Are you using independent contractors? Are you sure? The IRS has taken a renewed interest in the perennial question of whether workers are being properly classified for federal employment tax purposes. In addition, a California appeals court recently ruled against a major trucking company regarding its classification of drivers for state unemployment insurance purposes.
John Tuzynski, the IRS' chief of employment tax, told a meeting of the American Bar Assn.'s Section of Taxation on May 12 that the agency had joined with a variety of state workforce and tax agencies to share data and refer employment tax cases for audit. “It's safe to say if you thought worker classification cases were increasing, you are going to see a nice increase in our 2008 plan,” Tuzynski warned. “This will be a major area of emphasis for us.”
He added that he is “sending training materials to state workforce agencies, and we are training some of their examiners. We are sending them leads and they are sending us leads. We are also sending them information on cash payment reporting, and some day we see this extending out to all 50 states.”
Neither Tuzynski nor Janine Cook, a branch chief in the IRS chief counsel's office, who also spoke at the meeting, mentioned trucking as a focus of the new initiative. But over the years, there have been many court cases involving classification of trucking personnel.
Owner-operators who actually own their vehicles — or lease them without the involvement of the carrier they drive for — generally do not have a problem establishing that they are independent contractors. But drivers with little or no investment and little discretion over the loads they accept are more problematic. Carriers can also run into trouble if they treat other types of workers, such as “lumpers,” driver's helpers and packers for movers, as independent contractors.
Separately, the IRS announced on June 6 that it is in the final stages of a compliance research project examining the reporting compliance of S corporations. The research encompasses about 5,000 returns for 2003 and 2004. The announcement was included in a press release revealing that the agency will begin a new “National Research Program” in October to examine 13,000 randomly selected tax year 2006 individual returns.
There was no mention of trucking or worker misclassification. But past compliance studies have identified misclassification as a persistent problem, and trucking businesses are major users of contractors.
The California case involved drivers for Air Couriers International, UPS Service Parts Logistics Group and UPS Logistics Group, collectively referred to as Sonic. In 2003 Sonic sued the California Economic Development Dept. to recover state unemployment taxes it had paid after the department ruled its package drivers were employees.
The trial court sided with the agency, placing considerable weight on the testimony of several drivers that contradicted the company's assertions in support of independent status. The court found that drivers did not have a substantial investment, did not have contracts, worked exclusively for Sonic, were paid by the hour, and used company logos, forms and shirts. In an April 12 ruling, a three-judge panel of the California Court of Appeal not only upheld the trial court, but also ordered Sonic to pay the department's court costs.
The bottom line: Don't be lulled by the relative inactivity regarding worker classification in the past decade. Shifts in Congress, a re-energized IRS, and new cooperation between employment and tax agencies at the federal and state levels mean you could face fresh scrutiny for what you assumed was an accepted practice.