New Year Wishes From The IRS

Happy New Year from the IRS! As 2010 quickly approaches so does the IRS’ National Research Project where 6,000 unlucky companies will have the unfortunate pleasure of being scrutinized by an IRS agent.

The agent’s main focus will be on:

• Form 1099 Independent Contractors – are they properly classified
• Executive pay and fringe benefits
• Expense reimbursement plan qualification

For any company out of compliance they will likely receive hefty fines and penalties to go along with the back taxes.

IRS to Audit 6,000 US Companies

The IRS will audit 6,000 U.S. companies to determine whether they pay all their required employment taxes to fund Social Security and Medicare benefits. The IRS said the audits will provide data for its first statistical analysis since 1984 of how often companies misclassify workers to duck tax obligations, fail to pay taxes on fringe benefits such as personal use of company cars, and improperly pay taxes for company executives. The audits will begin in February, and the companies will be randomly chosen. …

The Treasury Department in 2005 estimated, based on the 1984 IRS data, that companies underpay employer taxes by about $14 billion annually. In particular, federal agencies have raised concerns about whether employers are properly classifying workers as company employees or independent contractors.

Link

House Bill Would Prevent Improper Worker Misclassification

A bill that would remove a loophole, which allows employers to bypass the IRS’s test of whether a worker is an employee or an independent contractor, was reintroduced in the House on July 30, 2009. Called the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (H.R. 3408), the bill would make it more difficult for employers to avoid employment tax liability if they have misclassified a worker as an independent contractor and significantly increase employer penalties in the event of the misclassification.
Reasonable basis test

The bill would add a new section to the Code allowing employers to avoid employment tax liability only if they are able to demonstrate that they had a “reasonable basis” for classifying the independent contractor as an employee. This new Code Sec. 3511 would repeal the safe harbor provisions of current Section 530 of the Revenue Act of 1978.

The “reasonable basis” standard would be met if:

• the employer classified the worker as an independent contractor based on: (i) a written determination that it received addressing the employment status of either the worker in question, or another individual holding a substantially similar position with the employer; or (ii) a concluded employment tax examination stating whether the individual (or one holding a substantially similar position) should be treated an employee.

• the employer (or a predecessor) has not treated any other individual holding a substantially similar position as an employee for employment tax purposes for any period beginning after December 31, 1977.
For purposes of this new section, the determination as to whether an individual holds a position substantially similar to a position held by another individual would be made in accordance with the Fair Labor Standards Act. In addition, the bill provides that any individual who performs services for a taxpayer may petition (either personally or through a designated representative or attorney) for a determination of the individual’s status for employment tax purposes.

Penalty increases
Among other penalties, employers that misclassify employees as independent contractors would be subject to a minimum $250 penalty (an increase from the current $50 fine) per incorrect tax return, up to $3,000,000 (currently $250,000) per year. The penalty imposed could be lowered if the employer’s returns are corrected in a specified period of time. Employers with gross receipts not exceeding $5,000,000 would be subject to fines of up to $1,000,000 per year, up from the current $100,000 fine. Employers that intentionally disregard the filing requirement would be subject to a $500 fine per tax return, up from the current $100 fine. If enacted, the bill would apply to information returns required to be filed after December 31, 2009.

IRS Increases Business Audits

Starting November 2009 the Internal Revenue Service will be increasing business audits as it rolls out an NRP (National Research Program.) The IRS announcement of this NRP advises that it will be focusing on four areas: worker classification, fringe benefits, non-filers and officer’s/directors compensation (especially S corporations). An NRP is rather like an industry-wide audit, and the data gathered from this audit will be used to improve agency compliance efforts with regard to employment taxes.

This program creates a far greater likelihood of your company being audited over the next three years, because the scope of the audit is to randomly select up to 2,000 companies a year for the next three years for inclusion in this audit. Moreover, the NRP doesn’t replace standard IRS audits which will continue at their usual, escalating pace. The selection process is already underway, so there is nothing you can do to avoid being subject to an NRP audit. However, it isn’t too late to take steps to protect yourself, should you be one of the businesses selected for audit either as part of the NRP or outside the NRP.

For further information on steps that your company can take now to protect itself from assessments in connection with IRS audits under the new NRP, contact ICon.

Northwestern Mutual Being Sued for $200M by Misclassified ICs

Three former Northwestern Mutual Life Insurance Co. employees have filed a $200 million class-action lawsuit against their ex-employer, alleging denial of minimum wages and overtime pay. In a suit filed in federal court in San Diego, the employees claim salespeople served as employees but that Northwest Mutual misclassified them as independent contractors, according to the Milwaukee Journal Sentinel.

Employees are not exempt from federal and state wages, while independent contractors are. The Milwaukee, Wis.-based insurer claims that financial representatives selling its products are independent contractors, not employees, and that prior legal cases affirm that business relationship. The suit contends that when the financial representatives sold products, they had little or no discretion and needed management approval to make decisions, were required to work more than eight hours per day and more than 40 hours per week without overtime compensation, according to the Journal Sentinel. A spokesman for Northwestern Mutual told the paper that the allegations are without merit and the company will vigorously defend itself.

Fired Baby Trend Sales Director Awarded $8.4 Million in Wrongful Termination Case

LOS ANGELES—A senior sales representative who worked for Ontario, Calif.-based Baby Trend Inc. for 17 years June 30 was awarded a total of $8.4 million in damages after the company allegedly fired him for complaining about payroll deductions from his commissions, his attorney told BNA July 9 (Gardner v. Baby Trend Inc., Cal. Super. Ct., No. 05cc11681, 6/30/09).

A California Superior Court jury in March rejected Baby Trend’s assertion that Robert Gardner, who worked for the company from 1988 until his firing in June 2005, was an independent contractor, and instead unanimously found that he was an employee under California’s Labor Code, Irvine, Calif.-based attorney Steven R. Young said. As a result, the jury found that Gardner was wrongfully terminated in violation of public policy, and awarded him more than $8.4 million in damages, one of the largest single employee “misclassification” verdicts in history, Young said. While the verdict and jury award took place in March, the judge in the case entered the judgment June 30, Young told BNA.

Worker Alleged He Was Shorted on Commissions

Gardner had an agreement with Baby Trend that paid him a commission on all sales to major retailers Toys R’ Us and Babies R’ Us, but at a certain point, Baby Trend began “shorting” him on his commissions, Young said. After Gardner complained, the company ordered him to attend a June 30, 2005, meeting, which he said he could not make, Young added. He then was fired from his job. The company argued that because Gardner was an independent contractor, it could deduct whatever it wanted from his commissions, but under California labor law, the determination of whether a worker is an independent contractor or an employee largely turns on the measure of control the employer has over that worker, Young said.

Jury Found Sufficient Control

The jury had been convinced that by ordering Gardner to the June 30 meeting, and then firing him when he could not attend, Baby Trend had sufficient control to classify Gardner as an employee, Young said. The judgment assessed $6.9 million in damages jointly against Baby Trend and its owner, including economic damages of $5.1 million, lost earnings of $1.5 million, and mental suffering of $275,000; and another $1.5 million against Baby Trend, including failure to reimburse, $1.0 million; waiting time, $165,231; and breach of contract, $306,137. The jury also found that Baby Trend and its owner acted with malice, oppression and fraud, but the jury then deadlocked on punitive damages, Young said. However, motions for attorneys’ fees and costs, and supplemental penalties, could push the judgment to more than $10 million, he said in a July 7 statement.

Daniel J. Gonzalez, an attorney with Horvitz & Levy in Encino, Calif., who represented Baby Trend, told BNA July 9 that he had no comment. James Finberg, an employment law specialist with Altshuler Berzon LLP in San Francisco, agreed that the judgment was “certainly one of the largest I’ve heard of” for employee misclassification. The “control issue” is key in determining whether a worker is an employee or an independent contractor, he added.

New Colorado Law Increases Penalties for Misclassification of Independent Contractors

On June 2^nd 2009, Colorado Governor, Bill Ritter, signed H.B. 1310 into law.  Besides being ordered to pay back taxes and interest, should an employer be found to have willfully misclassified employees, the law imposes a $5,000 fine for each misclassification in first time offences, and $25,000 fines for each subsequent willful misclassification, plus a two year ban on receiving State contracts. 

It is more essential than ever that companies using independent contractors are certain that they are correctly classified according to both State and Federal Guidelines.  This trend of State governments imposing and enforcing higher penalties for the breach of existing laws is likely to continue as they scramble to balance their budgets in a struggling economy. 

It is far cheaper and easier to proactively institute a comprehensive independent contractor compliance program, than it is to handle the aftermath of a failed Federal or State audit.

http://www.leg.state.co.us/Clics/CLICS2009A/csl.nsf/fsbillcont3/5A72B6BA7FD7ABC3872575600081B8CE?Open&file=1310_enr.pdf

Revenue Proposal 2010 – Contractors must provide a Certified Tax ID, or have tax withheld

One of the proposals outlined in the Obama Administration’s proposed budget for Fiscal Year 2010, if enacted, will be effective for payments made to independent contractors after December 31st 2009.

Under this proposal any contractor receiving payments of $600 or more in a year from a business would be required to provide that business with a certified Tax ID Number (TIN). The business making payment to the contractor would have to verify the TIN with the IRS. If the accuracy of the number cannot be verified the business would need to withhold a flat rate percentage from the gross payments due to the independent contractor. In addition the contractor may require the business to withhold a certain percentage of gross payments to remit to the IRS.

Currently businesses have to report payments made to independent contractors to the IRS, but the details in the report are not verified by the IRS. In addition there are no provisions for tax withholding from independent contractors under Federal law.

The rationale behind the changes is that the current unverified reporting requirements are not helping in improving compliance with required tax payments. In addition, the thought is that withholding taxes at source will be beneficial for independent contractors who have difficulty in putting away the necessary funds to pay Self Employment taxes, increasing compliance on that front too.

http://www.treas.gov/offices/tax-policy/library/grnbk09.pdf

Disclosure of Tax Return Information

Companies collecting tax filings as evidence of an individual’s independent contractor status may run into issues this year when directed by such contractors to request the information directly from their tax preparers. An updated IRS ruling relating to disclosure by tax preparers of tax return information to third parties, modernizes the rules originally set forth in section 7216(a) of the Internal Revenue Code, by providing guidance related to circumstances in which disclosure of tax return information by a third-party tax return preparer is permissible by electronic means.

Under the final regulations (Revenue Procedure 2008-12), effective January 1st 2009, preparers must obtain taxpayer consent, by either paper or electronic means (specific security requirements are included with regard to an acceptable electronic signature), before tax return information can be disclosed to any third party or used for any purpose other than filing the return. Tax return information includes any information furnished in connection with the preparation of a tax return including the taxpayer’s name, address, and identifying number.

The consent must state the intended purpose of the disclosure, identify the recipients of the information, and describe the particular disclosure or use of the information that is being authorized. Taxpayers cannot be required to sign the consent and may limit the period of time for which the consent is valid. There are some exceptions to the obtaining of the tax payer’s consent, including disclosing the information to the IRS.

A violation under these regulations is a misdemeanor. The maximum penalty is equal to one year’s imprisonment or a fine of $1,000 or both.

Prior to the introduction of this clarification, tax preparers tended to accept a request by email from the taxpayer as electronic consent to forward tax return information to third parties. Under the clarifications in these final regulations such a request would not constitute acceptable consent.

http://www.irs.ustreas.gov/pub/irs-drop/rev._proc._2008-12.pdf

A Unified Independent Contractor Classification Test for Workers’ Compensation and State Unemployment Insurance?

Washington State uses a seven-part consolidated exception test for determination of independent contractor status under state unemployment compensation and workers’ compensation laws in Washington. All parts of the test must be met for a worker to qualify as an independent contractor.

The test combines the ABC Test with four additional requirements, making it more difficult for a worker to qualify as an independent contractor. For details click here:

http://apps.leg.wa.gov/documents/billdocs/2007-08/Pdf/Bill%20Reports/House/3122.HBA%2008.pdf

It will be interesting to see if other states adopt this approach, in a move towards streamlining the definition of an employee under that various different laws.