FedEx vs. The IRS

Dec. 27, 2007
“Taxation has made more liars out of the American people than golf has.” -Will Rogers Like almost every large company in the U.S. tries to do nowadays, FedEx attempted to hide some very bad news in a regulatory filing with the Securities & Exchange ...

“Taxation has made more liars out of the American people than golf has.” -Will Rogers

Like almost every large company in the U.S. tries to do nowadays, FedEx attempted to hide some very bad news in a regulatory filing with the Securities & Exchange Commission last week - and failed miserably.

Buried deep in its regulatory filing - and unearthed faster than gold from a Pharaoh‘s tomb - FedEx noted in very dry, terse language that the Internal Revenue Service slapped it with $319 million in fines and penalties for the 2002 tax year ALONE, as the tax man believes FedEx treats its independent contractors like full time employees and so must pay taxes on them as such.

At issue are the 15,000 independent contractors the company‘s FedEx Ground division uses as drivers - a business model FedEx used for years as a way to keep costs down. Yet that very same model also put FedEx in hot water with state governments and labor groups such as the International Brotherhood of Teamsters, which is engaged in a long-term campaign to unionize FedEx drivers like what‘s been done at FedEx‘s biggest rival, United Parcel Service.

At issue, said Bear Stearns analyst Edward Wolfe in a recent research note, is that FedEx exercises too much control over its ground drivers for them to be classified as contractors. As a result, FedEx‘s use of contractors is the focus of lawsuits in 36 U.S. states, brought by some current and former FedEx Ground drivers, alleging the level of control the company exercised over their work qualified them as employees -- and that they deserve the benefits that go with that status.

Massachusetts‘ Attorney General, for example, just cited FedEx Ground for intentionally misclassifying 13 pickup and delivery drivers as independent contractors rather than employees and fined FedEx $190,000 in penalties -- alos ordering the comapny to fix their employment status and pay those 13 drivers restitution.

Recently, the California Supreme Court refused to review a California Court of Appeal ruling that found single route FedEx Ground drivers in that state to be misclassified. So, in September this year, the company unilaterally terminated contracts for 1,000 contract drivers in California - paying between $25 million and $37 million in one-time severance costs associated, according to Teamster estimates.

Analyst Jason Seidl with Credit Suisse wrote in a research note to clients that should the FedEx be forced to offer the same deal nationwide, it could cost the company between $250 million and $430 million.

The big problem for FedEx is that the IRS isn‘t done with its audits yet, for the federal taxman is now reviewing the company‘s books for tax years 2004 through 2006. Credit Suisse‘s Siedl added in his research note that the company “could potentially owe nearly $1.5 billion in taxes and expenses when all audits are completed.”

Now, obviously, FedEx is fighting all this - but there will probably come a time when it may choose to settle, rather than carry on what‘s shaping up to be an expensive and protracted battle. A title bout against the IRS isn‘t what most companies want, and frankly, FedEx should be able to afford to write the agency a big fat settlement check, if you ask me.

Look, the company posted net income in just its SECOND fiscal quarter this year of $479 million on revenues of $9.45 BILLION. Not too shabby for one quarter in a year when freight ton-miles are down 2.2%, fuel costs are skyrocketing, and the U.S. economy seems headed for a recession.

And though concerned about the overall economic outlook, Frederick Smith, FedEx‘s chairman, president and CEO, put forth some confident words in his company‘s second quarter report. “High fuel prices and weak U.S. economic growth year over year have impacted our business,” he said. “We continue to benefit from solid international growth, which helps mitigate softness in U.S. industrial production. While we see challenging near-term economic trends, we remain confident about long-term prospects in all our business segments.”

Me, I am betting that FedEx is going to completely reshape - if not eliminate - it‘s independent contractor business model, settle with the IRS, let everyone get on a soap box and crow about the company‘s failures, then get on with business. My only question is why it didn‘t do something sooner about its contractors, instead of being forced to make changes under the hammer blows of the taxman and the courts. Would‘ve saved them a lot of grief.

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