Traversing the law: Beware the 1099-MISC "Employee"
With the economy remaining in the doldrums, companies continuing to lay off employees, and business owners looking for ways to save capital, there are many temptations out there to cut costs--and corners. But some of these temptations come with unknown risks and could have unexpected consequences.
Taking on a project for pennies on the dollar in an attempt to pay the light bills certainly falls into the “unknown” category. Low and under-budget projects create pressure to hurry the project along and perhaps take shortcuts along the way. In turn, this can often lead to errors and omissions that can cost thousands in the long run. A project that should have been budgeted at $3,000 but was awarded at a “bid” of $600--a real-life example that is all too common--could ultimately become a mistake costing tens or even hundreds of thousands of dollars. Only time will tell.
Another cost-cutting measure that might be classified as having “unknown risks” yet has long been a favorite of land surveyors is the 1099-MISC “employee.” Let’s be clear from the start--there is no such thing. Any worker being paid without the withholding of federal and applicable state income taxes, social security withholdings, Medicare, matching FICA (Federal Insurance Contribution Act), federal and state unemployment taxes, and worker’s compensation must be a true subcontractor. However, that fact does not appear to be a deterrent for many small business owners who “hire” these so-called employees and then pay them like subcontractors. The continued economic misery and never-ending government regulation only exacerbate the problem, but in the final analysis it will be the small business owner who will pay the piper for any improperly classified workers, missed withholdings and nonpayment of taxes.
It has only been within the last two years or so that the problem of the 1099-MISC “employee” came to my attention in a big way when I was a part of litigation involving such ostensible employees. The potential ramifications are enormous. Surveyors have always used subcontractors to do all kinds of tasks from field work to drafting. There can be little doubt that the sour economy and the extensive layoffs of full-time employees have caused a substantial increase in the use of subcontractors. Why wouldn’t this be appealing in a down economy and with a goal of cutting costs? An employee making $30 per hour without one single benefit is going to cost you in the neighborhood of $36 per hour when you figure in FICA, FUTA, Medicare and worker’s compensation taxes. Give them any kind of benefit like--let’s say a day off--and that figure starts to climb.
Throw in some insurance, two weeks of vacation and some retirement--now that figure skyrockets. Heaven forbid they get injured on the job or for any other reason cause you to call your insurance carrier. That $30 per hour employee is now costing you $60 per hour, and you must bill them out at $150 just to eek out a measly 5 percent profit. I know what you’re thinking: What profit? In the words of Bill Clinton: “I feel your pain.” On the other hand, you could afford to pay them $40 per hour as a subcontractor--you get the same trained and qualified person, and they get a $10 per hour raise. Everybody wins. The $100,000 question--with penalties, interest and jail time hanging in the balance--is, Are these really subcontractors?
What constitutes an employee is a very critical question, as is the reciprocal question of what constitutes a subcontractor. Since the IRS is the agency that will come knocking on your door for back taxes, withholdings, penalties and interest, maybe we should consult them. From the IRS website (www.irs.gov/ business/small), we find the following on employment status:
The determination [of employment status] is complex, but is based on whether the person for whom the services are performed has the right to control how the person performs the services. It is not based merely on how the person is paid, how often the person is paid, or whether the person works part-time or full-time. [Emphasis added.]
According to the IRS, there are three basic categories of factors that are relevant to determining worker classifications: behavioral control, financial control and relationship of the parties. Behavioral control means “does the company control or have the right to control what the worker does and how the worker does his or her job?” Id. Financial control has to do with control of the payer over the business aspects of the worker’s job (e.g. how is the worker paid, whether expenses are reimbursed, who provides the tools, etc.). The relationship of the parties considers whether contracts are in place, benefits provided, the continuity of the relationship and how key the work is to the business.
In order to fully understand what an employee is we must contrast and compare the definitions of independent contractor and employee. Again, from the IRS website:
The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control only the results of the work and not the means and methods of accomplishing the results. [Emphasis provided.]
Under common-law rules, anyone who performs services for you is your employee if you can 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. [Emphasis provided.]
By far and away, the behavioral control issues are where land surveyors are going to find the most problems with these definitions. It would appear from these definitions that if you, the professional land surveyor, tell the worker how to do the work, in other words, exert direct supervision, then the worker is an employee and not a subcontractor no matter how you classify that worker (employee or subcontractor) or how you pay that worker (form W-2 wages or 1099-MISC wages). Supervision of subordinate personnel is the essence of the land surveyor’s responsibility under state law. If you don’t believe me just check your own state regulations on this issue.
Chapter 11 of Title 34, Code 1975, deals with the professions of engineering and land surveying and regulates who may engage in these professions. In general, only registered land surveyors may perform land surveys. However, pursuant to § 34-11-14(2), Code 1975, there is a limited exception to the registration required of persons who engage in land surveying. Specifically, the nonregistered employee of a registered land surveyor may engage in such work if it “is done under the responsibility and supervision” of the registered surveyor. § 34-11-14(2), Code 1975.1
There are consequences for misclassifying the worker. From the IRS website, we find the following:
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply). See Internal Revenue Code section 3509 for more information.
The “more information” includes all back taxes that you were supposed to withhold for that employee, taxes you were supposed to pay and matching funds. There will certainly be penalties and interest on unpaid taxes, and in extreme cases you could be looking at prison time. (Has anybody seen Wesley Snipes lately?) In addition, once the state learns that you have misclassified the worker, they will come calling for their pound of flesh and then some.
This is all in addition to the fact that you may have committed civil or criminal conspiracy in the process. The essence of conspiracy is two or more people getting together to carry out a legal act by illegal means, or to carry out an illegal act by legal means (or an illegal act by illegal means). Certainly, in the vast majority of cases, land surveying is a legal act. However, to carry it out against the rules of the IRS, which is the law of the land, is to accomplish it by illegal means. I can’t fully explore the ramifications of conspiracy in this short column, but the essential elements are in place.
How is your relationship with your ex-employee who is now your supposed subcontractor? I hope it is very good. If this worker isn’t happy with the relationship, the IRS allows them to report their situation for action.
Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, “Uncollected Social Security and Medicare Tax on Wages” to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation. See the full article “Misclassified Workers to File New Social Security Tax Form” for more information.
Once they figure out what the worker owes, guess who they are coming to see next? I’m not even going to get into what a competitor might be able to do with a phone call to the IRS. I’ll let your imagination run wild with that one. But you can hardly watch television or listen to the radio without hearing the warnings that the IRS is stepping up its enforcement actions against individuals and businesses. Just in case you haven’t heard, the federal government is out of money, and they are desperately looking for more.
It would appear that the only legitimate way for land surveyors and land surveying companies to utilize IRS-defined 1099-MISC subcontractors is for the land surveyor to completely relinquish the supervision role. The only way that I can think of for this to be accomplished is to completely subcontract a project or a defined portion of a project to another licensed surveyor or surveying company. This would not include nonregistered subcontract crews, even if they have their own vehicles and equipment. The question to be answered is the behavioral one--who is supervising whom? When that question is answered, the supervisee must be an employee of the supervisor.
If you are in need of temporary employees, the best answer appears to be that you will need to “hire” temporary staff or part-timers. You have to make them W-2 employees and withhold and pay taxes. Another option is to “rent” staff from other companies with spare employees. Let’s face it, as long as income taxes are being withheld and submitted, and other taxes are being paid by somebody on that employee, Caesar will be happy.
In these tough economic times, cost cutting is a necessary part of doing business and staying in business. You may win the battle by surviving the economic mess we are all in just to lose the war by letting unexpected and the unknown future consequences put you out of business on the other side. This includes cutting corners and doing work too cheaply (unknown future consequences) as well as being ignorant of the ramifications of law (unexpected future consequences).
1. Lawler v. Hare, 587 So.2d 387, 388 (Ala.App. 1991).
Neither the author nor POB intend this column to be a source of legal advice for surveyors or their clients. The law changes and differs in important respects for different jurisdictions. If you have a specific legal problem, the best source of advice is an attorney admitted to the bar in your jurisdiction.
This column is a forum for analysis and discussion of closed court cases. Facts and information cited are limited to what is contained in the published legal documents. It is not POB nor the author’s intent to re-try cases that have already been resolved and closed by the court system.