and certainly for business people, that is a very frustrating kind of thing to confront. What we all want, and I guess what clients want, is sort of clear answers when someone, either an individual or a company that has hundreds or thousands or hundreds of thousands of worker,s sits down with an advisor and says, “Okay, what are these people,” this particular category, not necessarily every single worker, but this type of a salesperson, for example, what is this person? It would be really nice to have a litmus test. Unfortunately, we do not have that. The IRS still uses the 20 factors. More recently, the last few years, they have another reduced test of seven factors. It is essentially the same test. Most of the states have a knockoff of that, where they look at who is controlling the method, manner, and means, or the three M’s, if you will. But it is not easy. Very frequently, as you might expect, if you ask the government, they are going to opt in favor of employee status. Because, if it is the IRS, they get the money right away via withholding. They get much more money that way because it is earlier and it is more reliable than independent contractors filling out a Schedule C tax return and sending it in. I think it’s true for most other agencies too. That is, Worker’s Comp authorities and labor departments and industrial relations departments around the country. All of them want and need money, and they get that much more regularly from employees.
One key fact about any of these facts and circumstances discussions is simply that there is no litmus test. So, if you have 3 factors out of 20, or 7 factors out of 20, that does not mean you are safe, and it does not mean that you are not safe. Much depends on which factor may be the most important in your particular case, what is most likely – in a juror’s mind or the court’s mind – to weigh particularly in favor of employee status. So it’s very hard. I think it’s one reason why some of the work that I’ve done as an expert witness is not so much to say this is what the results should be, because that really is the ultimate issue in the case, but rather these are the kinds of methodologies that one uses, and these are the kinds of factors, let’s say in the IRS 20 Factors, which is basically a common law test.
These are the factors that probably do not matter on a given set of facts, because they are almost always going to cut one way or the other. They sometimes are kind of a 50/50 issue, right to terminate the person, right to quit. They are often reciprocal rights. The worker has the right to quit. The company has the right to terminate. If you have both of those things present, as you often do, they really should not matter too much. They should cancel each other out. That is the kind of thing that I think helps judges and juries sort out these things.
SURRAN: Both of these actions are in your neighborhood, Rob: the Northern District of California. Is it “telling” that the courts denied summary judgment in both cases?
WOOD: It is significant. The court sent a big message by denying summary judgment, saying this is not a legal issue, that it has to be based on a determination of the facts. So somebody-and that could be a judge, or it could be a jury – makes the decision. A jury frightens big companies, typically, in most cases like this, because they are going to say, “What are these people?” In a facts and circumstance analysis, some facts are going to cut one way. Some facts are going to cut the other way. That is going to encourage potentially inconsistent decisions. But they could be expensive decisions.
- Macy’s West Case
QUINLAN: In another ongoing court battle in California, Macy’s West Stores, Inc. – along with the department store’s logistics management company, Joseph Eletto Transfer Inc. – have agreed to pay four million dollars to settle a class action misclassification lawsuit brought by over six hundred truck drivers and their helpers. Of that amount, Macy’s agreed to pay $3 million – and the logistics company will pay $1 million – in settlement of the claims by the workers. According to the drivers and helpers, the department store and its delivery company misclassified them as independent contractors in violation of the California Labor Code. According to the plaintiffs, although the drivers signed independent contractor agreements with the logistics management company, the relationship was heavily regulated by the department store. Specifically, they alleged that the drivers and helpers were required:
One, to display the Macy’s logo on their trucks; Two, to wear Macy’s uniforms; Three, to follow Macy’s delivery schedules; Four, to leave their trucks at Macy’s sites at the end of the day; and Five, to be evaluated on whether they met Macy’s standards and expectations of delivery and customer service.
SURRAN: Mike just gave the facts of the settlement of the class action misclassification case against the Macy’s West department store. Maybe the drivers and helpers were employees, and maybe they were independent contractors. But here’s what I don’t understand: if the truckers had signed independent contractor agreements with the logistics management company, how could the department store be liable?
WOOD: Becky, you sound like a lot of employers with whom I sympathize that say that very thing: “Wait a minute, how can these people sue me, because they signed it and they understood it.” In fact, in some cases, it is not, you could say, an adhesion contract. It is something where the workers – and I have seen this – actually say: “This is what we want to be. We want to do all these things ourselves. We want to decide if we’re going to have three trucks or one truck. We want to be able to hire helpers,” and so on. So it’s not a one-way street, but it’s that kind of a case where you have an employer – whether Macy’s West had a good case, or not a good case, it made-I gather, what is a financial decision to say, $4 million dollars, or whatever the payment was, is less than the potential exposure. But once again, neither with a civil plaintiff, or a single person or a class action, nor with a government agency, is that document sort of the be-all and end-all. It is still going to be this murky facts and circumstances test, which is why I think it is so hard for advisors to give advice on these issues. An important point, Becky, about the Macy’s West case, and indeed I think it is an emerging trend here that might be even harder for some companies to understand, is that the contract may be not with the nominal employer, if you will. In this case, Macy’s West – as I understand it – contracted with a third-party trucking company. The third-party trucking company then hired independent drivers. How does Macy’s West end up getting roped into this dispute and end up paying a lot of money, you may ask. It is not unlike a franchisor/franchisee arrangement where you have a complaint. For example, think about Domino’s Pizza Delivery cases. There have been some of those that raised this same kind of issue. Of course, a good lawyer sues everybody who is in the room who may be involved, and then it’s up to the various defendants to sort out how they sort of parcel their liability. But it is not clear that you have to have a direct independent contractor relationship with a worker in order to be able to be sued. But I think there, too, in healthcare, one sees some of these kinds of tripartite arrangements, where you have a doctor going to a hospital. The hospital may well say: “We don’t hire doctors.” But if you have your own medical corporation, then we can enter into a service agreement and participation agreement, or whatever they may call it, with the doctor’s company. The doctor’s company or his professional corporation then enters into an agreement with a hospital. If there is malpractice, everyone gets sued. One of the key issues, oftentimes, is going to be the worker status of the doctor, even though there are these layers of legal relationships. So, it is a complex – and I think, emergently-even-more-complex – arrangement as we go forward. 4. Expanded Purview of IRS and Labor Department
SURRAN: A few years ago, Rob, you mentioned that the IRS and the Labor Department were now sharing information, as well as acting in concert with state regulators. Is it possible that these businesses – and others who use similar workplace arrangements – are going to face scrutiny from more taxing and regulatory authorities?
WOOD: It is possible. I think it is more than possible: it is happening. But I think like everything else in government, it tends to move slowly. So, it is not as though there has been a sea change overnight. But I think there is more of that information is being exchanged. One domino often leads to another domino falling. Some people, on the plaintiff side of these cases, actually try to bring in the government, and try to interest the government in pursuing a particular industry. In the food industry, there have been a lot of cases, as well as other types of truck use. Package delivery business, of course, impacting FedEx and companies of that ilk. But I think it is not a foregone conclusion that there will be an investigation or some industry-wide query. But it does happen, and probably more of it will happen in the future.
SURRAN: Think about our viewers, Rob. After all, they’re your clients. Let’s say that a company had a salesperson in a faraway state. He or she was treated as an independent contractor. Now, that worker has filed a complaint with his or her state’s unemployment agency or their worker compensation board. Doesn’t it make sense to just pay the $86 fine rather than contesting the reclassification?
WOOD: Given the way you asked the question, and the small magnitude of the fine, the answer is: “Of course, it makes sense.” Obviously, the more latent liability is whether that act of simply giving up and paying the $86 could be viewed as an admission, later in some other proceeding. I think the classic answer that a lawyer gives is not to pay the fine. Or, at least, if you are going to pay the fine, make sure that you do it while making a record that the only reason that you are paying it is not because this person is actually an employee but because your lawyer is going to charge you $500 an hour, or whatever it is, and that it is going to cost more to write a one-page letter than it is to pay the fine. You can do that in a way that preserves your rights. That is the tension in this area.
SURRAN: As accountants and financial professionals, our viewers are accustomed to hearing and receiving incentives from the government: “We’ll go easy on you if you come forward to us and reclassify your workers as employees.” To what extent is the IRS still promoting the idea of a so-called Voluntary Classification Settlement Program?
WOOD: Well, they are still doing it. I believe that the taxpayer or company response to the government program – the Voluntary Classification Settlement Program – has not been overwhelming. In my own personal practice, I have seen very little of it. I have seen a few clients who are interested, and then who get cold feet and do not do it. That experience is probably similar for many people. It is of interest and the IRS has not shut it down. There was a brief time, in 2013, where the IRS sort of “goosed” the program and offered some special benefits for a limited window. I do not think that resulted in huge volumes or a big uptake in interest. I would say it is very different from a program like the Offshore Voluntary Disclosure Program (OVDP) that the IRS has for foreign account matters, where there have been huge numbers of people that have come in and done that. I think this particular worker status one (VCSP) has only been modestly successful. Most people or companies still, in my experience, do not want to do it. The government program is very much designed to get employers to start doing what the government views as doing it right. That is, treating people as employees. So, whenever in doubt, treat people as employees. It is not an overstatement to say that the government, the IRS at least, would really like it if everyone was an employee. So, do that prospectively and then you are withholding, you are paying taxes right away, and you are paying employment tax. Everything is sort of hunky-dory.
SURRAN: Now, that may make sense, Rob, in terms of a business’ current workforce. But, as an attorney, you can tell me: don’t companies also need to consider their former workers? I mean, reaching a settlement agreement with the government is not binding on your former independent contractors, is it?
WOOD: There is concern and I have seen employers express it, that if we start treating everybody tomorrow as an employee, won’t Joe or Bob or Ted – those people that are kind of disgruntled that are still working for me or that no longer work for me – come back and say, “Hey, wait a minute. Give me something, too.” So, it is a slippery slope. Even if you are an employer, and you have a contract that the worker has signed saying that they are going to pay their own taxes, once you realize that that contract can abrogated, it is scary. So, yes, absolutely, you are right. If you do not have protection against everybody – the government entities and the workers – you may come up short and you may have to pay more money.
- Going Forward
SURRAN: Well, the good news is that, as the economy continues to expand, many businesses are growing – and they are starting to bring new workers on board. Is there anything that they should do now to avoid trouble later?
WOOD: I think so. You’ve probably asked me this before, Becky, and I’ve probably answered much the same way, in the past, which is-look at your agreements and be realistic. And I think-you mentioned kind of a go-go economy where people are being hired, companies are expanding. You mentioned companies like Uber and Lyft, and there are many others that are-see themselves as primarily technology companies, but need a lot of bodies to do the work. And-and it may be that a lot of those companies can, and we know that they do, use independent contractors. It always shocks me when – and I shouldn’t say “always.” It does shock me when I see it, and it is not infrequently when I see it, that companies open up their books to somebody – whether it is an outside advisor, or the government, or both – and things are sort of sloppy.
You would think companies that have a big valuation and that are growing, that are making money, would look carefully at an issue like this, which is potentially a make-or-break kind of issue. It seems to me, if you look at all the potential dollar ramifications, that they would do some kind of preventative maintenance. I think the biggest message I could give on this point would be: yes, it is great that people are being hired. It is great that there is an expanding economy. But don’t let it go to your head. Take a look at your facts and at your documents. Think about how you would respond if somebody said, “Give me all your documents about your workers. Give me all your contracts. Give me your manuals. Let me look at their files.” You know, “What do you call their files? Let us see what it is that you’re doing and how you’re doing it, so that we can examine whether you have a good case or a weak case.”
SURRAN: It’s not just the contract and the tax forms, is it, Rob? One of my sons applied for a temporary position with a big company. He was told what they needed for his so-called “employee file.”
WOOD: Becky, that is an issue I would call nomenclature. I think FedEx has been criticized for this in some of the litigation, perhaps rightly so, for using all sorts of euphemisms, but of avoiding saying that “e-word”: employment or employee. So, you do not have an employee file. If you are being careful and you believe that you have independent contractors, you have an independent contractor file. I mean, sometimes it sounds kind of silly. But sometimes – maybe, always or often – names do matter. So, be sure that you have – and use – a set of terms that make sense and that are consistently applied, so that you do not end up having egg on your face.
SURRAN: A worker signs an agreement. It covers what he or she is expected to be doing for the business. But, sometimes, things change. How often should companies be reviewing or going through these independent contractor arrangements?
WOOD: That is another good question. It presupposes that there is a thought process and some care in the terms, the so-called nomenclature, and in the contract itself, at the get-go. But then, as you say, Becky, things change. I would say that once-a-year is a good time. In some businesses, it may change more rapidly than that. But I think, if you said, “Every year, we’re going to look at what Mr. X is doing. Is Mr. X working 10 hours a week, 100 hours a week, or something in-between? Is Mr. X working for only us now? Or, is Mr. X still working for A, B and C, the other brand names in our industry? Some relatively easy things can be done. It does not have to be a major undertaking, and probably should be done, because – as you say – things change and often that is another place where companies get into trouble.
SURRAN: Expert commentator Robert W. Wood, thanks, as always, for bringing us up-to-date.
WOOD: Thanks, Becky.