Changing Employees to Independent Contractors? What are the Ramifications?
An employer made the decision to change the status of their workers from employees to independent contractors and it ended up backfiring.
An at-home nursing service provider owed almost $1.3 million in back employment taxes and penalties for a misclassification of 99 nurses. The taxpayer, for reasons that were unclear, made the decision in 2016 to switch their employees to independent contractors. After this decision, in the years at issue, the taxpayer did not make any federal employment tax deposits due to their change in the employment status of their workers.
The court decided to consider the five common law factors used by the Fifth Circuit Court of Appeals (the appellate court with jurisdiction to hear appeals):
- The degree of control exercised by the alleged employer;
- The degree to which the worker’s opportunity for profit or loss is determined by the alleged employer;
- The extent of the relative investments of the worker and the alleged employer;
- The permanency of the relationship; and
- The skill and initiative required in performing the job.
This is based on the relationship between the workers and the employer
After looking into the situation further, the court found that the employer acted as more of a dispatcher. As a “dispatcher”, the taxpayer controlled the schedules and working hours of the nurses. Additionally, the taxpayer allowed the nurses to exercise limited discretion as to how they would perform their duties as they had to follow a patient’s plan of care that was prescribed by the patient’s physician.
Not only that, but they also had little chance to control their own opportunities for profit or loss, all while the taxpayer was compensated for their services.
With the nurses having little to no capital investment in the company, the taxpayer provided them with reimbursements for certain out-of-pocket expenses. Some of the expenses that were reimbursed were for transportation and personal protective equipment (PPO). There was also the fact that the nurses didn’t carry their own insurance because the taxpayer purchased and maintained the professional liability insurance policies.
When the nurses were hired, they were hired on as “full-time employees”. They were also required to give two weeks’ notice if they were to quit to become employed elsewhere while the taxpayer had the ability to fire them at will if needed.
Ultimately, the nurses were provided training at the beginning of their employment, but the patient’s plan of care is what actually dictated how they performed their duties. They were also not allowed to find new patients because the taxpayer assigned them their caseload.
In light of all five common law factors, the Tax Court determined that the nurses and the taxpayer had a common law employment relationship.
The misclassification does not grant relief
Section 530 relief does not apply to taxpayers affected by past due employment taxes. These exemptions allow employers to avoid liability when they erroneously acted, even if they reasonably classified the workers as independent contractors rather than employees.
If you have any questions regarding the tax ramifications of switching employees to independent contractors or vice versa, please contact us any time. We are always happy to discuss your unique situation.