by Miles L. Kavaller, Esq. and Wayne Schooling
The use of independent contractor truckers has been a long standing practice in the trucking business. Understanding the difference between an employee and an independent contractor is therefore of critical importance. Mistaken or intentional misclassification can have catastrophic consequences.
The distinction between an employee and an independent contractor will differ depending on the context of the matter at issue. The different contexts include the payment of federal and state employment taxes including contributions for social security, unemployment insurance and federal and state withholding; workers’ compensation, labor issues (meals, rest periods, vacations, payment of wages and benefits) and tort liability. Mischaracterization of a worker as an independent contractor rather than an employee can have dire consequences exposing the employer to payments for social security, federal and state taxes, penalties and interest, payment of benefits as an uninsured employer under the workers’ compensation law and the imposition of additional workers’ compensation insurance premiums for those workers who were later determined to be employees in post-policy audits.
1. THE INTERNAL REVENUE SERVICE AND CALIFORNIA EMPLOYMENT DEVELOPMENT DEPARTMENT TESTS.
Misclassification is probably most significant in the context of federal and state employment taxes. The test applied by the Internal Revenue Service (“IRS”) and the California Employment Development Department (“EDD”) in determining whether the person providing service is an employee or an independent contractor focuses on the degree of control over, or the independence of, the worker. Facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
According to the IRS, look at the entire relationship, consider the degree or extent of the right to direct and control and document each of the factors used in making the determination. If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be filed with the IRS. A Form DE 1870 can be filed with the EDD.
2. ENFORCEMENT UNDER CALIFORNIA’S UNFAIR COMPETITION LAW.
A recent decision of the California Court of Appeal for the Second Appellate District in Los Angeles exemplifies the seriousness of a motor carrier’s misclassification of independent contractors. In People ex rel. Harris v. Pac Anchor Transportation, Inc. decided on May 18, 2011 the California Attorney General sued Pac Anchor Transportation (”Pac Anchor”), as well as the company owner Barajas personally, under California’s unfair competition law, alleging the following:
- Failing to pay unemployment insurance taxes as required by Unemployment Insurance Code §976;
- Failing to pay Employment Training Fund taxes as required by Unemployment Insurance Code §976.6;
- Failing to withhold State Disability Insurance taxes as required by Unemployment Insurance Code §984;
- Failing to withhold State income taxes as required by Unemployment Insurance Code §13020;
- Failing to provide workers’ compensation as required by Labor Code §3700;
- Failing to provide employees with itemized written statements as required by Labor Code §226 and to maintain and provide employees with records required by [California Industrial Welfare Commission (IWC) ] Wage Order [No.] 9, subsection 7;
- Failing to reimburse employees for business expenses and losses as required by Labor Code §2802; and
- Failing to ensure payment at all times of California’s minimum wage as required by Labor Code §1194 and IWC Wage Order 9, subsection 4.
According to the Complaint, as a result of these practices, Pac Anchor and Barajas “have obtained an unfair advantage over its competitors, deprived employees of benefits and protections to which they are entitled under California law, harmed their truck driver employees, harmed the general public, and deprived the State …of payments for California state payroll taxes.” The State sought restitution and civil penalties.
For the lawyers, the significance of this case is its novel use of California Business and Professions Code §§17200, et seq., the unfair competition law (“UCL”). Pac Anchor, as an interstate motor carrier, asserted that California law was preempted by 49 U.S.C. §14501(c) a provision in the Federal Aviation Administration Authorization Act (“FAAAA”) which states, in pertinent part, as follows:
“(1) … Except as provided in paragraphs (2) and (3), a State … may not enact or enforce a law, regulation, or other provision having the force and effect of law related to a price, route, or service of any motor carrier … with respect to the transportation of property.”
The Los Angeles Superior Court ruled in favour of Pac Anchor following the holding of Division Six of the same California Court of Appeal, Second Appellate District, in Fitz–Gerald v. SkyWest, Inc. (Fitz–Gerald ) finding all UCL causes of action against motor carriers preempted by the FAAAA. The court found that requiring Barajas and Pac Anchor to treat its truck drivers as employees would increase the motor carrier’s operational costs, and therefore, the action related to the motor carrier’s prices, routes, and services. The court concluded that the action threatened to interfere with the forces of competition by discouraging independent contractors from competing in the trucking market.
Disagreeing with Division Six, Division Five of the same California Court of Appeal stated as follows:
“The State’s action to enforce Barajas’s and Pac Anchor’s statutory obligations as an employer is not related to Pac Anchor’s prices, routes, or services, even though it may remotely affect the prices, routes, or services that the motor carrier provides. Case law supports finding that the effect of California’s minimum wage law (Lab.Code, §1194) on a motor carrier’s prices, routes, and services is too tenuous for preemption under the FAAAA. (See Fitz–Gerald, supra, 155 Cal.App.4th at p. 423, 65 Cal.Rptr.3d 913 [connection of minimum wage law to higher fares, fewer routes, and less service is tenuous]; Mendonca, supra, 152 F.3d at p. 1189 [California’s prevailing wage law applicable to public works contractors is not preempted by the FAAAA].) Other California labor and unemployment insurance provisions that Barajas and Pac Anchor allegedly violated have a similarly indirect and tenuous connection to Pac Anchor’s prices, routes, and services. We hold that the State’s UCL action based on Barajas’s and Pac Anchor’s alleged violations of generally applicable state laws governing an employer’s relationship with employees is not an action related to the price, route, or service of a motor carrier and, therefore, not preempted by the FAAAA.”
Although rare, there are, from time-to-time, conflicts not only among the several California Courts of Appeal, but also, as here, a conflict between divisions of a single California Court of Appeal. Resolution of this conflict can only be addressed by the California Supreme Court and given the significance of the case a petition for review will undoubtedly be filed.
3. GENERAL GUIDELINES FOR MAINTAINING AN INDEPENDENT CONTRACTOR RELATIONSHIP BETWEEN A MOTOR CARRIER AND A TRUCKER.
Under workers’ compensation law, a person who performs services for another is presumed to be an employee. This presumption can be rebutted by showing the worker is an as follows:
“Independent contractor” means any person who renders service for a specified recompense for a specified result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished.”
Courts therefore generally employ the “manner and means” test when determining whether a person is an employee or an independent contractor. See for example S. G. Borello & Sons, Inc. v. Department of Industrial Relations . These tests are similar to those used by the IRS and the EDD.
At a minimum, a trucking firm must have a written contract with a driver who owns or leases his, her or its own tractor, a person referred to typically as an owner-operator, contractor or occasionally a “sub-hauler”. The person or company should have a MC (motor carrier) number from the Federal Motor Carrier Safety Administration (“FMCSA”) if the motor carrier is engaged in interstate operations, and if also providing intrastate transportation, the person should have an MC-P (motor carrier permit) number issued by the California Department of Motor Vehicles. The contractor should also be responsible for paying his or its own expenses including insurance, licensing, operating expenses including fuel, maintenance and repairs.
Misclassification of employees as independent contractors can have serious financial
consequences in the context of lawsuits by workers themselves who challenge their independent contractor treatment and assert they are employees. A recent California class action involving Federal Express resulted in a settlement for some $27 million for lost overtime and expense reimbursement.
4. GOVERNMENT FINES.
If the IRS or the EED audits your firm, you must clearly show that your workers are really independent contractors…or your company will face large fines.
In other words… you’re guilty until you prove yourself innocent by showing unequivocally that your independent contractors are NOT employees.
As of November 1997, State Fund Compensation Insurance adopted a policy that owner-operators will be treated as employees for workers’ compensation purposes. This would add approximately $40,000 per 25 drivers to your P & L plus lead other state and federal agencies to your door. This policy can be rebutted with evidence that the owner-operators are independent contractors by establishing they own or lease their equipment, have FMCSA and/or California DMV MC-P numbers and pay their own operating expenses.
If you lose an audit because your worker is really an employee, your firm may have to pay more than 41 % of the money you have already paid to your ” independent contractors ” in taxes and penalties. This is because the government says employers hold the full responsibility for withholding employees’ personal income tax, Social Security tax, and any other employee-employer taxes.
5. LAWSUITS BY INDEPENDENT CONTRACTORS.
When workers are injured, employees generally are limited to workers’ compensation benefits. The federal courts are divided over the right of independent contractors to sue for discrimination. The split widened in November 2009 when the U.S. Court of Appeals for the 9th Circuit ruled in Fleming v Yuma Regional Medical Center that an independent contractor can sue under the Rehabilitation Act.
6. IRS AND EDD AUDITS.
The IRS and/or EDD may audit a firm for misclassification when the carrier terminates its working relationship with an independent contractor who seeks unemployment insurance, when the independent contractor is injured and wants disability or workers’ compensation insurance and when.the independent contractor hasn’t paid taxes.
The IRS now examines independent contractor relationships in all business audits, regardless of the original purpose of the audit. The EDD periodically targets certain industries or areas which it believes may have major problems from independent contractor misclassifications.
With either occurrence, your business will be audited. The IRS or EDD will ask for evidence that your workers were really independent contractors. The burden of proof is always on the hiring firm… the worker is presumed to be an employee unless the hiring firm proves otherwise. This is the basis that LATA, WRTU, CWA and others use. If the initial audit was to verify one contractor the auditors may choose to expand the audit and investigate all other independent contractors you may have.
If you lose an IRS audit, the taxes can total:
15.3% Social Security Tax (on income up to $65,400, plus 2.9% of income over that amount);
20.0% Federal Income Tax; and
6.20% Unemployment Insurance
… a whopping 14.5% of the contractor’s payment… and audits can go back 3 to 7 years.
For companies that the IRS feels did not intentionally ignore the law, the fines are less: 11.48% of the contractor’s payment if you filed 1099’s and 13.71% of the contractor’s payment if you didn’t file 1099’s
If you lose an EDD audit the taxes can total:
1 – 11.00% State Income Tax
.50 % Disability Insurance
.50 – 5.40% Unemployment Insurance
.10% Employment Training Tax
2.9% to 17.8% of the contractor’s payment and the auditors can go back three (3) years if returns were filed… eight (8) years if no returns were filed.
In addition, you can be fined as reflected in the following chart:
|Failure to file W-2 or 1099||IRS: The minimum fine is $50.00 for each form that you failed to file. The Maximum fine is $250,000 per business or $100,000 for small businesses.
EDD: 11% of the total amount paid to the worker if no 1099 or W-2 was given PLUS $50 for each W-2 not given to an employee; $10 for each W-2 not filed with the EDD
|Failure to file quarterly returns||IRS: 25% of the unpaid tax liability
EDD: 10% plus additional 10% if the return is more than 60 days late.
|Failure to pay taxes||IRS: ½% of the unpaid tax liability for each month up to 25%
EDD: 10% if not paid within 30 days of assessment
|Failure to get Social Security Number||IRS: $50 for each Social Security number you did not get|
There also are significant fines if the IRS or EDD believe you committed fraud or were negligent, plus fines for many other situations.
Although the company, a corporation, limited liability company or limited liability partnership, is primarily liable for payment of the taxes, interest and penalties, the business owners as well as other responsible employees can be personally liable for payment.