Over the past few months both the IRS and the Department of Labor (DOL) have separately issued guidance emphasizing the importance of proper worker classification and some of the more common employment tax-related issues posed by businesses.^[1] Business owners would be wise to both (i) recognize these publications as forecasts of enforcement trends by various government agencies, and (ii) prepare accordingly so as to mitigate potential significant legal exposure.

I. Worker Classification/Misclassification

Both Federal agencies are focusing on one of the most common errors made by businesses – the misclassification of a worker as an independent contractor, when in fact the individual should be properly classified as an employee. This problem plagues employers of all sizes – from the smallest mom-and-pop operations to publicly-traded companies. It is also arguably one of the most costly mistakes a business owner can make. Failure to properly classify a worker may result in paying for the same error on multiple fronts.

• First, from a tax perspective, the employer will be liable to the IRS for certain unpaid taxes, together with interest and penalties. Significantly, certain individuals who, on behalf of the employer, were required to collect, account for and pay over certain employment taxes may be personally liable for such amounts.
• Second, separate and apart from the IRS, various other Federal and state agencies^[2] may bring an enforcement action against the employer. For example, pursuant to the Fair Labor Standards Act, the DOL could allege that by misclassifying its workers as independent contractors, the employer arguably denied its employees important workplace protections such as minimum wage and overtime compensation. Indeed, the DOL launched a comprehensive “Misclassification Initiative” which seeks to coordinate efforts respecting information sharing and enforcement of these issues among Federal agencies (e.g., Employee Benefits Security Administration, OSHA, Office of Federal Contract Compliance Programs and the Office of the Solicitor) and multiple states.^[3] Accordingly, a simple and arguably innocent misclassification could expose an unwitting employer to liability for violations of laws concerning family and medical leave, unemployment insurance, worker’s compensation, workplace safety, employee benefits and/or employment verification. The consequences for an employer misclassifying workers, then, can prompt investigations by, and penalties from, various Federal and state agencies.
• And third, the failure to properly classify employees can result in a lawsuit from the workers themselves. By way of example only, following a 2014 Ninth Circuit ruling that FedEx misclassified its drivers as independent contractors, news outlets reported discussions regarding a $228 Million settlement between the company and its drivers.

The IRS’ Voluntary Classification Settlement Program allows employers to voluntarily reclassify their workers as employees for future tax periods and, in doing so, obtain partial relief from the Federal employment taxes which arose during the prior misclassification periods. This program, while quite beneficial, deals only with Federal employment taxes; it does not protect an employer from penalties which may be imposed by other Federal and state agencies for historic misclassification. Therefore, prior to participating in this IRS program, employers are strongly encouraged to consider how other government agencies will react to a change in employee classification.

II. Fringe Benefits

In its most basic form, fringe benefits are a form of payment in exchange for the performance of services and can be paid to employees, independent contractors, partners and, in certain instances, volunteers. The general rule is that the value of fringe benefits are includible in a worker’s income, taxable to the worker and reported to both the worker and the government (e.g., on a Form W-2 for employees, or a Form 1099 for independent contractors).

An exception to the general rule, however, provides that certain fringe benefits may be excludible from an employee’s gross income.^[4] Whether a fringe benefit is taxable to the recipient will always depend on the facts and circumstances, and the rules respecting each type of fringe benefit vary. For example, some fringe benefits are available only to an employee, while others can be offered to certain members of an employee’s family. While fringe benefits are a wonderful way to compensate an employee without creating a corresponding tax liability for the employee, employers must be careful to adhere to the rules to ensure full compliance.

III. Information Returns and Withholding

In its recent publication, the IRS also reminds business owners to secure taxpayer identification numbers (e.g., a Social Security Number for an individual) from each payee so that the business can properly report the payment. Failure to properly report the payment on a Form W-2 (employee), Form 1099-MISC (certain independent contractors) or Schedule K-1 (partner or S corporation shareholder) can result in penalties to the payor. In addition, certain payments may be subject to backup withholding, currently at a rate of 28% if, for example, a taxpayer identification number is not properly provided.

Business owners need to be particularly sensitive to situations in which a payee either fails to provide the requested information, or provides incorrect or misleading information. In this respect, when dealing with non-employees, a business should request an IRS Form W-9. And, when dealing with employees, businesses must timely obtain the various documentation associated with employment e.g., IRS Form W-4 (federal withholding allowance certificate) and USCIS Form I-9 (employment eligibility verification form). There are different procedures to follow depending on the manner in which incorrect or misleading information is discovered by the employer.

IV. Conclusion

In all instances, care should be taken by each business, its owners and its management team to ensure that the business is in full compliance with all applicable rules and regulations. The good news is that businesses can be proactive instead of reactive respecting compliance. For example, an employer could initiate its own Form I-9 “self-audit” or otherwise reach out to a tax law or employment law professional to confirm that the business is properly operating with respect to these and similar administrative matters. As many business owners know, it is far better to spend time in an effort to get these matters in order on the front-end, rather than after a Federal or state agency has commenced its own investigation.

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Notes:

^[1] In November, 2015, the IRS issued FS-2015-25. And in July, 2015, the Dep’t of Labor issued Administrator’s Interpretation No. 2015-1, July 15, 2015, “The Application of the Fair Labor Standards Act’s ‘Suffer or Permit’ Standard in the Identification of Employees Who Are Misclassified as Independent Contractors.”

^[2] For example, the U.S. Dep’t of Labor’s Wage and Hour Division; the Occupational Safety and Health Administration (OSHA); the U.S. Citizenship & Immigration Services (USCIS); and U.S. Immigration and Customs Enforcement (ICE).

^[3] The DOL has entered into partnerships with at least 27 States respecting this initiative.

^[4] Internal Revenue Code § 132. Examples of fringe benefits which may be excludible from a worker’s income are: (i) no-additional cost services (e.g., free travel on a standby basis for airline employees), (ii) qualified employee discounts (e.g., discounts on goods and services purchased by an employee), (iii) de minimis fringe benefits, (iv) working condition fringe benefits (e.g., use of a company vehicle or a cell phone allowances), (v) qualified transportation fringe benefits (e.g., transit pass to and from work), (vi) qualified moving expense reimbursements, (vii) qualified retirement planning services, (viii) on-premises athletic facilities, and (ix) qualified military base realignment and closure fringe benefits.