THE

FIVE EVIL SISTERS: AN ATTACK ON INDEPENDENT CONTRACTORS

NOTE: Handouts, in the form of a computer disk, will be provided at the end of this session. It will include this memo and source documents referenced. It will also provide our firms profile and contact information should you wish to contact me with additional questions. Hopefully, this onehour experience will raise your awareness to participate in the political process, and to discuss with TEANA reps, your attorney, and CPA riskbased strategies that will allow you to continue to grow your business and prosper as entrepreneurs while utilizing the IC model.

The Fair Playing Field Act of 2012,1 introduced March 1, 2012, may soon be considered the evil twin sister to the Patient Protection and Affordable Care Act.2 If enacted, this Act may single handedly end the Independent Contractor/Owner Operator model (hereinafter referred to as IC) for the transportation industry, which has withstood numerous IC related legal challenges over recent years. Most notable, the transportation industrys IC model has survived, in large part, under the protective strong arms of two Federal District Court rulings (both of which favored the FedEx3 IC model) and the safe harbor provision of Internal Revenue Code section 530.4 H.R. 4123, as currently written, would delegate authority to the Secretary of the Treasury to rewrite the rules on the definition of what is considered the proper classification for a contingent worker as either an employee or independent contractor. Section 530, which has been the safety valve for trucking companies since 1978 with regards to IC classifications, would be repealed on a prospective basis. In short, the safe harbor per section 530: Prohibits the IRS from retroactively reclassifying ICs as employees and collecting arrearage federal employment taxes, penalties, and interest; Does not specifically prevent the IRS from reclassify ICs to employees; however, if the IRS does reclassify ICs as employees, back employment tax assessments cannot be assessed and the right to appeal such decision with the IRS or in federal court still exists. (Note: You will never see the IRS reclassify an employee as an IC.); and Prohibits the IRS from providing regulations or revenue ruling on employee/IC status.

1 See Exhibit 1 for the full text of the Congressional House Bill H.R. 4123, a.k.a. Fair Playing

Field Act of 2012.

2 See Exhibit 3 for the Health Care Individual Mandate and the recent U.S. Supreme Court

ruling. Both FedEx cases can be found in their entirety at Exhibits 4 and 5. 4 See Exhibit 6 for the full text of IRC 530.
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 To obtain the safe harbor status, section 530 requires the company to establish the following: Consistency in reporting ICs as such (THOUGHT: What if an employee truck driver moves to owner operator status, and thus changes from receiving a W2 to a 1099?); All 1099 forms must have been filed on each IC for each year in question (THOUGHT: What about the argument that 1099s are in fact not required to be issued for ICs who are involved in interstate commerce?5 Our firms position is to issue the 1099s why would you want to give up the safe harbor?); and A reasonable basis to classify the IC as such the most common reasonable basis is industry practice; however, a prior audit of the company and federal court decisions are also considered to be foundation for a reasonable basis.

Under the provisions of H.R. 4123, an annual written statement would be required to be provided to the IC by the employer and include the following disclosures: The IC is independently subject to all Federal tax obligations, which would include liability for all the ICs employees. For instance, during the earlier FedEx case, FedEx came out and restructured its IC model for package delivery ICs, which required individual ICs to incorporate thus requiring them to treat their own drivers as employees for state and federal purposes. This resulted in the ICs being subjected to the liability for payments of employment taxes and workers compensation;6 The IC has voluntarily foregone all rights to labor and employment law protections (Note the interweaving of the DOL and the IRS on this requirement.); and Notification to the IC of their rights to independently request an employment status determination from the IRS if so desired by the IC.7 As a prelude to the FedEx cases, in July 2006, the United States Government Accountability Office (GAO) sent then Senator Ed Kennedy a GAO white paper on Contingent Employment.8 (Note: Congress and the Federal government like floating paper trails.) At that time, the total US labor force was about a third contingent type laborers. Contingent workers types are noted on page 11 of the report enclosed at Exhibit 2 and include contract company workers, agency temps, directhire temps, selfemployed workers, independent contractors, and standard parttime workers. The report stated that contingent workers were not protected to the same extent as employees with regards to enforcement of

5 See Exhibit 7 for various memos regarding the 1099 issuing requirements for ICs engaged

in interstate commerce.

6 See Exhibit 8 for current FedEx articles and web site information in regards to their ICs. 7 See Exhibit 1 for the full proposed bill requirements and details. 8 See Exhibit 2 for the full text of this GAO white paper.

Federal and State laws by governmental agencies, i.e. DOL, IRS, DHS, PBGC, EEO, ERISA, NLRB, SSA, State ESD, and State WC.9 The GAO white paper noted that only about 13% of contingent workers received health insurance thru their employer,10 while similarly situated employees were covered by health insurance coverage 72% of the time. Fastforward to the present and the Supreme Courts decision to uphold the Patient Protection and Affordable Care Act (ACA) last month.11 The passage of the ACA will, in theory, provide universal health coverage for most U.S. workers and citizens and possibly certain classes of immigrants. If enacted, the evil twin sister, H.R. 4123, would accomplish what the GAO white paper of 2006 set out to do empower the Secretary of the Treasury (i.e. the IRS) to determine the definition of an employee. As a result, it can be reasonably assumed that the IC model would be regulated out of existence, along with section 530; thereby causing all ICs to be classified as employees, a task that governmental agencies have not been able to totally accomplish thru the court or legislative system. Under the ACAs threshold of 50 equivalent full time employees, a transportation Company using the IC model with 50 equivalent employees and ICs would incur additional costs for health insurance. The two evil sisters, the ACA and the possible passage of H.R. 4123, would terminate the IC model as we know it and thereby increase employment taxes, fringe benefits, workers compensation, and other employee related costs to transportation industry employers. But dont forget to tack on the additional administrative costs of the ACA that will be incurred by both employers and the IRS. For instance, employers with more than 250 W2s issued during a year will be required in 2012 (Note: The filing deadline for W2s for 2012 is January 31, 2013.), to list on ALL W2s the value of employer provided health insurance. On the other hand, employers with less than 250 W2 employees will not be required to report such information at this time, but wait and see what happens in 201312! You may be asking yourself, why would the IRS desire this information? Just to be clear, the ACA reporting requirements as to the health insurance coverage provided by all employers for the year 2014 and beyond only become more extensive. The employer will bare the burden of additional reporting on a separate form, not yet released, to the Federal government for all employees, which is to give notice of the entire health insurance

9 See page 8 of Exhibit 2 for the full list and names of such governmental agencies. 10 See page 15 of Exhibit 2.
11 See Exhibit 3 for

a quick snapshot of the ACA mandate for individuals and companies as provided by the Congressional Research Service. Also included is a full text copy of the Supreme Court opinion. 12 See Exhibit 10, IRS bulletin no. 201204, for additional reporting requirements in future years.
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program provided by the company and paid for by either the employer or employees. Yet again, why would the IRS do this? As to filling in the box on the W2 insurance benefits, the answer is simply to obtain additional tax revenue. There is now a third evil sister being discussed; however, the Congressional bill is still in the incubator. The current tax code allows a taxfree benefit for all employee provided health insurance paid for by the employer, excluding amounts paid for the owners and highly compensated employees. A 2008 article in the New York Times Opinion page puts forth the argument that the health care system today relies on employers to provide coverage (I agree entirely with this statement!); however, due to the current taxfree benefit to the employee, it encourages more health insurance and spending.13 You be the judge of that I was asked by TEANA to prognosticate future economic events, so WRITE THIS DOWN... If Biden continues to head up the MOU, as discussed below in more detail, the DOL, SSA, State taxing authorities, and IRS will push to tax the employee on employer provided health insurance for social security, Medicare, as well as Federal and State income taxes in the future. Why else would ACA want all the insurance information on each employee?14 If you begin to look for the fourth evil sister, that joins the ACA, H.R. 4123, and the proposed taxation of employer provided health insurance benefits to employees, look no further than a new initiative called MOU. The Memo of Understanding (MOU)15 has been reached between the DOL, IRS, and 13 states (Note: Louisiana is one of the 13 states) to share information among the agencies as received from all entities. This sharing of information will allow for joint enforcement. For instance, if employees are found to be misclassified as ICs by a state unemployment agency in one of the 13 states for unemployment tax purposes, such information will be sent directly to the IRS. Consequently, the IRS will be able to investigate whether the specific ICs should be reclassified as employees for federal tax purposes as well. Remember, section 530 may be a safe harbor for taxes in arrears but it does not provide such on a prospective basis. The DOLs budget for 2013 includes $14 million designated to worker misclassification determinations. Of that, $10 million are designated state grants

13 See Exhibit 12 for the blog article 14 See Exhibit 11, IRS bulletin no. 201217, which is a joint statement by the DOL and IRS.

The gist of this memo, which is discussed later in more detail, is the need to report the policy information for the purpose of an employee tax credit or supplemental insurance payments for employees who have certain income and family dependent guidelines. My analogy to this is to say, this is a new Earned Income Credit only this time it is for health insurance premium payments. 15 See Exhibit 14.
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with the remaining $4 million being directed to the Wage and Hour division for reclassification audits. The employee only classification model would allow the Federal and State agencies to administer determinations of all workers as one, homogenous type; simplify regulation of the work force; and add revenues to the governmental agencies to carry out its missions. Note the following example. In 2014, an employer with 50 plus full time equivalent employees will be required to provide health insurance coverage under minimum standards as outlined in IRC section 4980(H).16 In short, an employee is first defined as: o An employee under the rules of the English common law (Note: H.R. 4123 is not law, and section 530 is still alive); and o A seasonal or parttime employee is calculated as a partial equivalent. The notice explains the whatif scenarios in great detail. If that employee is not offered or provided minimum coverage, as defined by the code, the employer company must pay a penalty of $2000 per employee (the first 30 are exempted from this penalty) for not providing such coverage. Furthermore, there is a $3000 penalty as well if you provide insurance coverage, and an employee obtains a subsidy to help assist to pay for the employee paid portion.17 Though I have not reached a consensus from my fellow tax lawyers, I would assume that the penalty payment is not tax deductible. If this is the case, along with an increase in tax rates back to the Clinton years (which we will refer to as the fifth evil sister), employer costs will yet again increase. Beginning in 2013, the top tax rate of 35% is set to increase to 39.6%. Therefore, an S corporation taxpayer reporting income from his corporation, along with his W2 wages, and other investment income could expect to pay about 42% Federal tax with disallowance type add backs (i.e. the marriage penalty and itemized deductions limitations), plus State tax. Thus, for illustration purposes, say a trucking company owner is subject to a cumulative Federal and State tax rate of 50%, which would make a $3000 penalty the equivalent of paying cash outright in the amount of $4500. To further add salt to the wound, if the S corporate taxpayer had Medicare W2 wages above $200,000, his company will withhold out an additional 0.9%, starting in 2013 for the ACA tax increase. (Note: If the actual wages are under $250,000, and the taxpayer files a joint return, a return on the differential is credited.)18 But the hypothetical only gets worse for the taxpayer. In

16 17

See Exhibit 13, IRS bulletin no. 201136. Refer to Exhibit 11, IRS bulletin no. 20129, to more fully understand what is defined as an employee equivalent. 18 See Exhibit 9.
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2013, the capital gains tax rate will increase from 15% to 20% (Note: Some sources say the capital gain tax rate will only increase to 18%.) and the new ACA investment income tax of 3.8% will be imposed on all modified adjusted gross income that exceeds $250,000 for a joint return, or $200,000 for singles. In this scenario, investment income refers to all interest income, dividends, royalties, rents, capital gains, and passive investment income. Furthermore, in 2013, the dividend income rate of 15% is scheduled to revert back to maximum rate schedules of 39.6%. At this time, I think it is important to note that if you plan on passing away next year, remember that if your estate is greater than one million dollars, tax will begin to be assessed at $1,000,001 at 41% and will be 55% any amounts over $3,000,000! The government is definitely your partner in your business the only problem is the government is a vendor payment due 9 months after the date of your death! You be the judge as to whether you have received adequate services or goods for the estate taxes you are paying under the redistribution theory of wealth at death. In summary, the five evil sisters, will not rest until all ICs are reclassified as employees; thus, allowing Federal and State governmental social programs to be harmoniously carried out and administrated.