Landscape companies that focus on smaller projects, like delivering and spreading mulch, helping out with spring planting, installing lawn drainage or a sprinkler system, likely experience awho peak season and a low season, in terms of demand. Rather than keeping a crew of employees, one answer to staffing a seasonal business is to hire independent contractors, which allows companies to scale up and down as the amount of work fluctuates.
The landscape company and its independent worker usually prefer the independent contractor status. The company’s accounting is simpler—they provide no worker’s compensation insurance, they don’t have to worry about whether the workers are undocumented, they make no tax withholding, and there are no unemployment claims. The worker gets to keep more of his/her money.
The fly in the ointment is that the government has strict definitions for independent contractors and employees, and is cracking down on misclassifications. The consequences of being caught in an audit are steep.
Why should you care? Because the government cares. Independent contractors who do not report all of their income on their tax returns deprive the government of revenue from income, FICA and FUTA taxes. The Internal Revenue Service (IRS) and Department of Labor (DOL) are looking to squeeze tax dollars from any place they can find money. To that end, they have focused on the ‘misclassification’ of independent contractors.
New investigators have been hired. Fines are up. The IRS uses sophisticated software to search for misclassifications. Among other factors are businesses with numerous IRS Form 1099-type payments to individuals over threshold amounts. And government agencies have started sharing data on potential violators, making them easier to catch.
This means that the IRS is looking for landscape companies who treat workers as contractors when they should be employees. It also means that workers who should have been treated as employees may have claims against the landscape companies.
How bad could it be? In an audit, a landscape company (employer) could be assessed half of back payroll taxes, penalties, interest and possibly the workers’/contractors’ half of back payroll taxes, and the amount that ‘contractor’ should have had withheld for income tax purposes. In some cases, this number approaches 40 percent of the amount paid to each ‘contractor’ over the last three years.
Worse, it probably won’t end with the IRS. Because the agencies are sharing information, the IRS may hand you off to the DOL. The DOL will then ask for the timesheets for those ‘contractors’ who were really employees. Because you treated them as contractors, you won’t have any timesheets, so the DOL will interview the workers and ask how many hours of overtime they worked in the last three years. With a free pass to answer and no time records to dispute, the worker can tell the DOL just about anything and the DOL, in turn, will assess you for that overtime.
And, it doesn’t end there in some states. In Texas, for example, the Texas Workforce Commission may then audit for unemployment benefits for terminated ‘contractors’ who should have been treated as employees. And, once bitten by the IRS and DOL themselves, your competitors could turn in everybody else using the same approach. For this, they will receive up to 15 percent of the recovery.
“What is the test to determine whether someone should be treated as an employee?” The answer is complicated. The agencies each have their own tests. Thankfully, the general ideas are similar. The following questions should tell you whether this could be a problem for you:
• Do you provide training? Are there set working hours?
• Do they work on jobsites under your direction?
• Have you eliminated per diem payments?
• Do you provide tools and lawn equipment?
• Do you pay based on hours worked or a rate per day?
• Do you not charge back if the client rejects the work or requires it to be redone?
• Do they get paid for all their time on a project, rather than having to complete a project in a certain time for a certain price?
• Do you not have a written contract describing the relationship?
• Do you not require workers to work through an entity that they own?
• Do they work for you over a long period of time, or for years?
• Do they not work for other companies or handle services for other general contractors?
• Do you provide health insurance or other benefits?
If you answered ‘yes’ or ‘correct’ to any of these questions, you could be a candidate for investigation. No certain number of positive answers creates risk, but the more ‘yesses’, the more risk of an audit and reclassification.
If you answered ‘yes’ enough to become concerned, what should you do?
You have two options: (1) reduce or eliminate the ‘yes’ answers and hold on to the Section 530 Safe Harbor defense; and (2) take advantage of the favorable settlement program now offered by the government to reduce your liability and re-characterize the contractors as employees.
How the factors are minimized will be different for every business, but start with these thoughts:
• Have a written contract that maximizes support for independent contractor status.
• Require workers to form entities that then contract with your business.
• Provide no training.
• Switch to a project- and invoice-based pay schedule.
• Create risk of loss for the workers in each project.
• Make them responsible for their own place to work and their own supplies.
It makes sense and might save money to work with employment law counsel to help with this process to ensure less risk moving forward.
What is the Section 530 Safe Harbor defense? Some subcontractors are holding on to the idea that they can defeat the IRS misclassification argument using the defense based on Section 530 of the Revenue Act of 1978. The idea is that if everyone is doing the same thing, the IRS cannot declare a misclassification.
While this may be true, it only has the potential to be successful. Claiming Section 530 before the DOL or a state’s employee rights organization will fall on deaf ears because they are not subject to it.
What is the settlement program and why is it such a good deal? Even with more investigators, the government can’t catch all the violators.
With that in mind, the IRS has offered a settlement to bring violators into the fold so that the government gets that tax revenue going forward. To qualify, an employer must:
• agree to treat contractors as employees going forward;
• have timely filed all 1099s in years past;
• be in compliance with all past audits; and
• not be under audit presently.
We do not know how long this program will be offered. It could be withdrawn without warning, so there is risk associated with waiting to enter the program.
EDITOR’S NOTE: Michael Kelsheimer is a partner at Gray Reed & McGraw LLP and focuses his practice on the employment law needs of Texas businesses and executive employees. Michael attended Texas Tech University and then Baylor Law School. Michael is also the author of TexasEmployerHandbook.com, a guide for Texas business owners. (firstname.lastname@example.org)