Now, the IRS has announced a new program, the Voluntary Classification Settlement Program (VCSP), for businesses who have misclassified workers as independent contractors.  Effective September 21, 2011, the program gives employers an opportunity to proactively reclassify their workers as W-2 employees.

To be eligible, the employer must meet certain criteria:

• They must have consistently treated the workers as non-employees;
• They must have filed 1099s for the workers for the previous three pears;
• Cannot already be under an audit by the IRS or other government agency regarding classification of workers.  If an employer had been previously audited, they may participate in this program only if they have complied with the results of that audit.

If the taxpayer meets the criteria, they may participate in the VCSP by agreeing to the following:

• They must pay 10% of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year;
• They will not have to pay interest and penalties on it;
• They will not be subject to audit of the reclassified workers for prior years; and
• They will agree to extend the statute of limitations on assessment of employment taxes from three to six years.

When considering whether to participate in the program, employers should be aware that while the VCSP protects employers from the IRS, it does not offer protection from state initiatives or from claims for the noncompliance during the past time periods.  For example, there may be prior state or local taxes or unemployment or workers’ compensation insurance now due or the worker could have been entitled to leave, participation in benefit programs or been denied minimum wage or overtime wages.

Employer should do a thorough risk-benefit analysis with competent professionals prior to deciding whether to participate in VCSP.  Anyone who wishes to do so must submit Form 8952, Application for Voluntary Classification Settlement Program (VCSP) at least sixty (60) days before they wish to begin the process.  If eligible, the IRS will contact the employer.

For more information, see:

http://www.duanemorris.com/alerts/irs_announces_new_voluntary_worker_classification_settlement_program_4226.html

http://www.irs.gov/pub/irs-drop/a-11-64.pdf

http://www.nixonpeabody.com/publications_detail3.asp?ID=4053

The new law assumes a worker is a W-2 employee unless they meet all of the following criteria:  1) they are free from direction and control in performing services; 2) the service(s) being performed are outside the scope of the company; and 3) they are engaged in an independently established trade, occupation or business similar to the task or service they are providing.

The law also contains a 12-part test (see the hyperlink) to determine when a sole proprietor, partnership, corporate or other entity is a “separate business entity” from the entity for which it is providing the service.  All 12 items must apply for the entity to be deemed separate.

Violations of the Fair Play Act will result in significant penalties.  Employers will be assessed $2,500 per employee for a first violation and $5,000 for any subsequent violations.  Employers can also be subject to criminal prosecution with up to thirty (30) days in jail, up to a $25,000 fine and debarment from Public Work for up to one year for a first offense.  Subsequent offenses could result in sixty (60) days in jail, up to a $50,000 fine and up to a 5-year debarment. 

Employers must post a notice about the Fair Play Act in a conspicuous place in the workplace within thirty (30) days of the effective date of the new law.  Failure to post can result in a fine of $1,500 for a first offense and up to $5,000 for a second offense.

Pennsylvania joins sixteen (16) other states that have enacted legislation seeking to eliminate misclassification of employees, particularly targeting the construction industry, where misclassification appears to be the most rampant.

A construction worker will be considered an independent contractor only if 1) there is a written contract in place; 2) the individual is free from control or direction over the performance of services; and 3) the individual is customarily engaged in an independently established trade or business.

If an employer fails to properly classify a worker, civil penalties of up to $1,000 for the first violation, and up to $2,500 for subsequent violations, could be levied.  Further, an employer, officer or agent of the employer can be convicted of a third degree misdemeanor for the first offense.  Subsequent offenses would be considered second degree demeanors and could mean jail time.

Employers should review their policies to ensure compliance with the new legislation.

Employers would be required to provide written notice to those employees they have identified as independent contractors, which includes 1) their classification; 2) the Department of Labor (DOL)’s website established for providing additional information about employees’ rights; 3) address and telephone of their local DOL office; and 4) any additional information as required.

The EMPA would ensure that employers keep accurate records classifying each worker accordingly, and would increase penalties for noncompliance.  It would also provide protections to workers who are discriminated against because they have asked to be accurately classified.  For any infraction, employers could be fined up to $1,100 per day per employee, up to $5,000 per employee per day for repeated violations, and liquidated damages.

Lastly, the EMPA would enhance state and federal efforts to combat misclassification by mandating DOL-monitored state audits, increasing state penalties, providing a mechanism for the DOL and Internal Revenue Service to refer incidents between each other, and directing the DOL to perform audits on “frequent offender” industries.

In addition to the federal proposed legislation, many states, including New York, New Jersey, Connecticut, Nebraska and Ohio are strengthening state legislation on their own.

Employees who are misclassification as independent contractors are deprived of the benefits and protections they are legally entitled to, such as overtime and unemployment benefits.  The government also does not get the money they are entitled to, specifically in the Social Security, Medicare and Unemployment Insurance Trust Funds, as well as any other taxable benefits an employee may otherwise receive.  To reinforce the Department of Labor’s commitment to solving this problem, the 2011 budget also includes an additional $25MM for a Misclassification Initiative.  It includes the addition of 100 additional enforcement personnel and competitive grants to boost state incentives and capacity to address the problem.  

The budget also includes $50MM for a State Paid Leave Fund within the Labor Department, which will provide grants to help states who wish to introduce paid leave legislation pay their start-up costs.

The detailed budget can be found at http://www.dol.gov/dol/budget/.

The auditors will focus on three areas: 

1. Worker classification.  The IRS will focus on exempt status as well as an employer’s utilization of independent contractors.  Classifying workers incorrectly results in a loss of revenue for the government, in the form of nonpayment of taxes for those incorrectly classified as independent contractors, as well as additional taxes on overtime wages not paid to employees who were misclassified as exempt.
2. Benefits.  The IRS will focus on whether employers properly included taxable benefits in wages.  Since some benefits are taxable, an employer could find itself responsible, for example, for failure to pay taxes on benefits that should have been offered to a worker incorrectly classified as an independent contractor. The government will also scrutinize expense reimbursement practices. 
3. Executive compensation.  The IRS will look at regular compensation, as well as nonqualified deferred compensation structures.

Employers are encouraged to review their workplace procedures and practices.

The bill would require businesses that pay more than $600 annually to corporate service providers to file Forms 1099, and would significantly increase penalties for a company’s failure to do so.  It would also revise Section 530 of the Internal Revenue Code by limiting its safe harbor provisions for businesses that classify workers as independent contractors.

Under the proposed legislation, a business would have a reasonable basis for treating an employee as an independent contractor only if 1) no other classified employee held a similar position after 1978; or 2) the IRS did not conclude, in writing or by personal interview with the worker in question, that the worker is an independent contractor.

It is now more important than ever to classify your employees correctly.  It is tied to wage and hour laws, specifically payment of overtime, which is a fast-growing area of contention and litigation.  Non-compliance with the rules can lead to government fines, penalties and enhanced government presence in your workplace.

The text of the bill can be found at http://www.govtrack.us/congress/billtext.xpd?bill=s111-2882

The DOL has received an 18% budget increase for 2010. 

In addition, the IRS has instituted what they call “the National Research Program on employment tax compliance has focused their efforts on improper worker classification as well as “non-conforming benefits.”  These are benefits that could be considered wages and therefore subject to employment taxes, i.e. personal use of company vehicles, employee discounts, educational assistance, etc. 

The IRS will be looking at tax records for 2007 and 2008.

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Over 350 workers at a California maid service and carpet cleaning company were awarded $2.5 million in back wages, including unpaid overtime, after the U.S. Department of Labor found that their employer wrongly classified them as independent contractors.  The owners were also fined $1 million in liquidated damages.  The owners disregarded the court order, and were recently taken into custody for failure to make the required payments.  They were later released pursuant to their promise to pay the required fines within a week’s time.

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Wal-Mart won final approval of an $85 million settlement to pay workers who sued for unpaid wages.  The settlement is part of a global $640 million settlement reached in December.  Workers in 30 states filed actions against Wal-Mart, claiming the company denied them rest breaks and manipulated their timecards to reduce their wages.