Independent Contractor Misclassification Should Remain Key Area of Concern for Employers

By Frederick Dawkins and Douglas Weiner

Earlier this month, at the ABA Labor and Employment Law Conference, Solicitor of Labor M. Patricia Smith reaffirmed that investigating independent contractors as misclassified remains a top priority of the U.S. Department of Labor’s (“DOL”) enforcement initiatives.  The DOL will continue to work with other federal and state agencies, including the IRS, to share information and jointly investigate claims of worker misclassification.  The joint enforcement effort is certainly driven by, among other things, an interest in collecting unpaid tax revenue, and could result in significant liability to employers.  

In addition to potential liability resulting from strengthened federal enforcement initiatives, in previous blog posts, we have emphasized that misclassification could become the subject of the next wave of class and collective actions, particularly in view of states enacting new legislation providing for higher penalties.  Further, the re-election of President Obama may augur the re-emergence of the Employee Misclassification Prevention Act, would require employers to keep records of all workers performing labor or services for them, and to notify each worker of their classification and exemption status.  Finally, the Affordable Care Act (“ACA”) adds yet another challenge to employee misclassifications as the reclassification of workers from independent contractors to employees could push an employer over the 50 full-time employee threshold for ACA coverage. 

The expenses of  misclassification are often significant – including calculations of unpaid overtime wages, back employment taxes, income tax withholdings, unpaid workers’ compensation and unemployment insurance premiums, contributions to Social Security and Medicare, and perhaps 401K matching and pension contributions. 

In short, over the next four years of the Obama Administration, which will continue to fund the DOL’s aggressive enforcement efforts, it is undeniable that contractor misclassification investigations will continue to increase in volume and strength.  Employers are best advised to scrutinize their own independent contractor classifications in self-audits before federal and state investigators, or perhaps even worse, plaintiffs’ class action lawyers target what had been common practices.

IRS Announces Voluntary Classification Settlement Program

by Dean L. Silverberg, Jeffrey M. Landes, Susan Gross Sholinsky, and Jennifer A. Goldman

On September 21, 2011, the Internal Revenue Service ("IRS") announced a new program that will give businesses the opportunity to resolve prior worker classification issues by voluntarily reclassifying their non-employee workers (such as consultants, freelancers, and independent contractors) as employees for federal employment tax purposes. Officially called the "Voluntary Classification Settlement Program" ("VCSP"), this program is part of a larger "Fresh Start" initiative at the IRS to aid taxpayers and businesses in addressing their federal tax liabilities.

Read the full advisory online

Here's a Tip: Follow the Rules for Reporting Tip Income

By Betsy Johnson

In light of the IRS’ increased efforts to root out and capture unreported income, one of our hospitality clients recently asked us to provide some clarification regarding: 1) the obligations of employees to report tip income; 2) the obligations of employers to report tip income; and 3) the risks of underreporting of the tip income of its employees.

Employee Obligations:  Pursuant to the Internal Revenue Code and regulations, employees are required to report as income all tips they retain. Nevertheless, the actual amount that employees report to the IRS is an individual matter between the employee and the IRS.  While the employer may have a policy that mandates that employees report all cash tips and provide employees with reports of tips that are distributed through credit cards, the employer should not report tips to the IRS on behalf of employees and should not advise employees regarding how much tip income they should report.

Section 6053(a) of the Code requires employees to furnish written statements to their employers reporting all tips received (credit card and cash) in each calendar month.  However, employees should be required to report their tips for every pay period so that the total wages and proper FICA withholding can be taken in each pay period.  The employees are responsible for reporting their tips to be reported to the IRS back to the employer on a form created by the employer or on the IRS Form 4070. A copy of Form 4070 can be obtained at www.irs.gov/pub/irs-pdf/p1244.pdf.

The IRS publishes a pamphlet for employees which explains how tips should be recorded and reported. A copy of the “Guide to Tip Income Reporting” for employees can be obtained at www.irs.gov/pub/irs-pdf/p3148.pdf.

Employer Obligations:  On an annual basis, employers must report tip income reported by employees on IRS Form 8027. A copy of IRS Form 8027, "Employer's Annual Information Return of Tip Income and Allocated Tips" can be obtained at www.irs.gov/pub/irs-pdf/f8027.pdf.  The IRS Form 8027 requires that employers report the gross amount of charge tips (tips paid by credit card) for all employees, tips reported by employees, total credit card receipts, and gross sales. The IRS publishes a pamphlet for employers which explains how tips should be tracked and reported. A copy of the “Guide to Tip Income Reporting” for employers can be obtained at www.irs.gov/pub/irs-pdf/p3144.pdf.

To promote tip reporting compliance, the IRS has established the Tip Reporting Alternative Commitment (TRAC) program.  An explanation of the TRAC program can be obtained at www.irs.gov/pub/irs-utl/foodtrac.pdf. Employers can voluntarily sign an agreement with the IRS to participate in the TRAC program. The TRAC program is part of the Tip Rate Determination/Education Program that the Internal Revenue Service implemented in 1993 to promote tip reporting compliance.   

The TRAC program allows employers to avoid liability for FICA contributions where employees underreport tip income. Pursuant to a TRAC agreement, employers agree to:

  • Educate the employees about tip reporting
  • Establish tip reporting procedures
  • Stay current with all employer tax payments and filing obligations

In return for these commitments, the IRS agrees that it will not access FICA taxes due as a result of tip under reporting unless the IRS first examines all of the employees who have under reported tips. The IRS will not initiate any tip audits of employers while the TRAC agreement is in place, but the IRS may continue to conduct individualized tip income examinations of current or former employees.

To satisfy the educational commitment, it is recommended that employers establish a written policy for tipped employees that explains their tip reporting obligations. In addition, employees should receive information regarding tip reporting during their orientation. 

The commitment to establish a procedure to encourage employees to report 100% of their tips can be met by providing employees with the IRS Form 4070 and a written or electronic tip statement on a regular or monthly basis which contains all tips attributable to each employee. The statement must include:

  • Employee’s name, address and SS number
  • Employer’s Name
  • Period Covered and Date Reported
  • Total Amount of Tips Received by the Employee
  • The Employee’s Signature

The procedure should allow employees to verify or correct the report provided by the employer. However, employers should not provide the IRS with a copy of the statement or report the tips recorded on these statements to the IRS on behalf of the employee.

In order to satisfy the commitment to stay current with tax obligations, employers should implement an internal audit and review process to ensure that employees are complying with the tip reporting policy and procedures. The reality is that employees will not report all of their tips and, as a practical matter, employers cannot force employees to do so. Nevertheless, employers should exercise their best efforts to “encourage” (i.e., nudge, nag and/or discipline) employees to comply with the tip reporting policy and rules.

 

Conclusion: The inaccurate reporting of tips by employees and employers can result in significant liability for unpaid taxes, interest and penalties for employers. In spite of these potential liabilities, employers should not implement a practice of reporting tips to the IRS on behalf of each employees. To do so, may be detrimental to employee morale and retention. In addition, employers who usurp employee control over how much tip income is reported run the risk of having employees seek advice and/or protection from outside sources, such as a union or an attorney. As such, employers must take care in developing and implementing tip reporting policies and practices.

 

More information regarding tipped employees can be found at: http://www.wagehourblog.com/admin/mt-xsearch.cgi?blog_id=828&search_key=keyword&search=tips