Along with 26 other co-sponsors, Rep. Jim McDermott (D-Wash.) introduced on March 1, 2012 the Fair Playing Field Act of 2012 (H.R. 6128), a bill that appears to be identical to the Fair Playing Field Act of 2010 (H.R. 6128), which was never acted upon by Congress. This is the second time in 18 months that Congress has introduced a bill intended to eliminate the so-called “safe harbor” in the federal tax laws relied upon by some businesses that for years may have consistently misclassified employees as independent contractors (ICs).
The principal sponsor of the House bill (H.R. 4123), Rep. McDermott, refers to the safe harbor provision as a “tax loophole” that “needs to be fixed so that employers who properly classify their workers are no longer at a disadvantage in the marketplace and so that workers get the rights they deserve.” Another purpose of the bill, according to its detailed “Findings,” is to address the “Federal and State tax gap” created by IC misclassification.
A bill with the same text has reportedly been introduced in the Senate by Sen. John Kerry (D-Mass.), but it is not yet available. The White House is likely to quickly endorse the Fair Playing Field Act of 2012, just as it did when the 2010 bill was introduced.
This is the second of two IC misclassification bills that Congress has introduced in this Congress. The other bill is the Employee Misclassification Prevention Act of 2011, which was introduced in both houses of Congress on October 13, 2011 as H.R. 3178 and S. 3254 and is the subject of an October 17, 2011 Pepper Hamilton Client Alert, “Congress Reintroduces the Employee Misclassification Prevention Act that Would Make Misclassification of Employees as Independent Contractors a Federal Offense.”
Neither of the two federal bills, if enacted, would legislate an end to the use of ICs; rather, businesses may continue to use 1099ers provided they are properly classified as such. Indeed, Rep. McDermott acknowledged in his press release that “legal independent contractors play an important role in the economy.” As set forth below under “Analysis,” there are a number of alternatives that businesses can use to enhance their compliance with IC laws without having to curtail their use of such individuals or reclassify those workers that regulatory agencies or class action lawyers may claim to be misclassified employees.
The Fair Playing Field Act of 2012
The so-called tax loophole that the Fair Playing Field Act of 2012 seeks to close is Section 530 of the Revenue Act of 1978. That law currently affords businesses a safe harbor to treat workers as ICs for employment tax purposes if the company has had a reasonable basis for such treatment and has consistently treated such employees as ICs by reporting their compensation on Form 1099s.
This safe harbor was reportedly used recently by FedEx to escape a $319 million back-tax assessment by the IRS related to FedEx’s classification of its Ground Division drivers as ICs. Although the IRS concluded that such drivers were common law employees, it withdrew its assessment based on the protection afforded FedEx under Section 530.
In its findings, the bill recognizes that “many workers are properly classified as independent contractors,” but “in other instances, workers who are employees are being treated as independent contractors.” After noting that Section 530 was intended to be an “interim measure,” the findings state that this safe harbor had become permanent. Therefore, “in the interest of fairness and in view of many service recipients’ reliance on current Section 530,” the Fair Playing Field Act of 2012 would direct the Secretary of the Treasury to issue guidance to workers and businesses on a prospective basis only.
Going forward, the Fair Playing Field Act of 2012 would eliminate the continued use of the Section 530 safe harbor. It would also require the Secretary of the Treasury to issue regulations or other prospective guidance clarifying the employment status of individuals for federal employment tax purposes. In addition, the act would prohibit the IRS from making retroactive assessments for past unpaid taxes in cases in which the business consistently treated the worker involved as an IC and filed Form 1099s each year for the worker, unless the business had “no reasonable basis for not treating such individual as an employee.”
The bill sets forth “one method of satisfying the [reasonable basis] requirement” – if the business acted in reasonable reliance upon: (A) judicial precedent, published rulings, technical advice, or a letter ruling issued to the business; (B) a past IRS audit of the business in which there was no assessment attributable to individuals holding positions that were substantially similar to the worker in question; or (C) a long-standing recognized practice of a significant segment of the industry in which such individual was engaged. The Fair Playing Field Act of 2012 defines a “significant segment of the industry” as no more than 25 percent of the industry, and clarifies the term “long-standing recognized practice” as not requiring the business to show that the practice continued for more than ten years.
The act would also:
- eliminate the reduced penalty provisions of the Tax Code for failure to withhold income taxes and the employee’s share of FICA taxes in cases in which the business did not have a reasonable basis for treating a worker as an IC
- require businesses who use an ICs “on a regular and ongoing basis” to provide them with a written statement informing them of their federal tax obligations, notifying them of the employment law protections that do not apply to them, and telling them how they can seek a determination of their status from the IRS, and
- exclude certain skilled workers (engineers, designers, drafters, computer programmers, systems analysts, and the like), who were not eligible for the safe-harbor protection of Section 530, from the prohibition on retroactive tax assessments.
The safe-harbor provisions of Section 530 and the Fair Playing Field Act of 2012 only apply to the classification of workers as ICs under the federal employment tax laws. The bill has no application to state tax laws or federal and state workplace laws, which would be unaffected by passage of this federal bill.
Pepper Points: This federal bill augments the crackdown on IC misclassification by the IRS and the U.S. Department of Labor, each of which entered into a joint Memorandum of Understanding on September 19, 2011 to coordinate both agencies’ law enforcement efforts aimed at businesses that misclassify employees as ICs. The Fair Playing Field Act of 2012 also dovetails with vigorous efforts at the state level to eliminate employee misclassification: in addition to a number of states that have established a misclassification task force comprised of various state workforce and tax agencies, more than 20 states have passed legislation aimed at curtailing the misuse of ICs. In addition, federal-state coordination is increasing: a dozen states have now entered into state-specific Memorandums of Understanding with the U.S. Department of Labor to share information about companies that have been found by either a state or federal agency to have misclassified ICs.
Most companies that have business models that are IC-dependent or simply make use of multiple ICs are aware that their use of ICs creates a risk of IC misclassification liability. Many businesses with legitimate IC business models fail to document and/or put into practice their IC model in a manner that fully complies with all applicable IC laws. The means by which companies can enhance IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers is set forth in our white paper, “Independent Contractor Misclassification: How Companies Can Minimize the Risks.”
Pepper Hamilton’s multi-disciplinary Independent Contractor Compliance practice assists businesses to eliminate or minimize misclassification exposure. Using Pepper’s IC Diagnostics™ and its proprietary IC compliance tools, Pepper’s two dozen labor, tax, and employee benefit lawyers in its IC Compliance practice are able to assess a company’s level of IC compliance and provide businesses with legal advice to choose the most suitable means to enhance their current level of IC compliance.
Richard J. Reibstein, Lisa B. Petkun and Andrew J. Rudolph