Monday, May 19, 2008

NORTH BAY – Stepped up enforcement efforts and a new audit partnership between California and the IRS are calling attention to the risks associated with rules surrounding payment of employment taxes.

Employment taxes are deducted from company payrolls and include payments for state unemployment insurance, employment training and disability insurance. At the federal level, they include items such as Social Security, Medicare and federal unemployment insurance.

Employers do not have to pay such taxes for workers who are considered independent contractors, but tax officials and local experts warn that it is easy to misclassify an employee.

When that happens, companies can face audits and become liable for thousands of dollars in fines.

“Employment-tax audits are something that don’t happen to most employers, so employers aren’t used to dealing with them,” said Richard Rybicki, a director in the Napa and Santa Rosa offices of Dickenson, Peatman & Fogarty. “When they happen, they usually happen at the state level.”

In March, state officials swept through Sonoma and Napa counties in an enforcement effort targeting the day spa industry. They inspected about 20 spas and fined at least eight of them for various payroll-related violations, many of them related to misclassifying massage therapists.

“There is a gray zone in what an independent contractor is,” said Sonja Akey, owner of Greenhaus European Day Spa in Napa, which was fined $5,000 because it classified several massage therapists as independent contractors.

Ms. Akey said she didn’t consider her massage therapists to be company employees because they don’t have consistent schedules and are called in only for specific appointments.

“They all have other jobs,” she said. “They are working sometimes at four other places.”

Now, all Greenhaus workers are classified as company employees, a change that has added 20 percent to 25 percent in costs for each massage therapist, according to Ms. Akey. The results were worse for some of the other spas, which were fined up to $24,500 and could be liable for more money following additional investigations.

Rules for classifying employees can be complicated, but according to Mr. Rybicki, companies can minimize the risks that come with surprise audits by maintaining careful payroll and tax records.

“If you maintain good records, when an auditor shows up you’ll have what you need to show you’ve been paying properly,” Mr. Rybicki said. “One of the best things you can do when an auditor comes in is to convince them that you’ve been diligently doing what you need to do to keep track of these things.”

In addition to employment taxes, state agencies are working together to enforce rules in related areas such as workers’ compensation insurance and minimum wage and overtime requirements, according to John Stroot, who manages the employment-tax audit program in Northern California for the state Employment Development Department, California’s largest tax-collection agency.

Mr. Stroot’s department is part of a special enforcement unit called the Economic & Employment Enforcement Coalition, which also includes representatives from the Department of Industrial Relations, the Contractors State License Board and the U.S. Department of Labor.

“In terms of the dollar amounts of assessments, by far the largest” source of employment-tax-related fines is the “misclassification as independent contractors,” Mr. Stroot said.

According to Mr. Stroot, California and federal laws regarding employee classification are similar, but the IRS hasn’t historically had the resources for large enforcement efforts.

“We do far more audits and investigations than the IRS does,” Mr. Stroot said. “It’s a staffing issue.”

But in November, California became one of at least 29 states to sign an agreement with the IRS to share the results of audits and investigations. The agreements are part of the IRS’s new Questionable Employment Tax Practices initiative, which is aimed at increasing employment-tax compliance.

An IRS spokesman said it is too early to report the results of the initiative, but Mr. Rybicki said he expects to see more joint enforcement take place between federal and state agencies.

“Computerization and new software that the IRS is developing and state agencies are developing is going to make that type of enforcement easier,” Mr. Rybicki said.

In the meantime, California employers can take some of the guesswork out of employee classification by asking the state for a ruling regarding a particular employee. There is no cost. A form can be downloaded by visiting www.edd.ca.gov and searching for “DE 1870.”

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