Battling for independent contractor status

Although independent contractors are a proven way for aggregate producers to achieve workforce flexibility and save money, they are also a popular strategy that provide operations a great deal of flexibility and, in many cases, lower tax bills. Combine those lower tax bills with the difficulty in determining who is and who isn’t an “independent contractor,” and you have an explanation for the Internal Revenue Service’s (IRS) ongoing crackdown on worker “misclassification.”

The Government Accountability Office estimates that worker misclassification costs the federal government $2.7 billion per year, while both the IRS and the U.S. Department of Labor (DOL) believe that up to 30 percent of employers are misclassifying workers.

Recent court cases, such as the suits brought against Uber and Lyft by their drivers in California, have resulted in both the IRS and DOL announcing even more crackdowns on worker misclassification. In fact, cracking down on employee misclassification is a proven revenue generator for the IRS, but should that crackdown strike fear into the hearts of those in the aggregate mining industry?

An independent contractor

What all independent contractors have in common is they’re not considered “employees” of those who utilize their services. What makes them “independent contractors” is that those who use their services say they are, usually so they don’t have to pick up the costs of having full-time employees. As an independent contractor, a worker operates outside the protection of the labor laws.

Under common-law rules, anyone who performs services for another is an employee – if the one paying for the services can control what will be done and how it will be done. Therefore an employer-employee relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to result, but also as to details and means. All independent contractors are considered to be self-employed and, therefore, their earnings are subject to Self-Employment Tax.

While independent contracting is on the rise, true independent contractors differ from the quasi-freelancers created by companies such as Uber and others championing the so-called “gig” economy. Although those who work “gigs” appear to be a new class of free agent, in reality they have autonomy, yet not complete control.

Uber sets the fares for each service in each city based on its own formula, which is calculated using either per-mile or per-minute rates, on top of a base fare. Genuine independent contractors determine and negotiate their own rates with clients. They possess refined and in-demand skills. They often bring a rare expertise that clients can’t find in the typical labor pool. In other words, they operate as micro-business entities.

Start-up basics

For the most part, independent contractors are individuals who are hired to do a particular job, receiving payment only for the work being performed. Independent contractors are business owners, and are not their customers’ employees. They do not receive employee benefits or the same legal protections as employees, and are usually responsible for their own expenses.

As an independent contractor, a worker is responsible for paying his or her own taxes, Social Security, unemployment taxes, workers’ compensation, health insurance and other benefits. The aggregate producer will not withhold taxes. As a business owner, an independent contractor will need to pay estimated taxes throughout the year instead of once a year on April 15.

Becoming a true independent contractor means becoming a small, separate business entity. The nature of the working relationship between independent contractors and clients or customers is not without risk. By taking every precaution to establish a self-governing operation, an independent contractor can mitigate exposure to these risks – both for themselves and for the clients and customers of their independent business.

Proof positive

No less a body than the U.S. Supreme Court has said that there is no definition that solves all problems relating to the employer-employee relationship under the Fair Labor Standards Act (FLSA). The court has also said that determination of the relationship cannot be based on isolated factors or upon a single characteristic, but depends upon the circumstances of the whole activity. In general, an employee, as distinguished from an independent contractor who is engaged in a business of his or her own, is one who “follows the usual path of an employee” and is dependent on the business that they serve.

The IRS formerly used what was known as the “Twenty Factor” test. Today, the IRS has attempted to simplify and refine the test, consolidating the 20 factors into 11 main tests and organizing them into three main groups:

• Behavioral: Does the client or customer have the right to control what the worker does and how the worker does his or her job?
• Financial: Are the business aspects of the worker’s job controlled by the payer? This includes such things as how payment is made, whether expenses are reimbursed and who provides tools/supplies.
• Type of Relationship: Are there written contracts or employee-type benefits such as a pension plan, insurance, vacation pay, etc.? Will the relationship continue and is the work performed a key aspect of the client or customer?

Obviously, there is no “magic” or set number of factors that makes a worker an independent contractor or someone an employee. The key is to look at the entire relationship, consider the degree or extent of the right to direct and control and, finally, to document each of the factors used to produce the proper label of worker or independent contractor.

If there is any doubt remaining after reviewing the three categories of evidence, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS by either the aggregate producer or the independent contractor. Unfortunately, review of the facts and circumstances can take at least six months for the IRS to reach a determination.

The employer’s perspective

The IRS recently expanded its Voluntary Classification Settlement Program (VCSP), paving the way for more businesses to take advantage of this low-cost option for achieving certainty by reclassifying their workers as employees for future tax periods. VCSP also provides partial relief from federal payroll taxes for eligible employers who are currently treating some or all of their workers as independent contractors and now want to treat them as employees.

Under the revamped program, employers, other than those undergoing an employment tax audit, can qualify for VCSP. To be eligible for the VCSP, an employer must be treating workers as “nonemployees” and file any required Form 1099s. What’s more, employers cannot qualify if they are under audit by the DOL or state agency concerning the classification of these workers.

Pitfall

Recently, the Los Angeles office of the National Labor Relations Board issued a complaint based on an unfair labor practices charge brought by the International Brotherhood of Teamsters against Intermodal Bridge Transport, a California company in the logistics and transport business.

The complaint alleges, among other things, that the employer’s classification of its delivery drivers as independent contractors constitutes an unfair labor practice. The argument is based on the claim that misclassification inhibits individuals who would otherwise be employees from engaging in their Section 7 rights to concerted activity, including unionizing.

For businesses that utilize the services of independent contractors, this action presents one more potential front on which the misclassification war may be waged. This is in addition to state and federal agencies, which include the United States Department of Labor, the Internal Revenue Service, state departments of labor and state unemployment offices. Obviously, every aggregate producer should be wary of classifying workers as independent contractors. The tests are difficult to meet, and the penalties are severe.

According to U.S. Secretary of Labor Thomas Perez, worker misclassification is “a national problem that has three sets of victims: the worker himself or herself; the employers who play by the rules (they can’t compete for contracts, they can’t compete for business because they pay their taxes); and then the tax collector, because when a business is cheating and not paying their workers’ comp taxes, unemployment taxes go up because the pool has grown smaller.”

An independent contractor:

• Does not have the same legal rights and protections as employees.
• Is paid only for work performed. Clients and customers are not required to pay employee benefits under FLSA, including overtime and minimum wage.
• Is not covered under the client or customer’s workers’ compensation benefits.
• Is not entitled to employee benefits.
• Are not covered under the Equal Employment Opportunity laws.
• Taxes are not withheld and paid by the client or customer, including income, FICA and unemployment.

The crushed stone and sand and gravel operation that misclassifies a worker as an independent contractor may be required to pay back taxes as well as provide employee benefits, workers’ compensation, unemployment and more. And, just as businesses should be very careful to distinguish between employees and independent contractors, so should every worker. Are your workers clearly “independent contractors”?

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Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.