The cost of improper worker classification
By Dori Eggett, C.P.A.
From the Spring 2019 Journal of the Colorado Dental Association
Tax season brings many questions each year and one that is always a hot button is whether a dental hygienist should be issued a W-2 or 1099. And that brings up the question: Are dental hygienists independent contractors or employees in your office?
This question gets even more confusing when hygienists work temporary jobs or temporary full-time. A full- or part-time temporary position puts an individual into the common-law employee category. “Under common-law rules, anyone who performs services for you is your employee if you control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”1 Simply put, most dental hygienists work under some sort of supervision of a dentist, see the dentist’s patients, and use the dentist’s equipment. For these reasons, most dental hygienists, whether employed full-time or part-time are employees and should be issued W-2 forms, not 1099 forms.
In recent years, the Department of Labor (DOL) and the Internal Revenue Service (IRS) have increased investigation and enforcement of proper worker classification. The dental care industry is not immune. For many years, dental practice owners have treated associates and some registered dental hygienists as independent contractors. The classification of an individual as an independent contractor is largely dependent on federal and state tests, not an employer’s desire to reduce administrative burdens or payroll costs.
Worker misclassification can be costly to an employer. It is not uncommon for an employer to have multiple years of exposure, resulting in costly fines, penalties and associated payments. An employer’s cost associated with the discovery of misclassification can reach up to 20-40% of compensation and, in addition to any litigation fees, may include:
- Improper withholding of federal and state taxes
- Unpaid worker’s compensation premiums
- Unpaid minimum wage and overtime considerations
- Unpaid work-related expenses
- Complications under the Patient Protection and Affordable Care Act (ACA) for incomplete worker coverage
- Penalties and interest on the above
The IRS is involved in independent contractor classification because they must provide guidelines for employers’ tax liability. Depending on the type of business relationship an employer has with their workers, they may or may not be responsible for withholding income taxes, withholding and paying Social Security and Medicare taxes, and paying unemployment tax on wages.
In order to determine if a worker is an independent contractor or an employee in the eyes of the IRS, businesses must weigh common law rules—facts that provide evidence of the degree of control and independence in the relationship between a worker and a business. These degrees of control fall into three categories:
Behavioral control looks at how much input a business has over the work being done and how the work is done. Generally, if a worker is told when, where, and how to do a job, they are generally considered to be an employee. On the other hand, if a worker does not require guidance or training, and works where and when they like, they are generally considered to be an independent contractor.
Financial control looks at whether a business has the right to direct or control the financial and business aspects of a worker’s job. Determining factors include:
- The extent to which the worker has unreimbursed business expenses
- The extent of the worker’s investment in the facilities or tools used in performing services
- The extent to which the worker makes his/her services available to the relevant market
- How the business pays the worker, and
- The extent to which the worker can realize a profit or incur a loss
Relationship of the Parties
Relationship of the parties covers facts that show the type of relationship the parties had. This includes:
- Written contracts describing the relationship the parties intended to create
- Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
- The permanency of the relationship, and
- The extent to which services performed by the worker are a key aspect of the regular business of the company
Since 2009, the DOL has collected more than $1.6 billion in back wages on behalf of misclassified workers. In 2015 alone, $246 million was recovered for 240,000 workers, including a Ninth Circuit settlement of $228 million to resolve claims of over 2,000 FedEx workers misclassified. Recent contradictory rulings about whether Uber drivers are employees or independent contractors add to the confusion and complexity of this important question. Earlier employment tax controversies litigated by the Department of Justice have resulted in rulings that part-time general and specialist dentists, including oral surgeons, periodontists and orthodontists, were employees, rather than independent contractors [Nash, (DC Pa., 11/7/95)].
Guidance on worker classification comes from multiple sources (e.g. IRS, DOL, FLSA), further muddying the process for determination. Dozens of federal- and state-level tests exist to help businesses determine whether a worker is an independent contractor or an employee, but these tests vary from one another and are open to interpretation.
Determining worker classification remains a complex issue. While the IRS common law test for worker classification can be used as a general guide, situations can have different facts and circumstances that warrant careful consideration. It is highly recommended that you engage the services of a competent tax advisor, who is familiar with the guidance and recent rulings. Organizations should follow federal and state guidelines, engage competent advisors and document their classification decisions to minimize the risk of misclassification and the corresponding liabilities.
Dori Eggett, C.P.A., is a director at Plante Moran. She leads the company’s nonprofit tax practice in the Rocky Mountain region. Contact her at 303-224-4621 or Dori.Eggett@plantemoran.com.