Earlier this year, the First Circuit United States Court of Appeals issued its decision in United States v. Albania Deleon, 704 F.3d 189 (1st Cir., January 11, 2013). This case illustrates that worker misclassification may, in addition to the imposition of taxes and civil penalties, lead to criminal sanctions, including imprisonment.
Albania Deleon owned and operated two businesses: an asbestos abatement training school (“ECT”) and a temporary employment agency (“MSI”). This case focuses on Ms. Deleon and MSI. MSI supplied temporary workers to asbestos abatement contractors.
MSI maintained two separate payrolls for its workforce. One payroll reported a minority of the workers as employees, proper withholding of payroll and income taxes was done, and Form W-2s were issued to the employees. MSI reported in writing to both its customers (including governmental entities) and the occupational safety division of local government that it was responsible for and was complying with all employee withholding tax obligations.
The second payroll, which encompassed most of MSI’s workers, treated the workers as independent contractors—no withholding was done. Rather, IRS Form 1099s were issued to the workers. MSI told its accountants that these workers were independent contractors. Evidence in the trial record indicated Ms. Deleon had absolutely no factual basis for that conclusion.
In late 2006, as a result of an anonymous tip to the government that MSI was violating immigration laws and was involved in fraudulent payroll activity, state and federal investigators raided the offices of both companies. Based upon the information gathered in the raid, including computer records, the IRS concluded MSI had fraudulently avoided paying over $1,000,000 in payroll taxes.
As many employers have painfully learned, misclassifying employees as independent contractors can be an expensive mistake. Worker misclassification may become even more costly in 2014, when a new potential trap for the unwary will exist. If a non-complying employer gets caught in this new trap, it could be faced with significant monetary penalties.
Beginning in 2014, as a result of the Patient Protection and Affordable Care Act, employers who misclassify employees as independent contractors may be subject to an additional penalty regime. Section 4980H(a) of the Internal Revenue Code (the “Code”) imposes a penalty on “large employers” who fail to offer full-time employees health insurance with a minimum level of coverage. Because employers generally do not provide health care coverage to independent contractors, reclassification of an independent contractor to a full-time employee could trigger this penalty.
According to a Bureau of Labor Statistics study conducted almost 8 years ago, approximately 10.3 million workers in the United States, or 7.4% of the workforce, are classified as independent contractors. Today that number, despite recessionary times, is likely dramatically larger.
The federal government, based upon recent case studies including federal and state income tax and unemployment tax audits, recently concluded many workers classified as independent contractors are actually employees. Consequently, worker classification is currently a hot topic for the Internal Revenue Service, the state departments of revenue, and other federal, state and local agencies.
Government focus on worker classification is not a new phenomenon. Due to current economic and political pressures, however, it has risen to the forefront of governmental attention. During the last few years, federal, state and local agencies have dramatically increased audit activity, targeting worker misclassification.
Larry J. Brant
Larry J. Brant is a Shareholder and the Chair of the Tax & Benefits practice group at Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Entity Classification – The Check-The-Box Regulations Revisited," New York University 81st Institute on Federal TaxationNew York, NY, 10.23.22-10.28.22
- "The Intersection of Code Section 1031 and Opportunity Zones," 2022 OSCPA Northwest Federal Tax Conference10.24.22
- "Entity Classification – The Check-The-Box Regulations Revisited," New York University 81st Institute on Federal TaxationSan Diego, CA, 11.13.22-11.18.22