New guidance issued by the U.S. Department of Labor provides clarification on the definition of an independent contractor (Administrator’s Interpretation No. 2015-01). This guidance may be helpful to employers who are contemplating hiring extra workers but are concerned about all of the obligations associated with hiring employees, including health insurance, workers’ compensation, unemployment insurance, sick time and vacation time.
Employers generally prefer to classify workers as independent contractors to lower costs, even if it means less control over a worker’s day-to-day activities. But the government is on the lookout for businesses that classify workers as independent contractors to reduce taxes or avoid their health insurance obligations under the Affordable Care Act (ACA).
Here’s an overview of the worker classification issue, along with the scoop about a form that can be filed by your business or a worker to ask the IRS to make worker classification determinations.
Why Classification Matters
When your business classifies a worker as an employee, you generally must withhold federal income tax and the employee’s share of Social Security and Medicare taxes from his or her wages. Your business must then pay the employer’s share of Social Security and Medicare taxes, pay federal unemployment tax, file federal payroll tax returns and follow lots of other burdensome IRS and DOL rules.
You may also get socked with state and local unemployment and worker compensation taxes and have to comply with more rules and regulations. Dealing with all this can cost thousands of dollars per year for each employee.
On the other hand, independent contractor status is attractive because you don’t have to worry about employment tax issues, and you don’t have to provide expensive fringe benefits like health insurance, retirement plans and paid vacations. If you pay $600 or more to an independent contractor during the year, you must issue a Form 1099-MISC to report what you paid. That’s generally the extent of your bureaucratic responsibilities.
Businesses now have an extra incentive to classify new hires as independent contractors: It lowers their headcounts for purposes of complying with the ACA, thereby reducing their health insurance costs and reporting requirements.
Here’s the rub: If you incorrectly treat a worker who is actually an employee as an independent contractor, your company could be assessed unpaid payroll taxes plus interest and penalties. You also could be liable for employee benefits that should have been provided but weren’t, including significant penalties under federal laws.
How to Support Contractor Status
The DOL and IRS apply an “economic realities test” to determine worker classification (see “Factors to Decide Worker Classification” at right). But the determination traditionally boils down to this: A worker is an independent contractor if you have little or no control over the way that person gets the job done. If you provide substantial day-to-day supervision, the worker is probably an employee.
To complicate matters, a worker may also be considered an employee if he or she works full-time for you, has no other significant clients, is required to make extensive daily progress reports and gets paid by the hour (or day, week or month) rather than by the job.
It certainly helps your independent contractor argument if the work is performed away from your premises using equipment owned by the worker. But those facts aren’t a cure-all — especially if you treat another worker in essentially the same circumstances as an employee.
A written contract can help support a worker’s independent contractor status and minimize ambiguity. The contract should:
• Refer to the worker as a contractor and refer to payments as contract payments (not wages),
• Permit the worker to take on other projects,
• Refrain from requiring full-time work or request daily visits to your premises,
• Specify that payment is due on completion of the project or at designated progress points,
• Limit the term, rather than be open-ended, and
• State you won’t pay for expenses except in specific instances.
Of course, you must then adhere to the terms of the contract.
Why Businesses Refrain from Using an IRS Form
Alternatively, you can file IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Then, the IRS will prescribe how to classify a worker. However, be aware that the IRS has a history of reflexively classifying workers as employees rather than independent contractors.
Businesses should consult with their tax advisers before choosing this alternative, because Form SS-8 may alert the IRS that your business has worker classification issues — and inadvertently trigger an employment tax audit.
When Workers File Form SS-8
A worker seeking a determination of his or her status as an employee or independent contractor can also file Form SS-8. Disgruntled former workers are especially likely to file the form to show that a business improperly denied employee benefits by classifying him or her as an independent contractor.
Once a worker files Form SS-8, the IRS will send a letter to the business that explains the situation, provides the worker’s identity and includes a blank Form SS-8. The IRS will ask the business to complete the form and return it to an assigned IRS technician who will render a worker classification decision. The business and the worker will both receive a written determination letter that states the IRS’s conclusion.
If you receive notice that one of your workers has filed Form SS-8, understand the following:
• The odds are good that the worker’s Form SS-8 will skew the facts in favor of employee status, because the worker understands that status is more beneficial to him or her. Workers may claim employee status to gain health, retirement and paid-to-off benefits and to eliminate self-employment tax liabilities.
• The IRS technician may discount the Form SS-8 responses that you turn in and decide the worker is an employee.
• Form SS-8 instructions state that the IRS’s determination letter applies only to the worker (or class of workers) that requested a determination.
• Your business can safely disregard the IRS’s determination letter if you’re entitled to Section 530 relief. Basically, this relief is available if there’s a historical or tax law precedent for treating the type of worker in question as an independent contractor if 1) your business has always treated such workers as independent contractors and 2) has reported payments to them on Form 1099-MISC. When Section 530 relief is available, the IRS cannot force you to reclassify affected workers as employees. Your tax adviser can help you determine if your business qualifies for Section 530 relief.
• Neither the Form SS-8 determination process nor the review of any records in connection with the determination constitutes an official IRS audit. While there’s no procedure to appeal a Form SS-8 determination, ask your tax adviser if your business can simply disregard it.
Stand Your Ground
What should you do if your business has been properly classifying workers as independent contractors and a worker turns in a Form SS-8 indicating the contrary? You may want to continue to treat the worker as a contractor — regardless of what the IRS determination letter says. However, if you stand your ground, be prepared for an employment tax audit. Your tax and legal advisers can help with that and other issues involved with independent contractors.
Factors to Decide Worker Classification
The federal government and courts apply an “economic realities test” when deciding whether workers should be classified as independent contractors or employees for federal employment tax purposes and compliance with labor laws:
1. Degree of control,
2. Investment in equipment and facilities,
3. Whether the worker has an opportunity for open-ended profit or outright loss,
4. Whether the worker can be discharged,
5. Whether work is related to the employer’s core business,
6. Permanency of relationship between the employer and worker, and
7. Relationship the employer and worker believed they were creating.
The recently issued Department of Labor guidance also introduces the concept of “economic dependence” into the economic realities test.
In addition, there’s historical precedent for classifying these types of workers as independent contractors:
• Nurses, home health care workers, physical and occupational therapists and special education instructors who work for staffing agencies,
• Taxi, limo and commercial truck drivers,
• Messengers and delivery service drivers, and
• Freelance photographers, writers, dance instructors, cable and internet installers, medical and legal transcriptionists, IT consultants, massage therapists, cosmeticians and carpet installers.
Contact your tax and legal advisers for help deciding whether to classify workers as employees or contractors. This is an important decision that can have significant consequences if handled improperly.
Stuart Katz, CPA, MST and Ralph Citino, CPA of Shechtman Marks Devor presented an informative program on Taxable vs. Nontaxable Fringe Benefits and Employment of Foreign Nationals to the staff at Your Part Time Controller at Temple University Center City.
As the U.S. Supreme Court adjourns for its summer recess, the landmark cases about same-sex marriage and the Affordable Care Act premium tax credits have garnered most of the publicity. However, you should also know about these three lesser-known Supreme Court decisions that may significantly affect your business.
Kimble v. Marvel Enterprises (S. Ct. No. 13-270, June 22, 2015)
An inventor created a toy that simulated the web-shooting powers of Spiderman. The invention consisted of a glove with a valve and a canister of pressurized foam, allowing users to shoot webs from the palms of their hands.
In 1991, the inventor obtained a patent on the device. Subsequently, he met with representatives from an affiliate of Marvel Enterprises (Marvel) that markets Spiderman products, but the company didn’t enter into any agreement with him. Soon afterward, Marvel began selling a similar toy.
The inventor sued Marvel in 1997 and the two sides settled in 2001. Under the terms of the agreement, Marvel agreed to pay an ongoing 3% royalty rate on sales of the toy. The patent expired in 2010, but the settlement had no “sunset date.” The parties went to court after they disagreed about the royalty calculation.
In a 6-3 decision, the Supreme Court preserved its holding from a controversial 1964 case — Brulotte v. Thys Co. — that effectively punishes parties who sign away their patent rights. Citing Brulotte, the Court ruled that royalty agreements weren’t enforceable after a patent expires.
This case reinforces the controversial notion, based on Brulotte, that royalty payments may be limited to the patent term. In practice, many royalty agreements don’t include a “sunset date,” or they otherwise imply that payments will occur indefinitely.
In the United States, the term of a new patent is generally 20 years from the date on which the application for the patent was filed in the United States or, in special cases, from the date an earlier related application was filed, subject to the payment of maintenance fees. Although 20 years may seem like a long time, it often takes several years from the application date for a patent to be approved by the U.S. Patent and Trademark Office and for a product to go to market.
As the dissenting opinion points out, entities that own patents — such as inventors, high-tech start-ups, research hospitals and universities — may be adversely impacted by this decision. On the other hand, businesses that pay royalties may be able to reduce their royalty expenses by keeping track of patent expiration dates.
Equal Employment Opportunity Commission v. Abercrombie & Fitch Stores, Inc. (S. Ct. 14-86, June 1, 2015)
Abercrombie & Fitch Stores (Abercrombie), a national chain of clothing stores, requires employees to meet a “look policy” reflecting its style. The policy prohibits black clothing and caps, although it doesn’t expressly define the term “cap.” If a question concerning the policy arises during a job interview, the policy specifies that the job applicant should contact the company’s human resources department.
In 2008, a practicing Muslim applied for a position at an Abercrombie store. The job applicant wore a hijab, a kind of headscarf, every day, including on the day of her interview. There was no discussion of the hijab during the interview, but it did result in a lower rating in the “appearance” section of the application.
The Equal Employment Opportunity Commission (EEOC) sued Abercrombie on behalf of the job applicant. It claimed that the company had violated Title VII of the Civil Rights Act of 1964 (“Title VII”) by refusing to hire the applicant because of the hijab.
Abercrombie argued that the applicant had failed to meet her duty to inform the interviewer that she required a special accommodation from the appearance policy. The Tenth Circuit Court of Appeals reversed a lower court ruling, deciding that the trial court should have granted summary judgment in favor of Abercrombie because the job applicant hadn’t expressed any potential conflict.
The Supreme Court held that the job applicant didn’t have to make a specific request to wear a headscarf to accommodate her religious beliefs, even if such a request was dictated by company policy. According to the opinion, proof of “actual knowledge” of the job applicant’s religious need isn’t required for an accommodation.
Title VII prohibits certain motives regardless of the employer’s knowledge of the applicant. So, the job applicant had to show only that her need for an accommodation was a motivating factor in the employer’s decision not to hire her. Thus, the Supreme Court ruled in favor of the EEOC.
Young v. United Parcel Service, Inc. (S. Ct. No. 12-1226, April 27, 2015)
A delivery driver for United Parcel Service (UPS) requested a leave of absence in 2006 to undergo in vitro fertilization. The procedure was successful, and she became pregnant.
During her pregnancy, medical personnel advised the driver that she shouldn’t lift more than 20 pounds while working. But company policy at UPS requires drivers to be able to lift up to 70 pounds. Because the pregnant driver couldn’t meet this work requirement — and because she had used up all of her available family and medical leave — UPS forced her to take an extended unpaid leave of absence.
While the driver was out on leave, she lost her medical coverage. After giving birth in 2007, she resumed her duties at UPS. In her lawsuit, she claimed that she was the victim of gender and disability-based discrimination under the Americans with Disabilities Act (ADA) and Pregnancy Discrimination Act (PDA).
UPS countered that the driver couldn’t prove that its decision was based on her pregnancy or that she was treated differently from any other worker in similar circumstances. Also, UPS argued that pregnancy didn’t qualify as a “disability” under the ADA. The U.S. Court of Appeals for the Fourth Circuit affirmed the lower court’s dismissal of the claim.
Although the ADA didn’t come into play, the Supreme Court advised courts to evaluate 1) the extent to which an employer’s policy treats pregnant workers less favorably than nonpregnant workers with similar inabilities to work and 2) any legitimate reasons for such differences. The top court’s interpretation of the PDA is that employers must offer the same accommodations to pregnant workers as others with comparable physical limitations, regardless of other factors.
The majority opinion concluded that a pregnant worker can “create a genuine issue of material fact as to whether a significant burden exists by providing evidence that the employer accommodates a large percentage of nonpregnant workers while failing to accommodate a large percentage of pregnant workers.” The Court remanded the case to the Fourth Circuit for additional analysis.
Supreme Court Rules on ACA Premium Tax Credits
On June 25, the U.S. Supreme Court released its long-awaited decision in King v. Burwell (S. Ct. No. 14-114). In a 6-3 ruling, it upheld a decision of the U.S. Court of Appeals for the Fourth Circuit that taxpayers purchasing health care coverage on a federal exchange can qualify for premium tax credits under the Affordable Care Act (ACA). The bottom line: The ACA remains intact.
In this case, four individuals who live in Virginia — a state using a federal exchange rather than establishing its own exchange — didn’t want to purchase health insurance. So they argued that, because Virginia’s exchange wasn’t “an Exchange established by the State,” they shouldn’t receive any tax credits for buying health insurance. If they weren’t eligible for the tax credits, the cost of buying insurance would be more than 8% of their income. This would make coverage unaffordable, exempting them from the ACA’s coverage requirement.
The Supreme Court found that the text of certain provisions of the ACA is somewhat ambiguous, requiring the Court to look to the broader structure of the law. To that end, the majority opinion concludes, “[The tax] credits are necessary for the Federal Exchanges to function like their State Exchange counterparts, and to avoid the type of calamitous result that Congress plainly meant to avoid. [...] Congress passed the Affordable Care Act to improve health insurance markets, not to destroy them.”
Missed “Passing the Torch: Business Succession Planning Considerations” event last week? Watch on video now: https://www.youtube.com/watch?v=e7rG5GfqA3s
On Thursday June 25th at the Merion Cricket Club, Russ Gordon, CPA, CVA of Shechtman Marks Devor; Tara Stephenson, of The Woodward Group; Howard Vigderman, of Montgomery McCracken, and moderator Bill Keffer, of Montgomery McCracken offered an informative panel discussion on business succession planning. The panelists covered Preparing for a Sale of Transfer or Business including buy/sell agreements, bylaws and minutes , estate planning considerations with outright gifts to family members, gifts to irrevocable trusts, gifts to GRATs, sale to family members and sale to grantor trusts; Determining What Your Business is Worth, including the valuation methodology and what it means for your business during a sale or transfer plus a review of tax implications and strategies, what to expect during a sale and what buyers look for in an acquisition; and Finding Success in Business Succession Planning with examples of clients’ success and how preparing your business for sale drives higher value during a transaction as well as a discussion of trends in sales of businesses.
Take note of new Philadelphia tax rates effective July 1st. Some changes may affect a number of service industry businesses including law firms, medical service providers, architectural as well as manufacturing and distribution. Click here for details.
What employers need to know about the New Philadelphia Mandatory Sick Leave Law https://lnkd.in/eAEKmYc
Harris L. Devor, CPA (of Shechtman Marks Devor) wins the 2015 Philadelphia SMART CEO CPA Service Area Firm award.
Congratulations to Harris L. Devor, CPA for winning the 2015 Philadelphia SMART CEO CPA Service Area Firm award. Hundreds attended the SMART CEO CPA & ESQ Awards luncheon, honoring the region’s most enterprising accountants and attorneys for their leadership, accomplishment, innovation and success at The Ben on June 11, 2015. A number of Harris’ colleagues, including Bruce Marks, Denise McKnight, Chuck Shechtman, Russ Gordon, Mike Sutter and Kirsten Flanagan joined him at the awards luncheon. http://www.smd-pc.com/smd-news-2/
Shechtman Marks Devor PC was proud to attend and sponsor The State of Women’s Health on June 10th at the Union League in Philadelphia. It was an educational and inspiring event and we were thrilled to meet Dr. Rachel Levine who had just been confirmed as the state Physician General. #SMDnews
Congratulations Mr. Shechtman, who received, from the Commonwealth of Pennsylvania House of Representatives, a letter of commendation because of his continued support, time, and dedication to the Free Library of Philadelphia. https://lnkd.in/ekTKNiS
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication or any attachment hereto is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.