In our May issue we speak with Gregory Homer, an attorney and partner in the Labor & Employment Practice Group at Drinker Biddle in Washington D.C. He has worked extensively with experts in statistics and labor economics in the preparation and execution of defense strategies and case analyses in complex class action and multi-plaintiff employment litigation, including several nationwide class actions. Typically, in the case of a worker misclassification audit, he is called after the government agent has already shown up. His role is to try to bargain with the representative about whether or not a worker is misclassified and how this can be resolved to the client's satisfaction. Read Homer's views on the utilization of independent contractors, on being audited and what advice he has on navigating an audit.
Q: What are the odds of being selected for an audit?
A: In the past the odds would've been fairly small. And that's whether we're talking about an IRS audit or a state labor agency audit or the federal Department of Labor audit. The federal Department of Labor, for example, in the past really didn't get involved in that type of audit. It would've been more an IRS audit. But recently, both at the federal level and the state level, governments have been devoting more resources to conducting those types of audits and in fact I think this year alone President Obama's budget has an excess of $20 million earmarked for this very purpose. So now the odds have increased.
Q: How can a company reduce the risk of being audited?
A: The best way would be to have no independent contractors. But failing that, since an independent contractor relationship is a commonplace and accepted working relationship, it doesn't always have to be an employer, employee relationship. So, if I do have those types of relationships or ones that I am calling independent contractor relationships, I would want to look long and hard at that relationship and make sure that I'm comfortable that it in fact is going to meet the criteria -- that the IRS uses in particular -- in assessing whether or not someone truly is an independent contractor.
Q: Would you suggest that the company have a third party to handle compliance or should they just do it in-house?
A: I think it depends on the level of expertise in the company. ... Some very large companies with independent contractor relationships oft times will have in-house expertise in employment and tax law, probably attorneys. I do know of companies with that level of expertise in-house that actually audit themselves in that area. But I think most companies are unlikely to have that expertise in house and they really do need to have an outside third party look at their relationships that they're classifying as independent contractors and see if that is in fact the case.
Q: What would you advise to companies that have been selected for an audit?
A: Again, it somewhat would depend on who selected them for an audit. Whether it's the IRS, the Department of Labor or state agency. And in particular what type of audit they were selected for.
Q: An independent contractor audit.
A: If it's a targeted independent contractor audit, I would get legal counsel involved as soon as you're aware that you have been selected for that type of audit, and have your legal counsel look at your areas of potential exposure and advise you from the outset whether or not you have an issue, and, if so, whether the appropriate course of action at that point would be move aggressively to fix that problem and/or possibly engage in discussions with the agency that's auditing you about resolving this as quickly and cheaply as possible.
Q: What is your role personally in the audit process?
A: Typically, I am called after the government agent has already shown up. So the horse is kind of out of the barn by the time I usually get involved. In that event, I may ... try to argue with and bargain with the government agent about whether or not somebody's misclassified. If they were, how we can get this resolved to the client's satisfaction.
Q: How can a company reduce the risk once it has been selected for an audit?
A: Well once you're selected [the government agencies are] going to be looking back, so there's not a whole lot you can do about classification decisions that you've made in the past. The one thing you can do is try to preserve in essence what's known as a good-faith defense that to an extent you may have erred in how you classified someone in the past. It was a good-faith error and that you can demonstrate that by, once you realized, having moved quickly to adjust their status and make any back, for example, tax contributions under FICA or FUTA that you were required to make. By doing so, you're not going to avoid liability, but you may be able to convince the government that they shouldn't assess you any penalties on top of the liability.
Q: What should a company do to prepare for an audit?
A: The first thing I would do is pull out any documentation I have of the relationship between the company and anyone designated as independent contractor. And while that paperwork isn't necessarily determinative of their status, it is something that the IRS in particular and the courts also will look at, particularly if it's a document that sets forth the elements used to establish independent contractor status.
For example, [any documentation in which] the individual acknowledges that they're an independent contractor. They acknowledge that they're free to set their own hours at work. That they're only responsible for producing an end product and how they go about producing that product is up to their discretion. There are all those sorts of things that you can set out in an independent contractor agreement. And if you have one of those you want to make sure that's the first piece of paper you're pulling out. And then I also, in preparation for that audit, would interview my own managers who are in charge of that relationship to get a level of comfort that in fact that's the way it worked.
Q: Who should be present during an audit besides legal counsel?
A: Normally, it's going to be whoever is the representative of the government and that individual may often want to interview your employees. Typically, if the government wants to interview management or supervisory employees, the company's attorney has a right to be present. If it's an hourly employee or the independent contractor, the company probably does not have a right to have its counsel present, but oft times you can convince the investigator to allow you to be present, although they usually will insist that you not interfere with that interview by asking questions or interjecting.
But beyond that I would not have anybody else in the company present necessarily unless there's a manager who is very knowledgeable about the independent contractor relationship at issue, and you might want to have that person there to advise you when the government investigator is speaking to the independent contractor so that [he or she] can point out whether something is being overlooked or misstated.
Q: Say you receive a worker misclassification audit notice. What sort of documents do you as a company need to have ready?
A: Again, I think it's hard to say what it's going to be like going forward because of the additional emphasis on this. Previously, when IRS audited you, they audited you for a particular tax year. And on occasion if they saw something suspicious they might ask you to go back a couple more years.
Q: And are there any requests a company can make of the government auditor?
A: Again, it's kind of informal discussions with the investigator and some of them are more open to this than others. But [a company] can certainly ask the investigator what he is particularly interested in. You can ask if is there anything else that you can provide in the way of information to convince him that in fact this is a true independent contractor relationship. But, generally speaking, if the government investigator wants to be close-mouthed about things, there's not much you can do about it.
Q: It's case-by-case basis, depending on the personality of the investigator.
Q: What's the company's right as far as assessment relief is concerned?
A: Again I think that's going to depend on which agency we're talking about. If it was the IRS, traditionally you do have a right of administrative appeal within the IRS and ultimately you can take that up to the tax courts if you wanted to, but that's going to be pretty expensive. In most cases, what you would do is -- assuming that the government's got a decent case -- try to negotiate a settlement.
Q: What's the worst-case scenario given this new focus on worker misclassification?
A: I haven't looked at a criminal issue, but I'd be willing to bet that for certain types of willful violations there's a potential certainly for fines. There's also a potential for criminal liability. Usually I'm focusing more on the civil side because it's not just taxes that you've got to worry about if you misclassified employees, there's a whole range of other issues under Employee Retirement Income Security Act (ERISA), including whether these folks should have been participating in your fringe benefit plans, health insurance, disability insurance, 401(k) -- all that sort of thing. Plus it opens [the company] up to exposure under a variety of statutes that only apply in the employer/employee relationship such, as nondiscrimination laws.
Q: When you say fines, is there a range?
A: If we're talking about the IRS, under the Internal Revenue Code there are specific ranges of fines that can be assessed for specific types of violations; I don't know what those are off the top of my head, but they are specified in the code.