New Misclassification Bill Introduced In Congress: The Independent Contractor Tax Fairness And Simplification Act Of 2012 Seeks To Eliminate ‘Safe Harbor’ For Businesses

by Pepper Hamilton LLP
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Yesterday, December 12, 2012, Rep. Erik Paulsen (R-Minn.) introduced a bill that bears many similarities to a bill introduced earlier this year by 33 Democrats. The Independent Contractor Tax Fairness and Simplification Act (H.R. 6653) would, like the Fair Playing Field Act (H.R. 4123) introduced on March 1, 2012 by Democrats, eliminate prospectively the “safe harbor” first enacted in 1978 and relied upon by some businesses that for years may have misclassified employees as independent contractors (ICs).

Similarly, both bills would allow a business that has treated a worker as a IC to qualify for a form of retroactive safe harbor for purposes of past employment tax liability if the business has had a reasonable basis for not treating the worker as an employee and has consistently reported the earnings of the worker and others similarly situated on a 1099 basis.

Neither the Democrats’ earlier bill nor this new bill introduced by a Republican congressman would, if enacted, eliminate the use of ICs; rather, the proposed “Findings” in both bills acknowledge the important role ICs play in the economy.

Key Differences

There are a number of key differences between the bills, however. The Fair Playing Field Act bill, if enacted, would require the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. H.R. 6653, on the other hand, specifically prohibits the issuance of new regulations or Revenue Rulings by the Department of the Treasury with respect to the employment status of any individual for employment tax purposes.

While both bills expressly state that the term “employment status” shall mean the classification of an individual as an employee or IC “under the usual common law rules,” H.R. 6653 (unlike the Democrats’ bill) would codify a new form of “safe harbor” if the worker meets all four of the following factors:

  • incurs significant financial responsibility for providing and maintaining equipment and facilities
  • incurs unreimbursed expenses or risks income fluctuations because remuneration is “directly related to sales or other output rather than solely to the number of hours actually worked or expenses incurred”
  • is compensated on such factors as percentage of revenue or scheduled rates and not solely on the basis of hours or time expended, and
  • “substantially controls the means and manner of performing the services” in conformity with regulatory requirements, or “the specifications of the service recipient or payor and any additional requirements” in the parties’ written IC agreement.

Analysis

This bill puts forth a new safe harbor that appears to be limited to a defined segment of ICs who bill for services on the basis of scheduled rates, such as truckers and messenger couriers. Thus, the bill would exclude from this safe harbor many legitimate ICs that are traditionally compensated on an hourly rate, such as professionals (including sole practitioner lawyers, accountants, architects, designers, and interpreters) as well as sole proprietors in the skilled trades (including electricians and plumbers). It would also exclude legitimate ICs who have little or no expenses or equipment, such as freelance editors and writers. Other legitimate ICs would undoubtedly also be excluded under the four-factor test.

The bill also appears to have an escape clause that has not been recognized by the courts and administrative agencies as indicative of IC status. In the fourth factor, a service recipient may direct the service provider by inserting into the parties’ IC agreement its “specifications” or “any additional requirements” without creating an employment relationship. Generally, requirements imposed by the service recipient as to how the work is to be performed are taken into account in determining if the hiring party exercises control or direction over the means and manner by which the services are performed. Such direction and control is indicative of employee status. In contrast, specifications and requirements as to the end-product of the services, i.e., what the services the individual is being hired to perform, are not indicative of employee status inasmuch as all ICs must be told what they are being retained to do.

The scope of both bills is also limited. Neither bill would have any impact on whether a worker is an IC or employee under the federal Fair Labor Standards Act (FLSA), which governs minimum wages and overtime. The determination of whether a worker is an IC or employee under that labor law is based on a variation of the common law standard frequently referred to as the “economic realities” test. Thus, a worker that may qualify for IC status under H.R. 6653 may not qualify for IC status under the FLSA.

State labor, unemployment, and workers compensation laws would not be affected by either bill. Some of those laws are not based on the common law but rather contain a different statutory scheme that have a list of factors that must be met in order to qualify for IC status.

Most companies that have business models that are IC-dependent or simply make use of multiple ICs are aware that they are at risk of IC misclassification liability if they have not properly classified these workers. Businesses can enhance IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers, as described in our white paper on minimizing IC misclassification liability.

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