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2012-05-30 Employee Classification


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2012-05-30 Employee Classification

  1. 1. Employee Classification Joel J. Borovsky, Jackson Lewis LLP May 3, 2012Thrive. Grow. Achieve.
  3. 3. EMPLOYEE CLASSIFICATION INTRODUCTIONEmployee Classification/ Page 3
  4. 4. EMPLOYEE CLASSIFICATION ADVANTAGES TO ENGAGING INDEPENDENT CONTRACTORS: • Allows employers to avoid the substantial payroll and administrative responsibilities and benefit costs typically involved in maintaining payroll personnel • Gives employers the chance to assess the skills and abilities of workers before hiring them as employees • Perception that independent contractor arrangements are easier to sever • Helps with recruiting: Some workers prefer to be contractors.Employee Classification/ Page 4
  5. 5. EMPLOYEE CLASSIFICATION GAO AUGUST 2009 REPORT • GAO August 2009 Report—“Employee Misclassification, Improved Coordination, Outreach and Targeting Could Better Ensure Detection and Prevention” • On federal level, misclassification results in revenue loss of at least $1.6 billion. • Recommends greater enforcement by U.S. Department of Labor (DOL) and Internal Revenue Service (IRS) • Recommends greater coordination of resourcesEmployee Classification/ Page 5
  6. 6. EMPLOYEE CLASSIFICATION IRS TARGETS IC RELATIONSHIPS • Tax regulatory compliance and enforcement is extremely active: ̵ Misclassification of workers appears as number 5 on the top-10 list of IRS audit and enforcement priorities in the business/ employer tax area. ̵ Audits have increased between 10 percent and 30 percent in the years since 2000. ̵ IRS collection of revenue in the area of corporate audit has increased more than 15-fold, from 219,778 levies in 2000 to 3.4 million in 2009. ̵ State tax environment is similar due to budget shortfalls.Employee Classification/ Page 6
  7. 7. EMPLOYEE CLASSIFICATION DOL’S INCREASED FOCUS • According to DOL’s FY 2011 budget request: ̵ “Worker misclassification . . . generates substantial losses to the Treasury and the Social Security, Medicare and Unemployment Insurance Trust Funds.” ̵ “A joint Labor-Treasury initiative to strengthen and coordinate Federal and State efforts” is needed.Employee Classification/ Page 7
  8. 8. EMPLOYEE CLASSIFICATION DOL’S INCREASED FOCUS • FY 2011 budget sought $25 million: ̵ $12 million for DOL’s Wage and Hour Division (WHD) to focus on misclassification ̵ $11.25 million for grants to states “to increase their capacity to focus on misclassification and reward the States that are most successful at detecting and prosecuting employers that fail to pay their fair share”Employee Classification/ Page 8
  9. 9. EMPLOYEE CLASSIFICATION DOL’S INCREASED FOCUS • FY 2011 budget sought $25 million (continued): ̵ $1.6 million for the DOL Solicitor’s Office “to pursue misclassification litigation, including multi-State litigation to coordinate enforcement with States and leverage their groundbreaking work” ̵ $150 thousand for OSHA to modify training “to allow inspectors to identify potential employee misclassification and share information with WHD”Employee Classification/ Page 9
  10. 10. EMPLOYEE CLASSIFICATION- OVERVIEW LEARNING OBJECTIVES: • Understand and recognize the factors that differentiate between contractors and employees. • Discuss the various laws that are impacted by improper classification of workers, and the consequences of misclassification. • Practice with real-life scenarios MAIN OBJECTIVE: YOU LEAVE THIS SEMINAR ABLE TO RECOGNIZE, DETECT, AND PREVENT EMPLOYEE MISCLASSIFICATION ISSUES.Employee Classification/ Page 10
  11. 11. EMPLOYEE CLASSIFICATION- OVERVIEW NOT Today’s Goal: To memorize and be able to describe in detail all of the factors of the multi-factor tests we will discuss. Today’s Goal: To be able to recognize red flags and problem situations, and to research further and correct misclassification issues.Employee Classification/ Page 11
  13. 13. EMPLOYEE CLASSIFICATION- LEGAL TESTS A VARIETY OF LEGAL TESTS ARE USED IN VARIOUS STATUTES TO DETERMINE IC STATUS: • Common Law Right to Control Test • Common Law “Economic Realities” Test • IRS Category Test (This replaced IRS “20 Factor” Test) • “ABC” TestEmployee Classification/ Page 13
  14. 14. EMPLOYEE CLASSIFICATION- COMMON LAW TESTS COMMON LAW RIGHT TO CONTROL TEST: • Hiring party’s control over details of the work. • Worker’s occupation and skill • Relevance of work to Company’s business • Worker’s investment, materials and tools. • Location of work • Duration of the relationship.Employee Classification/ Page 14
  15. 15. EMPLOYEE CLASSIFICATION- COMMON LAW TESTS COMMON LAW RIGHT TO CONTROL TEST (CONT’D): • Control of work hours • Method of payment • Right to hire assistants • Taxes, employee benefits • Parties’ intentionsEmployee Classification/ Page 15
  16. 16. EMPLOYEE CLASSIFICATION- COMMON LAW TESTS COMMON LAW “ECONOMIC REALITIES” TEST • Nature and degree of control exercised by the alleged employer as to the manner in which work is to be performed • Worker’s opportunity for profit or loss, worker’s investment in business • Degree of permanency and duration of the working relationship • Degree of skill required to perform the work.Employee Classification/ Page 16
  17. 17. EMPLOYEE CLASSIFICATION- COMMON LAW TESTS COMMON LAW “ECONOMIC REALITIES” TEST (CONT’D) • Extent to which service rendered is integral part of employer’s business • Employees are “those who as a matter of economic reality are dependent on the business to which they render service” ̵ Significance and use of the pure form of this test has been greatly diminished by judicial opinions.Employee Classification/ Page 17
  18. 18. EMPLOYEE CLASSIFICATION- FORMER IRS “20 FACTOR” TEST • Instructions • Order or Sequence Set • Furnishing Tools & • Training • Order or Written Reports Materials • Integration • Order or Written Reports • Significant Investment • Services Rendered • Payment of Business/ • Realization of Profit or Personally Traveling Expenses Loss • Hiring, Supervising, • Working for More than Paying Assistants One Business at a Time • Continuing Relationship • Making Services Available to the General • Set Hours of Work Public • Full-Time Required • Company’s Right to • Working on Business Discharge Premises • Worker’s Right to TerminateEmployee Classification/ Page 18
  19. 19. EMPLOYEE CLASSIFICATION- CURRENT IRS CATEGORY TEST THE IRS’S ONCE-COMMON “20-FACTOR TEST" HAS BEEN REPLACED BY A NEW TEST. THIS TEST EXAMINES THE RELATIONSHIP IN THREE AREAS: 1. Behavioral control covers the amount of control the employer has over the worker in terms of where, when, and how the job is done, among other factors. 2. Financial control dictates how much control the company has over a workers pay, business expenses, and facility investment. 3. Relationship type is based on written agreements, employee benefits, and length of relationship between the company and worker.Employee Classification/ Page 19
  20. 20. EMPLOYEE CLASSIFICATION-“ABC” TEST UNDER THE “ABC” TEST, USED IN ABOUT HALF OF THE STATES TO DETERMINE UNEMPLOYMENT ELIGIBILITY, A WORKER IS AN EMPLOYEE UNLESS: • The worker is free from control and direction in performing the services; • The service is performed outside the usual course of the company’s business; and • The worker is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.Employee Classification/ Page 20
  21. 21. EMPLOYEE CLASSIFICATION- ABC TEST A. “FREEDOM FROM CONTROL” “FREE FROM CONTROL AND DIRECTION IN CONNECTION WITH THE PERFORMANCE OF THE SERVICE, BOTH UNDER THE CONTRACT FOR THE PERFORMANCE OF SERVICE AND IN FACT.” •Employment contract/job description indicating that individual is free from supervisory direction of control is insufficient •Look at actual activities and duties, which should be carried out with minimal instructionEmployee Classification/ Page 21
  22. 22. EMPLOYEE CLASSIFICATION- ABC TEST B: “SERVICE OUTSIDE USUAL COURSE OF EMPLOYER’S BUSINESS” • If the worker’s services form a regular and continuing part of employer’s business, then individual is considered employee • Almost impossible to meet in many casesEmployee Classification/ Page 22
  23. 23. EMPLOYEE CLASSIFICATION- ABC TEST C. INDEPENDENT TRADE, OCCUPATION, PROFESSION OR BUSINESS: • The worker has to be engaged in independent trade or business • The worker can sell his services to a number of entities in community • Worker cannot be dedicated to one employerEmployee Classification/ Page 23
  24. 24. EMPLOYEE CLASSIFICATION- ABC TEST IRRELEVANT FACTORS UNDER ABC TEST: • Failure to withhold taxes • Contribute to unemployment compensation • Provide workers compensation • Employer’s belief/Employee’s belief ̵ Strict liability statuteEmployee Classification/ Page 24
  25. 25. EMPLOYEE CLASSIFICATION- ABC TEST Specific Laws, Tests and ConsequencesEmployee Classification/ Page 25
  26. 26. EMPLOYEE CLASSIFICATION- SPECIFIC LAWS Each statute and enforcement agency has slightly different tests for determining independent contractor status: • IRS: U.S. Tax Code (federal income tax withholding) • U.S. Department of Labor: – FLSA (Fair Labor Standards Act -- minimum wage and overtime); – FMLA (Family and Medical Leave Act); – ERISA • State Unemployment Laws/Agencies • State Workers’ Compensation Laws/Agencies • State income tax withholding • Federal Anti-Discrimination Laws (Title VII, ADA) • State and Local Anti-Discrimination LawsEmployee Classification/ Page 26
  27. 27. EMPLOYEE CLASSIFICATION- FEDERAL AND STATE TAX LAWS AS STATED ABOVE, THE IRS NOW USES A COLLECTION OF FACTORS GROUPED INTO THREE CATEGORIES: • Behavioral control analyzes the amount of control the employer has over the worker’s choice of work location, tools, assistants, supplies, and priority of tasks, among other factors. • Financial control involves how much control the company has over a workers method and amount of pay (by the hour or task), business expenses, and facility investment. • Relationship type is based on written agreements, employee benefits, and permanency of relationship between the company and worker. Note: State taxing agencies will vary.Employee Classification/ Page 27
  28. 28. EMPLOYEE CLASSIFICATION- FEDERAL AND STATE TAX LAWS CONSEQUENCES OF MISCLASSIFICATION: • Employer’s share of Federal payroll taxes going back three years, plus penalties and interest. • Possibly the employee’s share of taxes, which should have been withheld, plus penalties and interest. • Information sharing programs with the states likely will result in state income tax withholding penalties, unemployment tax liability, and disability program taxes. • State tax liability often will trigger investigation into unpaid worker’s compensation and unemployment benefits. This can also result conversely when contractors apply for such benefits after termination.Employee Classification/ Page 28
  29. 29. EMPLOYEE CLASSIFICATION- EMPLOYEE BENEFITS ERISA LIABILITY • The analysis for classifying workers established by courts under ERISA is virtually the same as that commonly used by the courts and the IRS under the Internal Revenue Code.Employee Classification/ Page 29
  30. 30. EMPLOYEE CLASSIFICATION- EMPLOYEE BENEFITS ERISA Liability: Consequences • Retroactive entitlement to benefits by the contractor. • Plan may fail coverage or discrimination tests, or may be deemed to violate minimum participation standards. • Plan may be liable for wrongful denial of benefits and breach of fiduciary duty claims.Employee Classification/ Page 30
  31. 31. EMPLOYEE CLASSIFICATION- EMPLOYEE BENEFITS Microsoft Liability • Class action lawsuit against Microsoft Corp. brought by a group of individuals who had been characterized by Microsoft as independent contractors. The members of the class were determined by the I.R.S. to be employees. Following the determination, the individuals sought retroactive coverage under Microsoft’s 401(k) plan and employee stock purchase plan. • Vizcaino -- 9th Circuit Case • Class action suit brought under ERISA (1,100 people) • At issue, benefits pursuant to Company’s savings and stock purchase plans • Each individual signed agreement – They were independent contractors – No employer-employee relationship – No withholdings – Individuals responsible for own insurance and benefitsEmployee Classification/ Page 31
  32. 32. EMPLOYEE CLASSIFICATION- EMPLOYEE BENEFITS • Ninth Circuit holds: – Internal determination regarding savings plan was “arbitrary/capricious” – Stock purchase plan - misclassified workers could maintain a contractual claim – Remanded – Case settled - $96.885 million • Consequences of misclassification can be severe. Be diligent in classification issues. Clearly express intention to exclude classes from eligibility in plan documents. Include inoculation provisions.Employee Classification/ Page 32
  33. 33. EMPLOYEE CLASSIFICATION- FEDERAL WAGE/HOUR LAW (FLSA) THE FLSA’S “ECONOMIC REALITIES” TEST: • Extent to which the services rendered are an integral part of the principal’s business • Permanency of the relationship • Amount of the worker’s investment in facilities and equipment • Nature and degree of control by the principalEmployee Classification/ Page 33
  34. 34. EMPLOYEE CLASSIFICATION- FEDERAL WAGE/HOUR LAW (FLSA) THE FLSA’S “ECONOMIC REALITIES” TEST (CONT’D): • Worker’s opportunities for profit and loss • Amount of initiative, judgment, or foresight in open market competition required for the worker’s success • Degree of independent business organization and operationEmployee Classification/ Page 34
  35. 35. EMPLOYEE CLASSIFICATION- EMPLOYEE BENEFITS FLSA LIABILITY: CONSEQUENCES • Retroactive entitlement to overtime pay by the contractor for two to three years. • Employer likely has not kept accurate time records, leading to inability to defend claims. • Liquidated (double) damages are applied; attorney’s fees can be awarded • DOL audits and investigations can result. • Class actions can result in exorbitant costs and settlements. State laws will have their own penalties.Employee Classification/ Page 35
  36. 36. EMPLOYEE CLASSIFICATION-THE FAMILY AND MEDICAL LEAVE ACT (FMLA) The U.S. Department of Labor administers the FMLA, which is based on the FLSA, so the definition of “employee” is the same.Employee Classification/ Page 36
  37. 37. EMPLOYEE CLASSIFICATION-THE FAMILY AND MEDICAL LEAVE ACT (FMLA) FLSA LIABILITY: CONSEQUENCES • Liability for denial of FMLA leave. • Liability for interfering with, restraining or denying leave entitlement. • Liquidated (double) damages and attorney’s fees can be awarded • Risk of class actions. • State FMLA laws can provide additional penalties.Employee Classification/ Page 37
  38. 38. EMPLOYEE CLASSIFICATION-THE NATIONAL LABOR RELATIONS ACT The National Labor Relations Act applies only to employees. A common tactic of labor unions seeking to organize workers is to challenge the independent-contractor status of a group of workers that perform a certain function for companies in a particular industry. The unions then seek a court determination that the workers are employees entitled to the right to organize and bargain for the terms and conditions of their work.Employee Classification/ Page 38
  39. 39. EMPLOYEE CLASSIFICATION-THE FEDERAL ANTI-DISCRIMINATION LAWS EEOC FACTORS INCLUDE: • Extent of control exercised by company. • Whether worker is in distinct occupation/business. • Type of occupation, of worker and whether type of work is generally done under direction of supervisor or by specialist without supervision. • Skill required in the occupation. • Whether company supplies equipment, tools and place of work for the worker. • Length of time worker is engaged to work. • Method of payment, whether by time or job. • Whether company withholds social security and other taxes from the worker’s pay.Employee Classification/ Page 39
  40. 40. EMPLOYEE CLASSIFICATION- THE ICS: EEOC FACTORS EEOC FACTORS (CONT’D) • Manner in which work relationship may be terminated. • Whether work is integral part of company’s business. • Intention of parties creating the work relationship. • Whether worker was required to work exclusively for company, or would have been permitted to perform same type of work for another employer. • Whether worker could delegate the work. • Whether workers is an employer with his/her own employees. • Whether worker was required to make capital investment. • Whether work afforded worker an opportunity for profit/loss depending on skills/management abilities.Employee Classification/ Page 40
  41. 41. EMPLOYEE CLASSIFICATION- THE ICS: EEOC FACTORS ConclusionEmployee Classification/ Page 41
  42. 42. EMPLOYEE CLASSIFICATION- PRACTICAL SOLUTIONS VIRTUALLY ANY INDEPENDENT CONTRACTOR CLASSIFICATION COULD COME UNDER SCRUTINY IF: • The work is part of the company’s normal business; • The company exerts significant control over the manner in which the work is performed, as opposed to the quality of the good or service provided; • The worker cannot or does not work for other clients or customers; and/or • The worker does the same work as company employees.Employee Classification/ Page 42
  43. 43. EMPLOYEE CLASSIFICATION- PRACTICAL SOLUTIONS VIRTUALLY ANY INDEPENDENT CONTRACTOR CLASSIFICATION COULD COME UNDER SCRUTINY IF: • Conduct an audit of all independent contractor arrangements, including contracts and actual job duties. • Consider all factors discussed above; balance the factors and make a determination. • Consider whether to terminate all independent contractor agreements and rehire as employees – Hire independent contractors through temporary agency or other company. – Loosen restrictions and control; allow subcontracting or work for other clients.Employee Classification/ Page 43
  45. 45. EMPLOYEE CLASSIFICATION- HYPOTHETICALSEmployee Classification/ Page 45