On August 27th, 2014, Judge W. Fletcher of the United States District Court for the Northern District of California held that FedEx drivers were employees as a matter of law under California’s right-to-control test. While this ruling is only law in the ninth circuit with a narrow construction based on California law, it is a wakeup call to all businesses that fail to properly classify their workers. All businesses should conduct an annual analysis to confirm that the status of all workers is appropriate: either employees that receive W2 wages/withholding or contract workers that receive 1099 wages. Further, businesses that pay contract workers should make sure that these contractors understand how 1099 wages work, the reporting and estimated payment requirements at both the Federal and State taxation levels.
All fifty states have worker classification laws. Most states (like the IRS) will fall back on the common law standards that revolve around behavioral and financial control, in addition to the type of defined relationship at the onset of employment and throughout the employment term. Definitions of these terms, per the IRS, are below:
- Behavioral Control: facts that show whether the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
- Financial Control: facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job
As FedEx learned in the recent lawsuit, control is a huge factor. However, with the proper implementation of procedures, control can easily be split between the definition of employees and contract workers. The more pressing differentiation should center on how the worker perceives their status within the organization. If a worker believes they are W2 employee but is being paid as a 1099 contract labor, has the organization given them the necessary information about payment structure and the ability to discuss any concerns with management or human resources?
The latest figures from the IRS show a tax gap of $54 billion dollars for employment taxes. The IRS has taken steps to initiate a voluntary disclosure program for employers that believe they have a misclassification issue with their workers. The Voluntary Classification Settlement Program (VCSP) allows employers to voluntary disclose these issues to the IRS, make the necessary changes, pay a minimal penalty and move forward in proper compliance.
Options like VCSP will not be on the table forever. The time to act to correct improper worker classification at both the Federal and State levels is now. Cases like the recently-decided FedEx misclassification case are likely to be more frequent now that there is precedence, and as mentioned before, the IRS had made this a hot button issue due to the high tax gap for the foreseeable future.
– – – – – – – – – – – – – – – – – – – – – – – – – – – – –
We can help businesses reach compliance with the IRS with respect to worker classification. Five Stone Tax Advisers has years of experience negotiating directly with the IRS to get the best possible outcome for you. Our Worker Reclassification unit has a team of tax attorneys, certified public accountants and enrolled agents that form a single sourced point of contact that will provide services for all the legal and compliance aspects of these cases.
