New Steep Penalties for Willful Misclassification of “Independent Contractors” Raises Concerns for Many Businesses in California
Kelly Creed, Tax Manager
A new law California enacted with little fanfare should cause all businesses using independent contractors to take notice. This new law dramatically raises the ante if an entity willfully misclassified “employees” as “independent contractors.”
Under this new law, state agencies can impose fines of at least $5,000 per violation—which might be interpreted as one fine per independent contractor, but might mean $5,000 per invoice or paycheck. These penalties range as high as $15,000 per violation and skyrocket up to $25,000 per violation if that entity engaged in a “pattern or practice” of misclassification.
The size of these penalties is unprecedented and can be tacked on to existing penalties under both the tax code (including back payroll taxes, SDI, and personal income tax withholding) and the labor laws. The true exposure is much higher.
Alison Hightower, Attorney - Littler
The new law also fines businesses for charging a “willfully” misclassified independent contractor a fee, or for having made “any deduction from compensation for any purpose.” These deductions could be for the contractor to pay for “goods, materials, space rental, services, government licenses, repairs, equipment maintenance, or fines arising from the individual’s employment where any of the acts described in this law would have violated the law if the individual had not been misclassified.” Employers generally must reimburse “employees” for reasonable and necessary business expenses under the California Labor Code.
In a novel approach, the new law also punishes any violator by a required posting of notice of this violation on its website in a prominent location for an entire year.
An independent contractor receives a 1099 rather than a W-2, and pays its own payroll and other taxes. The government has the incentive to seek offenders who may be dodging taxes. The California Department of Industrial Relations will use this law to enforce laws requiring that all “employees” receive minimum wage, overtime, meal and rest breaks, reimbursement for business expenses and even employee benefits. Private attorneys will seek the new penalties in representative actions in court on behalf of all misclassified “employees.”
The new law defines “willful misclassification” as avoiding employee status for an individual “by voluntarily and knowingly misclassifying that individual as an independent contractor.” While this definition will need to be explained by the courts, businesses can expect that the best defense is a professional opinion that the workers are correctly classified.
While the IRS uses one test to make that determination, California courts use another. Under all tests, multiple factors must be analyzed, and bright lines consequently are difficult to draw. Whether the retaining entity controls the method and means of doing the work is the most important factor. Businesses can gather helpful information from their contractors—such as business licenses, advertisements, and web pages—to bolster their argument if ever challenged as to the correct classification of their contractors.
Contact Kelly Creed at kcreed@rina.com or Alison Hightower at ahightower@littler.com if you would like assistance making this determination.
Client Profile – Challenge Day
Creating a world of more conntection. (One of Challenge Day's activities.)
Jaime Polson-Flanagin, CEO, attended a Challenge Day program six years ago and met co-founder, Rich Dutra St. John. Jaime was amazed at the work Rich was doing to inspire young people to change. At that time, Jaime had a career in hospital administration and wanted to become more involved in hands-on work and continue to make a difference in her community.
Challenge Day’s mission is to provide youth and their communities with experiential workshops and programs that demonstrate the possibility of love and connection through the celebration of diversity, truth and full expression. Since 1987, Challenge Day has served more than 1,000,000 youth in 400 cities, 45 U.S. states, and 5 provinces of Canada and has just recently established the program in Amsterdam. The 6 ½ hour Challenge Day program is designed for 100 students, grades 7 – 12. The program builds connection and empathy and fulfills the vision that every child lives in a world where they feel safe, loved, and celebrated. Challenge Day is more than a one-day program. It is the spark that ignites a movement of compassion and positive change, known as “Be the Change Movement”.
Challenge Day successfully addresses some common issues seen at most schools including: cliques, gossip, rumors, negative judgments, teasing, harassment, isolation, stereotypes, intolerance, racism, sexism, bullying, violence, homophobia, hopelessness, apathy, hidden pressures to create an image, achieve or live up to the expectations of others. I can attest to the success of Challenge Day. I was a facilitator for one of the programs at a Walnut Creek high school and participated in seeing change come about during the program.
Jaime notes that the organization is expanding its board of directors and will be reaching out to the corporate community. It is also looking for program sponsors. If you would be interested in sponsoring a Challenge Day, the cost is $32/student or $3,200. Please visit Challenge Day’s website at www.challengeday.com for more information.
“Tracy Teale, Audit Stockholder, really took an interest in our culture and wanted to make sure that RINA staff and our Challenge Day staff worked well with each other. Tracy has taken the time to understand our business practices and has been an important part of helping us grow the organization, especially when we go into new countries – it is very important to do things right and she has been very generous with her time.” – Jaime Polson-Flanagin, CEO
“I am extremely proud of my team but we couldn’t be there without the assistance from Tracy and Max.” – Ockemia Kates-Bean, Director of Operations
Ready, Aim, Fire – Are You Liable for Disclosures of Confidential Data?
Richard DelleFave, Tax Supervisor
Security breaches.We read about them every day. Sony reported 25 million in 2011, Zappos recently had to inform 24 million customers that personal data had been compromised – and those are only 2 of a long list that included Citigroup , NASA and the FBI. Is your company subject to security breaches that could cost you money and harm your reputation?
Let’s start with your potential sources of liability. If you have an online sales presence, you collect donations online, store customer or donor credit card or social security numbers on your servers or laptops; you need to know how to protect yourself.
Disclosure Requirements
First is the question of disclosure. When must you tell customers, donors or others impacted by a breach that their personal data has been compromised?
At a minimum, you have to report breaches of unencrypted personal data that is reasonably believed to have been acquired by an unauthorized person. If you fail to report, you may be charged by the state and customers that incurred damages.
Exposure to Liability
What happens if you have a breach and you report it as required? Can you still face liability? This depends on the circumstances. If the breach results in identity theft you may be subject to the amount of damages actually suffered. The Federal Trade Commission has brought suits against companies and stated the following. “Every business, whether large or small, must take reasonable and appropriate measures to protect sensitive consumer information, from acquisition to disposal.”
How to Manage Your Exposure
Fortunately, the FTC has issued a very helpful 5 step check-up to help guide businesses in how to manage their sensitive data and protect themselves from potential liability. See,http://www.cintas.com/pdf/Document-Management/FTC-Privacy.pdf.
Another area of exposure is stolen credit card data. To minimize this risk, we recommend you ensure you are in compliance with the standards set by credit card companies. Failure to do so can result in fines or the loss of the privilege to process credit cards.
Finally, take stock of whether your commercial general liability insurance policy covers you for this risk. While some policies will cover you, in some instances you may need a special rider for this coverage.
To find out more about identity theft and how to further minimize your risks, ask your RINA representative for a copy of our white paper on this topic.
Using a Conduit IRA Trust
Kati Oliver, Tax Manager
Tax deferral is the main benefit of an IRA, as the income earned on IRA assets is not taxed until it is withdrawn. The longer the money stays in the IRA, the longer the growth will compound on a tax deferred basis. Beginning in the year after the year of death an IRA owner, the designated IRA beneficiaries can take minimum required distributions (the MRD) from their inherited IRA’s based upon calculations of their own life expectancies, rather than calculations based upon the life expectancy of the IRA owner/decedent. This has the effect of stretching the payout from an IRA over a longer time period and allows the beneficiary to realize the growth that can occur with compounding income. The beneficiaries always have the ability in any given year to take more from their IRA than the MRD.
With a little proactive planning, you can take steps to protect your IRA so that your heirs get the maximum benefit from it. Using a trust can prevent your beneficiaries from cashing out the IRA immediately; it can keep the assets in the family in the case of divorce; and it can also protect the inherited IRA from creditor claims and bankruptcy. IRAs are normally exempt from creditor claims, but this is not true for inherited IRAs. This puts the IRA at risk if your beneficiaries have significant debt.
One method of protecting your IRA is setting up a conduit trust. With a conduit trust, your beneficiaries are entitled to the MRD from the IRA, but are not able to withdraw more than the required amount. The MRD is still calculated over the beneficiary’s lifetime, so there is still the benefit of stretching out the life of the IRA. A conduit trust is a flow-through entity and does not accumulate income, as each year’s MRD is distributed to the beneficiary and therefore it is not taxed at the trust level.
The IRS has set the following requirements under Treasury Regulation Sec. 1.401(a)(9)-4 for a trust to be used as an IRA beneficiary:
- The trust must be valid under state law
- The trust must be irrevocable at death
- The trust beneficiaries must be identifiable in the trust document
- All beneficiaries must be individuals
- Documentation must be provided to the custodian of the IRA by October 31 of the year following the IRA owner’s death
Each conduit trust should have only one beneficiary, it should be created before death, and designated as a direct beneficiary on the IRA designation form. It is important to note that the conduit trust for an IRA is normally a separate trust document from a Revocable Living Trust document.
The conduit trust is just one option for protecting your IRA. Each individual’s situation is unique and may require a different approach. Please contact RINA to discuss what options are available to protect your assets in a way that your objectives are met.
Due Diligence: Checking Out the Deal
- Howard Zangwill, Stockholder
How do you know before you sign on the dotted line whether the deal will really work?
Anyone attempting to acquire another business should perform in-depth due diligence in four critical areas: marketing, financial, legal (which includes environmental matters) and cultural due diligence.
Marketing Due Diligence – This analysis involves looking at your assumptions regarding the company’s customer and prospect needs, future revenue growth and profitability. It requires looking behind the company’s numbers in order to understand what is actually creating them. Too often, buyers get so caught up in the numbers that they forget to look at where the market is headed. You wouldn’t buy a business where the biggest customer was about to jump to a competitor or the key porduct or service faces declining demand.
Financial Due Diligence – This can be broken down into four key elements: asset, liabilities, cash flow, and revenue and growth rate.
- Assets – do the assets actually exit and are they properly valued?
- Liabilities – any unknown product or environmental liabilities?
- Cash Flow – does the projected cash flow cover the acquisition debt service? What return on investment will you make?
- Revenue and Growth Rate – watch out for assumptions based on fantasy rather than fact. Are revenue projections too high?
Legal Due Diligence - This should be addressed by hiring the right attorney that is familiar with the industry and involved in mergers and acquisitions. One area RINA can help is reviewing the tax returns for any exposures.
Cultural Due Diligence – The lack of chemistry between key players and the two cultures can kill an otherwise sound deal. Suppose you acquire a company run by a benevolent dictator who tells everyone what to do. Don’t think for a moment that you can just walk in and immediately implement a culture of empowerment and responsibility. Know what type of culture you are acquiring; it is hard to change cultures without changing the people.
Before you sign on the dotted line, to make the due diligence perform at its best, ensure that you have vigorously looked for reasons why things might fall apart. What if a group of mortgages sour at the same time? What if a competitor launches a new product? What if the key customers leave? What if credit dries up? Looking at the dark side does not make you a pessimist or a naysayer. It makes you truly diligent.
This article gave a broad overview on key aspects of due diligence. RINA has frequently helped both business owners preparing their business for sale and investigating new opportunities. Contact your RINA representative for more information.
Stockholder Spotlight – Walt Tchirkine
Walt Tchirkine, Stockholder
RINA is pleased to announce that Walt Tchirkine, Tax Stockholder, has been elected to the Board of Directors of the National Association of Estate Planners & Councils. The NAEPC promotes the multi-disciplinary approach to estate planning and is committed to encourage attainment of the Accredited Estate Planner® and Estate Planning Law Specialist® designations by qualified estate planning professionals. The NAEPC also supports the efforts of the NAEPC Education Foundation to increase public awareness of the importance of estate planning by a team of qualified professionals.
Walt has over 25 years of experience in public accounting and currently chairs RINA’s Estate Planning Practice group. He assists his clients in many aspects of their financial lives; from business start-up planning to advising on efficient business operations and wealth accumulation (from both a financial and tax perspective), as well as assisting and advising on matters such as estate tax minimization, succession and legacy planning. He is a Past President and member of the Board of Directors of the East Bay Estate Planning Council.
RINA President’s Message January 2012
Ed Fahey, Stockholder RINA President
On behalf of all of us at RINA I must start with a thank-you to all who contributed to our success in 2011. Aided by the late 2010 addition to our San Francisco office, a recovering economy, support from referral sources and our great clients, RINA was able to set a revenue record for the firm. We look to continue our growth in 2012. In fact, the new theme for our strategic plan is One Firm, One Goal: Growth.
We expect that growth to come in client service as we continue to bring new ideas to help our clients be successful. We will see it in staff development through our efforts to grow personally and professionally. We will also continue to grow our niche expertise in real estate, not-for-profits, estate planning, employee benefit plans, food and beverage and business valuations. When all three come together we are able to create value in the marketplace and serve our clients more effectively.
We also start the year with a new website which we will leverage to provide important information to its users. In 2012, you will find us more active in blogging, Facebook and LinkedIn as we utilize these tools to connect with our clients, prospects and prospective staff. Still, we remain committed to communicating the “old fashioned” way by being responsive to your phone calls and meeting with you in person. The relationships we have developed over our 65 year history are very personal and we look forward to those growing in 2012 as well.
Elsewhere in this newsletter, you will find a profile of Ray Evans, our newest shareholder. Ray practices primarily in the tax arena and is that rare combination of a technician who can see the opportunities in tax law changes. If you know Ray, be sure to congratulate him on this important milestone and accomplishment.
I wish you all the best for the New Year.
MGI – Business Solutions Worldwide
Stockholders Tom Neff, Ed Fahey & Howard Zangwill attended the MGI Conference in New York on October 19-21. With 158 members and a presence in 280 offices and 82 countries across all continents, MGI is one of the largest alliances of independent auditing, accounting and consulting firms in the world providing for their members and clients, effective professional business solutions worldwide.
The stockholders interacted with other accountants from throughout the world, many of whom serve our clients or refer work to us. To encourage interaction among members, regional “circles” are being formed. RINA will host the North America Western Circle meeting on January 6, 2012. Ed Fahey is a member of the coordinating committee and Western Circle leader.
Stockholder Announcement
Ray Evans, Stockholder
We are delighted to announce our newest stockholder, Ray Evans. Ray brings to his new position over 20 years of experience in the accounting field, and has worked at RINA as a tax manager in our Walnut Creek Office since 2006. Ray currently heads our tax department. Ray’s areas of focus include tax planning for individuals and closely-held business, financial and estate planning and business succession planning.
“As a stockholder of RINA, I look forward to working with our dedicated team of professionals and instilling in them my passions of responsiveness and finding the best possible solutions for our clients.” – Ray Evans
Client Profile – MicroCredit Enterprises
By Pamela Raumer, RINA Business Development Director
MicroCredit Enterprises (MCE) is a non-profit organization with a unique business model. They utilize the financial capital and good credit of high net worth individuals and institutions to guarantee microloans that lead to sustainable communities and social good throughout the developing world. Specifically, MCE borrows private capital from banks and foundations that is backed by guarantees from high net worth individuals and institutions. MCE then lends the borrowed money to microfinance institutions (MFIs) throughout the developing world that use it to issue microloans to poor entrepreneurs. MCE’s mission is to reduce poverty in the most impoverished countries by providing loans to finance cottage businesses.
Microfinance client in Mongolia selling blackberries and blueberries.
Founded in 2005, MicroCredit Enterprises’ current loan portfolio includes 32 MFIs in 18 countries, impacting over 300,000 impoverished individuals. The first loan was issued in January 2006 and since then they have issued $46 million in loans in 22 countries. Their goal is to end this year with a total of $50 million lent since launching and their long-term goal is to raise $100 million in guarantees to support their lending.
As a MicroCredit Enterprises Management Fellow in 2004, Kyle R. Salyer, who now holds the position of Executive Vice President for Finance & Operations with MCE, co-researched and wrote an analysis of international lending to microfinance institutions and microfinance capital market trends. Prior to his internship with MicroCredit Enterprises, he was a regional manager with the Mexican Association of Rural and Urban Transformation where he developed and managed their Chiapas-based microfinance institution. Mr. Salyer was responsible for creating savings and loan products, identifying new markets, managing the loan portfolio, and developing a strategic plan for program growth.
Banana vendor in Cambodia. A microfinance client.
MCE is always looking for new sources of borrowing and new guarantors to sustain their growth plans. “Because of MCE’s high efficiency business model, we are able to keep our overhead at 3% to 4% of loans outstanding,” said Kyle. “Also, our borrowers have a near-perfect record of paying back their loans.” When vetting microfinance institutions, they heavily favor working with MFIs that have a focus on serving women in rural areas that live on less than $2/day. They are not providing hand-outs; rather, they promote financially struggling entrepreneurs to use their talents and skills that they already have. Over 80% of the entrepreneurs served by MCE are women.
Although Kyle recently assumed his current role of working with RINA as MCE’s auditor, he is impressed with our understanding of their unusual model and the fact that Howard Zangwill, (their audit partner) went on a study-mission to Guatemala in 2008 to learn microfinance and visit microfinance institutions.
“RINA has done a great job in comprehending our unique model and taking that into consideration in their work for us. RINA has been helpful in guiding us to improve our accounting and internal controls. They are always available and not just at audit time – Howard responds right away.” – Kyle R. Salyer, Executive Vice President for Finance & Operations, MicroCredit Enterprises.