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The Internal Revenue Service (IRS) and state agencies are increasing their enforcement actions against employers with respect to worker classification issues. In recent years, the worker classification issue has become an extremely hot topic and priority for state and federal taxing agencies.
In light of this fact, clubs are at an increased risk of being audited by the IRS, U.S. Department of Labor (DOL) and state agencies. These audits generally include an investigation into workers used by a club, such as caddies and golf pros, with the auditing agency focusing on whether the club has properly classified its workers as independent contractors or whether they should instead have been treated as employees.
Given the high level of scrutiny that the IRS and state agencies are giving to this issue, clubs should prepare themselves now so that they are in as good a position as possible if faced with an employment classification audit. While this article focuses on an IRS audit, the misclassification of a worker as an independent contractor also raises a host of other issues, including wage and hour law violations and issues relating to eligibility to participate in the club’s pension and welfare benefit plans.
The New Standards for Worker Classification
The first step in proper worker classification is to understand the factors that the IRS and state agencies will consider when making the determination of whether a worker is an employee or an independent contractor. For years, the IRS has applied what was commonly referred to as the “20 factor test” to determine whether a worker should be treated as an employee. More recently, the IRS has refined this test to focus on three main categories: behavioral control, financial control and the relationship between the parties. Clubs should familiarize themselves with each of these three broad categories to determine whether their independent contractors are properly classified.
1. Behavioral Control
The first category that the IRS will consider in a worker classification audit is whether a club controls (or has the right to control) what the worker does and how he or she performs his job. If the club controls or has the right to control how the services are performed, the worker will most likely be considered to be a club employee.
In determining whether a club has behavioral control over a worker, the IRS will look at factors such as (1) the type of instructions the club gives to the workers, (2) the degree of instructions given to the workers, (3) whether there are evaluation systems in place with respect to the services provided by the workers and (4) whether the club provides training for the workers.
Type of Instructions: If a worker is given instructions as to when, where and how to perform services, the worker is generally considered to be an employee. In applying this factor, club management should ask themselves whether the club provides instructions to its workers as to:
- When and where to do the work
- What tools or equipment to use
- What persons to hire or to assist with the work
- Where to purchase supplies and services
- What work must be performed by a specified individual
- What order or sequence to follow when performing the work
If these questions are answered in the affirmative, it is very likely that the worker should be classified as an employee.
Degree of Instructions: The more detailed instructions a club provides to workers on the above matters, the more likely it is that the worker will be considered to be a club employee. Less detailed instructions reflect less control and indicate that the worker is more likely to be an independent contractor. Notably, the amount of instruction necessary to rise to the level of employment status varies depending on the particular job. The key consideration is whether the club has retained the right to control the details of a worker’s performance or instead has given up that right.
Evaluation System: The IRS considers whether a club’s evaluation system for workers measures the details of how the work is performed (indicating employment status), as opposed to measuring only the end result (leaning toward a finding that the worker is more likely an independent contractor).
Training: The final factor the IRS will consider under behavioral control is whether a business provides training to a worker. The provision of periodic or on-going training to a worker is a strong indication that the worker is an employee.
2. Financial Control
The second category that the IRS considers in making a worker classification determination relates to financial control. The IRS will look at whether the worker has a significant financial investment in his or her business accompanied by the opportunity to generate a profit or loss from the business.
Factors considered under this category include whether a club reimburses workers for business expenses, whether the club (and not the worker) provides the tools and supplies necessary to perform the services, and whether the worker holds himself or herself out to the public as operating his or her own business.
Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs such as rent or equipment leases that are incurred by a worker regardless of whether work is currently being performed are indicative of independent contractor status.
Finally, the ability for a worker to seek out other business opportunities is indicative of independent contractor status. Evidence that a worker advertises his or her services, maintains a visible business location or website, and has a business license and/or business cards are all evidence of independent status.
3. Relationship Between the Parties
The final category that the IRS considers in making a worker classification determination is the relationship between the parties. Here, the IRS considers whether there are written agreements in place between the club and the worker indicating intent as to the status of the worker. The IRS will also look at whether the worker participated in the club’s health insurance plan, pension plan, or received sick or vacation days, all of which tend to indicate that the worker was a club employee. Clubs should keep in mind that the parties’ agreement that a worker is an independent contractor is not controlling; the IRS will look at all aspects of the relationship between the parties in making this determination.
Typically, the workers of concern to clubs are caddies and golf/tennis professionals. Golf professionals have been found by the IRS to be both independent contractors and employees, depending on the specific facts. For example, where a club paid the golf professional a fixed salary, set prices for lessons, and controlled the manner in which the golf shop was managed, the golf professional was considered to be an employee. Alternatively, where the golf professional made his own appointments for golf lessons, set his own prices, retained all fees, and received no instructions from the club, the golf professional was considered to be an independent contractor (see IRS Rev. Rul. 68-625 and 68-626).
Given the high level of scrutiny that the IRS and state agencies are now giving to the worker classification issue, it is prudent for a club to review its classification of workers prior to receiving notice of an audit by the IRS or a state taxing agency. By taking such action, a club can significantly reduce or eliminate its potential liability in a future employment tax audit.
Cindy S. Arellano is a partner at Atkinson, Andelson, Loya, Ruud & Romo in the firm’s Business & Tax Practice Group in Cerritos, Calf. Arellano’s practice focuses on employee benefits and executive compensation, qualified and nonqualified deferred compensation and retirement plans, health and welfare benefit plans, ERISA, tax audits and other tax controversy matters, MBE/WBE/DBE certification, nonprofit organizations including educational foundations, auxiliary organizations, charitable organizations and trade associations, mergers and acquisitions and general corporate transactional matters. She can be reached at [email protected] or 562-653-3200.