Our colleague and partner Amy Epstein Gluck writes about the long-anticipated ruling that the Supreme Court of California just issued in Dynamex Operations West, Inc. v. Superior Court, S222732, regarding the employee vs. independent contractor distinction in California. Read more about her analysis of gig economy drivers of a package and document delivery company. The case serves as a good reminder that, like California for employee wage issues, the Internal Revenue Service takes the misclassification of workers quite seriously and continually offers guidance regarding the federal payroll and income tax treatment of employees/independent contractors. Recall, from the tax side, these are some of the IRS issues regarding what would be reclassified wages for the reclassified employee:
- A failure to file (Form W-2s, etc.), failure to pay (employer portion of the Social Security and Medicare), and failure to deposit penalties (employee portion of Social Security and Medicare, income tax withholding, etc.);
How do employers get caught? One way is when a worker whom an employer treated as an independent contractor gets terminated; that worker files for unemployment benefits and gets denied. [I just saw this happen last week with a client.] Another way is when a worker gets hurt while on the job and files a worker's compensation claim and also gets denied. This causes the state where the unemployment benefit or worker's compensation claim was made to investigate. Still another way is if the state involved is one of the 11 states (Connecticut, Hawaii, Illinois, Maryland, Massachusetts, Minnesota, Missouri, Montana, New York, Utah and Washington) that have entered into a collaborative and cooperative agreement with the IRS, Department of Labor, Office of Federal Contract Compliance Programs (affirmative action), and the Occupational Safety and Health Administration to coordinate efforts to thwart the misclassification of employees as independent contractors. With respect to the IRS, there is a current program under which an employer can apply for limited tax/penalty/interest exposure if it voluntarily agrees to treat its independent contractors as employees for future years. Under the program, the employer would:
- Pay 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year;
- Not be liable for any interest and penalties on the amount; and
- Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified for prior years.
Note, though, where there is a need for caution. While an employer's application under this IRS program might control its federal tax exposure, an employer should consider that not all of its exposure is mitigated. After all, the DOL might investigate for overtime and minimum wage violations; the employer's state government might investigate for its share of state income tax, workers' compensation premiums, and benefits; and/or the newly-classified employees might have claims for employee benefits, which could include retroactive health care coverage, 401(k)/403(b) contributions, stock options, holiday and sick pay.My final bit of advice: if an employer is unsure of whether its worker is an employee or independent contractor (at least for purposes of federal employment and income tax withholding), it can affirmatively seek confirmation from the IRS by filing a Form SS-8. That would take the guessing game out of the equation from the start, and perhaps cases like Dynamex Operations West, Inc. v. Superior Court, S222732, won't even have a chance to get started.