In March of this year, the IRS began the Employment Tax National Research Program, the first comprehensive employment tax compliance study in 25 years. The IRS will randomly select 2,000 taxpayers each year for the next three years to conduct comprehensive audit examinations. Taxpayers selected for audit will receive notices describing the National Research Program process.
In these random audits, the IRS will focus on worker classification and fringe benefit policies. A fringe benefit is a form of compensation for the performance of services. However, a person who performs services for an employer for purposes of fringe benefit compensation does not have to be an employee. A person may perform services as an independent contractor, partner, or director. Furthermore, for fringe benefit purposes, a person who agrees not to perform services (such as under a covenant not to compete) is also considered to be performing services. An employer is considered the provider of a fringe benefit even if the benefit is actually provided by a client or customer of the employer. The key is that the benefit is provided to the employer’s employee, contractor, director, or partner for services performed for the employer. Similarly, the employee, contractor, director, or partner is still considered the recipient of the benefit even if it is actually provided to someone who did not perform the services for the employer, such as a family member. Again the key is that the benefit is provided for and because of services performed for the employer. Absent a specific exclusion, fringe benefits are taxable and must be included in the recipient’s pay, and therefore, creates an obligation on the employer to withhold, deposit and report employment taxes relative to fringe benefits.
Fringe benefits, though, are distinguishable from expense reimbursement plans. Generally an advance, reimbursement or other expense allowance received under an “accountable plan” is not income to an employee and does not create employment tax obligations on the employer. An advance reimbursement, or other expense allowance, is treated as made under an “accountable plan” if:
1. the employee receives the advance reimbursement or other expense allowance for a deductible business expense that the employee paid or incurred while performing services as an employee of the employer,
2. the employee adequately accounts to the employer for the expense within a reasonable period of time, and
3. the employee must return any excess reimbursement or allowance within a reasonable period of time.
If an advance, reimbursement or other expense allowance to an employee does not satisfy all three of these conditions, it is treated as paid under a nonaccountable plan. All advances, reimbursements or other expense allowances paid under a nonaccountable plan are taxed to the employee and create an obligation on the employer to withhold, deposit and report employment taxes relative to all such nonaccountable plan payments.
Similarly, improper classification of employees or independent contractors could have a significant impact on federal and state tax liabilities (including unemployment tax liability), health and welfare benefit obligations, Code-qualified benefit plan participation and funding, as well as IRS penalty exposure for an employer. Worker classification can be a complex area as each case requires careful analysis of the facts and circumstances in light of general common law principles and divergent IRS and case rulings. In very general terms, classification depends on the degree of control by the employer versus independence of the worker. Factors that provide evidence of the degree of control and independence generally fall into three categories:
1. Behavioral: Does the company control or have the right to control what the worker does and how, when or where the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship be ongoing? Is the work performed a key aspect of the business?
However, there is no “magic” factor or set number of factors that will tip the determination one way or the other. In fact, more likely than not, there will be some factors indicative of employee status, while other factors indicate that the worker is an independent contractor. Furthermore, factors which are relevant in one situation may not be relevant in another. An in depth discussion of this issue is beyond the scope of this article, but the general recommendation is to pay careful attention to worker classifications because, again, mis-classification can result in significant liabilities for an employer.
Even if not randomly audited as part of the current IRS study, employers should be on notice that the IRS is giving greater scrutiny to employer practices and will ultimately use the information gathered through this study to focus on particular types of employers and employment tax and benefits issues. As such, it is prudent for employers to review their fringe benefit and expense reimbursement policies and procedures as well their independent contractor relationships for correct classification. Identification and correction of any errors, omissions or inconsistencies relative to employment tax and benefits is much easier and less costly if done proactively as opposed to after coming under IRS scrutiny.
In the event you receive a notice of audit pursuant to the Employment Tax National Research Program or would otherwise like assistance with compliance review of your employment tax and benefits policies and procedures or employee classifications, the employment and tax attorneys at Wilke Fleury are happy to assist you.
The following is a synopsis of the notable changes in California and federal employment laws that were enacted or modified in 2009.
AB 5 – Electronic Discovery
Not specifically an employment bill, but it could dramatically affect employers’ costs of engaging in employment litigation. Amends California’s Civil Discovery Act to establish procedures for the discovery of electronically stored information (“ESI”). The party seeking production of ESI may specify the particular format. If no format is specified, the party producing the ESI may use any reasonable format when supplying the information. Further, the bill allows discovery through copying, testing, or sampling, as well as inspection.
AB 23 – Cal-COBRA
Extends the federal COBRA premium subsidy to smaller employers (between two and nineteen employees) covered by Cal-COBRA. The bill imposes the following additional notice requirements on healthcare service plans, contract administrators, and insurers of small California employers:
• Notify qualified beneficiaries regarding the premium assistance available under the Federal American Recovery and Reinvestment Act of 2009 (ARRA) to subsidize Cal-COBRA coverage.
• Provide written notice after certain qualifying events (occurring between September 1, 2008 and May 13, 2009) within fourteen calendar days of the bill’s effective date, or seven business days after receiving notice of the qualifying event, whichever is later.
AB 361 – Limitations on Employer’s Ability to Rescind Medical Treatment Authorization
Prevents an employer, regardless of whether it established a medical provider network or entered into contracts with health care providers, from rescinding an authorization made for workers’ compensation medical treatment if authorization was made before the treatment was provided.
AB 412 – Nooses Prohibited in Workplace
Expands the protections of California’s Hate Crimes Law to prevent anyone, who knows a noose to be a symbol representing a threat to life, from hanging one in a place of employment for the purpose of terrorizing an employee. A violator is subject to imprisonment and civil fines up to $5,000 for the first offense.
AB 485 – California Civil Air Patrol Military Leave
Employers with more than 15 employees must provide at least ten days of leave per year, beyond other legally required leave benefits, to employees who are volunteer members of the California Wing of the Civil Air Patrol (the civilian auxiliary of the U.S. Air Force) if the employee is called to respond to an emergency operational mission.
AB 1093 – Worker’s Compensation Coverage for Third-Party Torts
Labor Code § 3600 has been amended to provide that injuries or death inflicted by third parties at the worksite because of an employee’s protected characteristic (race, religious creed, color, national origin, age, gender, disability, sex, or sexual orientation) will not be disqualified from worker’s compensation coverage.
AB X2 5 – Alternative Workweek Schedule
Labor Code § 511 has been amended to define a “work unit” as “a division, a department, a job classification, a separate physical location or a recognizable subdivision.” A “work unit” may also include an individual employee if the employee satisfies the criteria of a “reasonably identifiable work unit.” The bill further specifies that employers may include as an alternative work-week arrangement the option of a regular schedule of eight-hour days and allows employees who have adopted a menu of schedule options to move from one schedule to another on a weekly basis with employer consent.
AB X4 17 – Wage Withholding Tables
Effective November 1, 2009, employers must use a new state income tax withholding table to increase the amount of income taxes withheld based on existing claimed exemptions by 10%. Additionally, the bill increases the withholding rates to 6.6% for supplemental wages and to 10.23% for stock options and bonus payments paid on or after November 1, 2009. The bill further accelerates quarterly estimated tax payments of corporations and individuals with non-wage income to 30% due in April, 40% in June, zero in September, and 30% in December. Of note, the new accelerated payment schedule begins for installments due in tax years starting on January 1, 2010.
SB 54 – Same Sex Out-Of-State Marriages Recognized as Legal
Effective January 1, 2010, a valid marriage between persons of the same sex that was entered into outside of California prior to the effective date of Proposition 8 (November 5, 2008) will be recognized as a valid marriage in California. Such couples will be entitled to all the same rights, protections, obligations and duties in California that are granted upon spouses.
SB 313 – Increased Workers’ Compensation Penalties
Increases the penalty against employers who fail to carry workers’ compensation insurance to $1,500 per employee who is employed during the time the employer was uninsured. The bill further restructures the laws governing penalties for noncompliance with payment of workers’ compensation.
SB 367 – Price Discounts for Unemployed Consumers
Effective November 2, 2009, this bill establishes that discounts offered to or conferred on a consumer because of loss of employment (including a furlough) would not be considered discrimination in violation of the Unruh Civil Rights Act.
National Defense Authorization Act of 2010
The National Defense Authorization Act of 2010 (“NDAA”) went into effect on October 28, 2009. This Act expands employers’ duties and family military entitlements of the Family Medical Leave Act of 1993 (“FMLA”). The FMLA applies to public agencies, including state, local and federal employers, schools (public and private), and private sector employers with fifty or more employees. The key changes effected by the NDAA include:
• Qualifying exigency leave is now available to family members of those in the regular components of the armed forces during the servicemembers deployment to a foreign country. Previously, such leave was only available to family of servicemembers in the National Guard or Reserve who had been called to active duty.
• A family member of a veteran undergoing medical treatment, recuperation, or therapy for a serious injury or illness incurred in the line of duty may take caregiver leave if the veteran was a member of the military within five years of receiving such treatment.
• The definition of “injury or illness” is modified to include the aggravation of pre-existing injuries. Therefore, covered employees may now take up to 26 weeks of FMLA leave to care for a service member who had a pre-existing injury that was aggravated in the line of military duty.
American Recovery and Reinvestment Act
On December 21, 2009, President Obama signed into law an extension of the COBRA subsidy created by the American Recovery and Reinvestment Act (“ARRA”). This legislation both extended the period during which involuntary terminations would trigger subsidy eligibility and expanded the duration of the subsidy. The following new rules apply:
• The maximum subsidy period is extended from 9 to 15 months.
• The period during which a COBRA-qualifying event can trigger eligibility for the subsidy is extended from December 21, 2009 to February 28, 2010. Eligibility for the subsidy is conditioned on the timing of the qualifying event, which is the event causing the loss of coverage. Subsequently, if an employee experiences an involuntary termination on or before February 28, 2010, the employee will be eligible for the subsidy regardless of when COBRA coverage would eventually start.
• Employees who exhausted their nine months of subsidized COBRA coverage and did not elect to continue coverage by paying the full premiums are able to continue coverage by paying premiums retroactively. Their employers can apply the same refund rules in the ARRA so that the employees can take advantage of the subsidy for the full 15 months.
• A notice must be issued to all individuals who were or are assistance-eligible or terminated on or after October 31, 2009. Special notice must also be sent to individuals who dropped COBRA or paid the full premiums when their nine-month subsidy expired. The notice must explain their eligibility to either reinstate their coverage retroactively at the subsidized rate or receive a credit.
• To assist employers with the notice effort, the Department of Labor just issued three new Model Notices to advise employees and their dependents of these new rights.
Health Information Technology for Economic and Clinical Health Act
The Health Information Technology for Economic and Clinical Health Act (HITECH Act) was enacted on February 17, 2009 as part of the federal economic stimulus bill. The HITECH Act establishes new notice requirements for employers and health care providers when there is any breach of unsecured protected health information (PHI) of individuals. In the case of such a breach, employers and health care providers must provide notice to the affected individuals, the U.S. Department of Health and Human Services (HHS), and prominent medial outlets in certain circumstances. According to the HITECH Act, any notices are subject to the following requirements:
• The notice must contain a brief description of what happened, the types of unsecured PHI involved in the breach, steps the affected individual can take to reduce the risk of harm from the breach, a description of the entity’s investigation, efforts to mitigate harm and steps taken to prevent recurrence, and the contact information for obtaining additional information.
• The notice must be sent by first-class mail to the affected individual’s last-known mailing address. If unknown, the entity must post the notice on its website.
• If the breach involves 500 or more affected individuals, the entity must also notify HHS. If the breach involves 500 or more individuals from a state or jurisdiction, the entity must notify prominent media outlets serving the state or jurisdiction.
• An individual can prevent a covered entity from disclosing PHI if the PHI pertains to care for that individual that was paid solely out of pocket.
• The exception of not accounting for certain disclosures has been eliminated, thus requiring all disclosures of PHI to be accounted for by the covered entity in the case of a request of accounting.
• Business associates (contractor or other non-workforce member who performs services or activities) of covered entities must amend their agreements with covered entities to reflect the new privacy and security requirements under HITECH that apply to covered entities and are also now subject to same criminal and civil penalties applicable to an entity violating the same provision. Business associations must notify the covered entity if there is a loss of PHI.
• State attorneys general are now authorized to enforce these requirements after Feb. 22, 2010. Moreover, the penalties have gone up to 1.5 million for a breach of PHI that is the product of willful neglect.
Revised I-9 Form for Employers
Effective August 7, 2009, employers were to start using a new I-9 form. The new form includes changes to the types of documents that can be accepted for purposes of identity and work authorization. Expired documents cannot be accepted. Employers need not go back and change or update previously completed I-9 forms.
Generally, when an employee quits or is fired, the employer must immediately pay all earned and accrued compensation, including wages, commissions, vacation pay and productivity-based bonuses. However, an employer need not pay amounts that have not yet been earned, such as commissions or bonuses where the employee has not satisfied the conditions necessary to earn the commission or bonus.
Schachter v. Citigroup, Inc.
In a recent case, an employer offered a voluntary stock purchase plan to its employees as an incentive for the employees to work efficiently and stay with the company. Under the plan, employees could designate a percentage of their salary to be used to purchase company stock. If the employee remained with the company for two years following purchase of the stock, title to the shares vested in the employee. On the other hand, if the employee quit or was fired for cause before the end of the two-year period, the employee forfeited the shares and the wages used to purchase the shares. If the employee was fired without cause, the employee still forfeited the stock but received, without interest, a cash payment equal to the amount the employee had invested in the stock.
The plaintiff was an employee who signed up for the stock purchase plan but voluntarily quit less than two years after he purchased the stock, thereby forfeiting all his stock and the wages he used to purchase the stock. He sued his employer in a class action lawsuit, alleging the employer failed to pay earned wages. The employee argued that, since he had used earned wages to buy the stock and since he forfeited those wages when he quit less than two years later, he had not really been paid the wages at all.
The California Supreme Court rejected that argument, explaining that eligibility to receive incentive based compensation is determined by the specific terms of the plan. Because incentive based compensation rewards future, as opposed to past, conduct, it is not “earned (and the employer has no obligation to pay) until the conditions set forth in the plan have been met. Since the employees in the class action did not continue their employment for the full two years after they voluntarily purchased stock through the company incentive plan, they never met the conditions set forth in the plan and they forfeited the stock and the wages used to purchase the stock.
Lessons for Employers
Incentive based compensation is not earned unless and until the terms of the incentive plan have been satisfied. Accordingly, it is very important that the terms of your incentive-based plans be clear as to any conditions that must be met to earn the compensation. Regardless of the terms of your plan, however, you cannot fire an employee without cause simply to prevent the employee from earning the incentive based compensation. An incentive based plan constitutes a contract and all parties have an obligation of good faith and fair dealing.
Wilke, Fleury, Hoffelt, Gould & Birney, LLP is pleased to announce the arrival of two new associates, Samson R. Elsbernd and Natalie A. Johnston.
Mr. Elsbernd joined the firm as an associate in September 2009. He attended Pacific McGeorge School of Law, graduating with distinction. He received the Certificate of Governmental Affairs and the Witkin Award in Legislation. He served as President of the McGeorge Federalist Society, and was a member of the Labor and Employment Practice Group Executive Committee for the national Federalist Society. While completing his studies, he was a legal extern for the California Emergency Management Agency. Additionally, he was a certified student attorney for Community Legal Services, a non-profit civil practice clinic, and for the Solano County Public Defender.
Ms. Johnston joined the firm as an associate in November 2009 after a year long judicial clerkship with the Honorable John E. Suddock of the Alaska Superior Court. She graduated with her J.D. and M.B.A. from the University of California, Davis in 2008. While in law school, Ms. Johnston served as a member of the U.C. Davis Law Review and chaired the King Hall Legal Foundation, a student-run nonprofit benefiting public interest law, and the Asian Pacific American Law Students Association. She also served as a teaching assistant for the U.C. Davis undergraduate studies program and volunteered to assist with the annual Prison Law Symposium.
Daniel L. Baxter, Wilke Fleury Hiring Partner, said, “We are truly excited to have Natalie and Samson on board, and know that our clients will appreciate the level of service these two talented lawyers will provide.”