Introduction to the New Initiative
Effective January 1, 2021, Virginia’s General Assembly added several new provisions to the Virginia Tax Code, Title 58.1 of the Code of Virginia (the “Code”), to address concerns raised by the Virginia Department of Taxation with worker misclassification. The Tax Department is now moving forward to enforce these new laws.
What is “worker misclassification”?
According to the Virginia Tax Department’s website, worker misclassification describes it as incorrectly identifying individuals as independent contractors when they are really employees. The new statutes, specifically Section 58.1-1900, explicitly conform to the IRS definition of worker misclassification. The IRS definition assumes that an individual performing services for an employer for remuneration — payment for their work or services — is an employee unless the business can show that the individual is an independent contractor according to established guidelines. As of 2021, Virginia Tax will use the IRS guidelines to make worker classification determinations.
This focus on worker misclassification is led by the Virginia Attorney General’s Worker Protection Unit, a multidisciplinary team of prosecutors and attorneys who will educate Virginia workers on their rights and investigate, stop, and prosecute the exploitation of Virginia workers, including worker misclassification. Virginia Tax intends to engage with the Worker Protection Unit as requested and allowed by law.
Virginia Tax has announced it is conducting regular audits looking into worker misclassification. Businesses that misclassify their workers can be found liable for civil penalties, as more fully discussed below.
How to Classify Your Workforce
As a general rule, anyone who performs services for you is your employee if you have the right to control both what will be done and how it will be done. The IRS Guidelines for classifying workers fall into 3 categories (behavioral control, financial control, and type of relationship) with assessment questions for each.
- Behavioral control: Does the employer control or have the right to control what the worker does and how the worker does their job?
- Financial control: Are the business aspects of the worker’s job, such as how the worker is paid, who provides tools and supplies, etc., controlled by the payer?
- Type of relationship: Are there written contracts or employee-type benefits such as pension plans, insurance, vacation pay, etc.? Will the relationship continue and is the work performed a key aspect of the business?
Planning for a Worker Misclassification Audit
The Virginia Tax Department has stated it will start with businesses and industries that have issued 1099-NECs and 1099-MISCs to determine if these individuals were appropriately classified as independent contractors.
If your business is selected, you need to review the list of required documents (e.g. W-2s, 1099s, cash disbursements journal, check registers, petty cash, etc.) the auditor will request at the initiation of the audit. You will need to confirm with your auditor the period of time under audit – knowing the specific period of time under audit is critical in gathering, reviewing, and providing the required documentation.
Violations and Penalties
If an audit finds an employer in violation of the worker misclassification statutes, they will be subject to an escalating set of penalties under Section 58.1-1901 of the Code. Any officer or agent of the employer can be found to be in violation through the audit as well, and fines are:
- First offense: up to $1,000 per misclassified individual.
- Second offense: up to $2,500 per misclassified individual.
- Third or subsequent offense: up to $5,000 per misclassified individual.
On its website, the Tax Department states that all occurrences of misclassification by the same employer within 72 hours will be treated as a single offense. In other words, 25 misclassified employees in one audit would mean it’s a single offense, not 25.
In addition to the penalties, under Section 58.1-1902 of the Code, any employer with more than one misclassification violation will be barred from certain government contracts for up to a year, and up to 3 years for subsequent offenses. In addition, businesses found to be in violation of the worker misclassification statutes will be liable for withholding taxes for any individual who was improperly classified for the period they were employed, as well as penalties and interest on those taxes.
Section 58.1-1903 of the Code bars employers from requiring or requesting an individual to sign an agreement that results in misclassification of the individual as an independent contractor or otherwise does not accurately reflect the relationship with the employer.
In addition, Section 58.1-1904 of the Code prohibits an employer or other party from discriminating in any manner, or taking any adverse action, against any person in retaliation for exercising rights protected under these new statutes.
These new worker protection initiatives mean that employers need to be particularly careful when making determinations as to whether to classify and treat individuals as employees or independent contractors.