The battle between employers and government agencies over the classification of workers as employees or independent contractors (an “IC”) has been waged for years. Last year, the Internal Revenue Service and the U.S. Department of Labor announced a joint effort to deal with worker misclassification.
One may ask why the government is so interested in this subject. Well, for one thing, there is the avoidance of payroll taxes by employers using the IC classification wrongfully at a time when the government is strapped for revenue. Another reason for government interest in the subject is the ability to enforce and monitor the status of employee benefits. Into the latter category falls health benefits particularly the provisions of the Affordable Care Act (“ACA”) (“Obamacare” per the pundits)), thereby giving even greater impetus to government investigation of worker status. Indeed many “small businesses” claim that the use of independent contractors allows them to remain competitive by reducing tax expenditures and overhead in the form of facilities, job related supplies and benefits. On the other hand, workers classified as independent contractors may take deductions against their income thereby increasing their desire to be classified as such. Workers may wish to secure health, overtime and leave protections by claiming to be employees, a claim with which employers might take issue for the reasons stated above.
The IRS and other governmental agencies are not bound by any agreement between the worker and the business classifying the worker as an employee or independent contractor. A multifactor test is usually applied to make the determination and the test is very fact specific. Many readers believe that a determination that a worker is an employee or IC is an “all or nothing” proposition, one way or the other, but a recent case in the Tax Court underscored the possibility that a worker may be an employee AND an independent contractor.
In Ramirez v. Commissioner, T.C. Summary Opinion 2013-38, decided May 20, 2013, the Tax Court dealt with a situation in which a worker claimed he was entitled to certain “self-employment” deductions in spite of the fact that he received a W-2 for all his earnings from a single workplace. The case was a small Tax Court case and the opinion cannot be treated as precedent for any other case or reviewed in any other court, but it is noteworthy for shedding additional light on worker classification issues and the ability of a worker to wear two “hats” with the same workplace. Despite its lack of “precedential weight” such small Tax Court cases are often closely followed by hearing officers and field agents within the IRS in reaching their conclusions in payroll tax audit matters.
Mr. Ramirez was a radio personality for a Texas radio station with which he had an employment agreement pursuant to which he was paid a base salary, bonus, and stock options. The employment agreement contained the usual provisions about the employer’s ability to direct and control the rendition of Mr. Ramirez’s services and required him to follow employer policies.
The radio station fell on hard times and considered cessation of broadcasting. In light of that, Mr. Ramirez became involved in seeking additional advertising sponsors for the station, initially with its own sales force. However he soon developed his own sponsorship base.
Mr. Ramirez worked directly with his sponsorship base, without a contract with them, at a price not set by station management but by him. His remuneration from the sponsors was dependent on the amount of effort he expended in working with them in developing their advertising and providing promotional efforts for them both on and off-air. The sponsors were paying for both his “radio persona” as well as his promotional acumen. This work was not governed by Mr. Ramirez’s employment contract and the only oversight by his employer consisted of making sure that the on-air material was not fraudulent and that it did not jeopardize the radio station’s license.
The station served as a conduit for sponsor payments to Mr. Ramirez for his “promotional activities” and his fee was included as a line item in the sponsor’s invoice from the station. His earnings statements had two components: salary was noted as “Regular” earnings; and “Talent and Remote” reflected payments for his promotional services. The station withheld income tax and payroll taxes with respect to each category of payment and Mr. Ramirez was issued a “W-2” for all his earnings.
On the joint return he filed with his wife, Mr. Ramirez reported all his income but claimed deductions on his return’s self-employment schedule, without separately stating the promotional income included in his W-2. A note from Mr. Ramirez and a letter authored by the station explained the nature of the “Talent and Remote” promotional income and its inclusion in the W-2.
The issues asserted were, by Mr. Ramirez, that he was an employee with respect to his radio personality duties but an independent contractor with respect to his promotional efforts for his sponsorship base and the expenses he claimed were deductible as such. The IRS contended that the expenses claimed, while reported accurately, were Miscellaneous Itemized Deductions, not deductible self-employment expenses, and, as such, were subject to the 2% floor on adjusted gross income. (Mr. Ramirez’ accountant had requested that both a W-2 and a 1099 be issued to Mr. Ramirez, but the radio station refused to do so resulting in reporting of all the income on the W-2 as “wages” on the Ramirez’ return so that the return and the W-2 matched.)
The Tax Court decision highlights some of the key factors in determining whether a worker is an employee for tax purposes and notes that not one factor alone is the sole determinant of status. However, the opinion notes that the “degree of control exercised by the principal over the worker is the crucial test in determining the nature of a working relationship” including control over the result of the work and the “means and methods used to accomplish the result”. As to this “crucial test” the Tax Court found that Mr. Ramirez was not under the control of his employer for purposes of his work with the sponsor base he secured. The opinion goes on to cite additional factors, discussing each separately, which led to the conclusion that he was not an employee for that work.
In the labor and employment arena, the U.S. Department of Labor (Wage and Hour Division) is focused on the classification of workers from a compensation and benefits perspective. To that end the DOL launched a “Misclassification Initiative” in 2011which sought to prevent, detect and remedy employee misclassification. Pursuant to the Initiative, the DOL entered into a “Memorandum of Understanding” with the IRS in September, 2011 pursuant to which the IRS and the DOL share information on worker classification cases under review in those agencies. Maryland is one of fourteen states which have also entered into a Memorandum of Understanding with the DOL similar to that entered into between the DOL and IRS.
Despite the cooperation evidenced by the Memoranda of Understanding mentioned above, the worker misclassification issue is complicated by the fact that the tests employed by the labor agencies are different from those employed by the taxing authorities. While not altogether dissimilar they are sufficiently so that a different analysis is required under the facts of a particular case for each agency, be it tax or labor. The U.S. Wage and Hour Division sets forth its criteria for an “employment relationship” pursuant to the Fair Labor Standards Act in Fact Sheet 13 and notes that if such a relationship is found to exist the rules on Federal minimum wage, overtime, youth employment and record keeping are brought into play.
In Maryland, the Worker Classification Protection Unit, Division of Labor and Industry, is charged with enforcement of worker classification matters, which describes “knowing” misclassification as “workplace fraud”, as misclassification relates to the construction and landscaping industries. As to those workers, there is specific statutory protection in Maryland to enforce proper classification of workers.
In addition, Maryland established the “Joint Enforcement Task Force on Workplace Fraud” which issued an Annual Report in 2011 highlighting issues relating to Workplace Fraud and worker misclassification in Maryland. That Report noted that “potentially inconsistent determinations” between state agencies might result from the application of different tests for worker classification by different state agencies, but also notes that the federal and state tests often result in the same outcome. (The Workplace Fraud Act, dealing with construction and landscaping businesses, uses the “ABC” test long employed under the Maryland Unemployment Insurance law, setting forth three factors in determining whether an employment relationship is “presumed”, absent an exemption under the law.)
So what can employers do to protect their respective rights in worker classification matters? They should consider:
• Familiarizing themselves with the rules and possible remedial steps;
• Qualifying, if an employer, for the Internal Revenue Code Section 530 Safe Harbor in order to eliminate all (past and future) federal employment tax exposure for those independent contractor relationships which qualify; and
• Seeking Internal Revenue Code Section 3509 relief, the “Classification Settlement Program”, and the temporary Voluntary Classification Settlement Program with the IRS.
Employers who are concerned that they may have workers who are misclassified should have a labor and employment attorney assess the classification of their workers before they are contacted by a federal or state agency or a plaintiff’s attorney.