Tag Archives: attorney-client privilege

Firms Must Clean Up Worker Classifications

Businesses should heed the expansion of the Internal Revenue Service voluntary classification program (VCS) as yet another warning to clean up their worker classification practices and defenses for all workers performing services for the business in any non-employee capacity.

When businesses treat workers as nonemployees, yet they render services in such a way that they likely qualify as a common law employees, the businesses run the risk of overlooking or underestimating the costs and liabilities of employing those workers.

The U.S. Department of Labor’s Wage and Hour Division has an ever-lengthening record of businesses subjected to expensive backpay and penalty awards because the businesses failed to pay minimum wage or overtime to workers determined to qualify as common law employees entitled to minimum wage and overtime under the Fair Labor Standards Act.

Originally announced on Sept. 22, 2011, the VCS program as modified by Announcement 2012-45 continues to offer businesses a carrot to reclassify as employees workers who had been misclassified for payroll tax purposes as independent contractors, leased employees or other nonemployee workers. That carrot came with a stick: the IRS’ promise to zealously impose penalties and interest against employers caught misclassifying workers. And the IRS is only one of many agencies on the alert for worker misclassification exposures — worker misclassification also affects wage and hour, safety, immigration, worker’s compensation, employee benefits, negligence and a host of other obligations. Private plaintiffs are also pursuing businesses for misclassification.

All of these exposures carry potentially costly compensation, interest and civil and in some cases even criminal penalties for the businesses and their leaders. Consequently, businesses should act prudently and promptly to address all of these risks and manage their misclassification exposures. Because most businesses uniformly classify workers as either employees or nonemployees for most purposes, business leaders must understand the full scope of their businesses’ misclassification exposures.

VCS Program offers limited relief

Worker misclassification affects a broad range of tax and non-tax legal obligations and risks well beyond income tax withholding, payroll and other employment tax liability and reporting and disclosure. A worker classification challenge or necessity determination should prompt a business to address the worker reclassification and attendant risks in other areas.

Typically, in addition to treating a worker as a nonemployee for tax purposes, a business also will treat the worker as a nonemployee for immigration law eligibility to work, wage and hour, employment discrimination, employee benefits, fringe benefits, workers’ compensation, workplace safety, tort liability and insurance and other purposes.

Healthcare reform increases risks

Businesses can look forward to these risks rising when the “pay or play” employer-shared responsibility, health plan non-discrimination, default enrollment and other new rules take effect under the Patient Protection & Affordable Care Act (ACA). Given these new ACA requirements and the government’s need to get as many workers covered as employees to make them work, the IRS and other agencies are expanding staffing and stepping up enforcement against businesses that misclassify workers. Businesses must understand how workers are counted and classified for purposes of ACA and other federal health plan mandates.

ACA and other federal health plan rules decide what rules apply to which businesses or health plans based on such factors as the number of employees a business is considered to employ, their hours worked and their seasonal or other status. The ACA and other rules vary in the relevant number of employees that trigger applicability of the rule and how businesses must count workers to decide when a particular rule applies. Consequently, trying to predict the employer shared responsibility payment, if any, under Internal Revenue Code (Code) Section 4980H or trying to model the cost of any other federal health benefit mandates requires each business know who counts and how to classify workers for each of these rules. Most of these rules start with a “common law” definition of employee then apply rules to add or ignore various workers. Because most federal health plan rules also take into account ”commonly controlled” and “affiliated” businesses’ employees, businesses also may need to know their information.

For instance, when a business along with all commonly controlled or affiliated employers employs a combined workforce of 50 or more “full-time” and “full-time equivalent employees” but does not offer “affordable,” “minimum essential coverage” to every full-time employee and his dependents under a legally compliant health plan, the business generally should expect to pay a shared responsibility payment for each month that any “full-time” employee receives a tax subsidy or credit for enrolling in one of ACA’s healthcare exchanges.

If the business intends to continue to offer health coverage, it similarly will need to accurately understand which workers count as its employees for purposes of determining who gets coverage and the consequences to the business for those workers that qualify as full-time, common law employees not offered coverage.

In either case, ACA uses the common law employee test as the basis for classification, and the already significant legal and financial consequences for misclassifying workers will rise considerably when ACA gets fully implemented.

Consider relief in the full context

As part of a broad effort, the IRS is offering certain qualifying businesses an opportunity to resolve payroll liabilities arising from past worker misclassifications. The VCS Program settlement opportunity emerged in 2011.Touted by the IRS as providing “greater certainty for employers, workers and the government,” the VCS Program offers eligible businesses the option to pay just more than 1% of the wages paid to the reclassified workers for the past year. The businesses also must meet other criteria. The IRS promises not to conduct a payroll tax audit or assess interest or penalties against the business for unpaid payroll taxes for the previously misclassified workers.

Participation was low, partly because not all businesses with misclassified workers qualified to use the program. The original criteria to enter the VCS Program required that a business:

Be treating the workers as nonemployees;
Consistently have treated the workers as nonemployees;
Have filed all required Forms 1099 for amounts paid to the workers;
Not currently be under IRS audit;
Not be under audit by the Department of Labor or a state agency on the classification of these workers or contesting the classification of the workers in court; and
Agree to extend the statute of limitations on their payroll tax liabilities from three to six years.
After only about 1,000 employers used the VCS Program, the IRS modified it so that employers under IRS audit, other than an employment tax audit, now qualify. The IRS also eliminated the requirement that employers agree to extend their statute of limitations on payroll tax liability.

Many employers may still view use of the VCS Program as too risky because of uncertainties about the proper classification of certain workers in light of the highly specific nature of the determination. Employers may also have concerns about the effect that use of the VCS Program might have on non-tax misclassification exposures for workers who would be reclassified under the VCS Program.


One of the biggest challenges to getting businesses to change their worker classifications is getting the businesses to accept the notion that long-standing worker classification practices in fact might not be defensible. Although existing precedent and regulatory guidance makes clear that certain long-standing worker classification practices of many businesses would not hold up, business leaders understandably often discount the risk because these classifications historically have faced little or no challenge. Even when business leaders recognize that changing enforcement patterns merit reconsideration, they may be reluctant to reclassify the workers.

The common law employment test often relies on a subjective, highly fact-specific analysis of the circumstances of the worker. The business, rather than the IRS or other agency, generally bears the burden of proving the correctness of its classification of a worker. So, a business must ensure that its decisions can withstand scrutiny under all applicable tests and must retain evidence. Businesses also should exercise special care to avoid relying on overly optimistic assessments of the facts and circumstances.

When the factual evidence creates significant questions, an employing business generally should consider reclassifying or restructuring the position. Often, it also may be desirable to incorporate certain contractual, compensation and other safeguards into the worker relationship, both to support the nonemployee characterization and to minimize future challenges and exposures.

Importance of attorney-client privilege for risk management

Because of the broad exposures arising from misclassification, business leaders generally should work to ensure that their risk analysis and decision-making discussion is positioned for protection under attorney-client privilege and attorney work product privilege.

The interwoven nature of the tax and non-tax risks merits particular awareness by business leaders of the need to use care in deciding the outside advisers that will help in the evaluation of the risks and structuring of solutions. While appropriately structured involvement by accountants and other non-legal consultants can be a valuable tool, the blended nature of the misclassification exposures means that the evidentiary privileges that accountants often assert to help shield their tax-related discussions from discovery are likely to provide inadequate protection. For this reason, business leaders are urged to require that any audits and other activities by these non-legal consultants to evaluate or mitigate exposures be conducted whenever possible within attorney-client privilege. Accordingly, while businesses definitely should use appropriate tax advisers, they will want to first engage counsel and coordinate non-attorney advisers’ activities within the protection of attorney-client privilege

The Right Way to Handle Employee Complaints

California employers have a legal duty to respond to certain employee complaints.  Failure to respond or failure to respond appropriately can result in significant liability.  This is particularly true with complaints of harassment, discrimination and other unlawful conduct.  Accordingly, employers should never take employee complaints lightly.  Even if no legal duty to investigate exists, a well-managed response can minimize or even eliminate problems and improve employee morale.

Achieving the well-managed response is not easy.  It takes careful planning and execution.  Fortunately, most employers do a very good job of managing their employees, and complaints are infrequent.  Unfortunately, this means most employers have little experience at managing the complaint process.  Being aware of and strategically planning at each step of the process can help make up for the lack of experience.

Here’s how you do it:

Receipt of the Complaint

How an employee complaint is received can be critically important.  If the employer has not created a culture of trust and respect, employees will not be comfortable coming to management with complaints.  That may mean fewer complaints but will also mean bigger problems — employees are not required to complain to the employer before filing a lawsuit.  Consistent with the culture of trust and respect, the manager receiving a complaint should express an interest in and concern for the employee making the complaint.  Remember, the employee is not happy about something.  A closed-minded, uncaring demeanor during the first contact will only make the unhappiness grow.

It is also very important to be aware of and address the complaining employee’s expectations.  If the employee requests that the complaint be kept confidential, the manager must be able to explain why it cannot be kept completely confidential and must be able to do so in a way that does not alienate the employee.  The manager should also address the employee’s expectations for the process and the result.  Obviously, it is too early for the manager to make promises about the result, but he can help build confidence in the fairness of the process.

Act Immediately

Once a complaint is received, the employer should act immediately.  Any delay in taking action on an employee complaint will be magnified tenfold in litigation, and the employer will have a very difficult time overcoming the perception that the complaint was dismissed as unimportant.

Conduct an Investigation

Every employee complaint warrants an investigation.  That does not mean that every complaint requires a lengthy, formal process conducted by professional investigators.  The investigation might be as simple as asking the employee a few questions.  Regardless of its scale, the investigation’s purpose remains the same: to get an accurate understanding of the facts.  Only with a solid understanding of the facts can the employer make an informed decision on the complaint.

As an initial matter, the employer must determine who will conduct the investigation.  Will it be conducted by a single individual or several people working in coordination?  Will it be conducted by the employer’s own staff or by an outside investigator?  In either case, the employer should consider the following factors:

  • The nature and seriousness of the complaint.  Complaints about the speed of the copy equipment do not warrant the same level of investigation as complaints about sexual harassment.
  • The skill and experience of the investigator.  Whether an employee or outside professional, the investigator should understand how to conduct a good investigation and have the skill to do it.  In some cases, an internal investigation is preferred.  If the employer does not have a skilled investigator on staff, the employer should hire an expert to guide and coach the employee conducting the investigation.
  • The investigator’s neutrality regarding the facts and witnesses.  Any bias, real or perceived, can render the investigation useless.
  • The investigator’s quality as a witness.  The investigator may well be a key witness in future litigation.  The ability to speak well and inspire confidence is essential in that arena.  It is equally important in giving the complaining employee and witnesses confidence in the investigative process.
  • The outside professional’s qualification.  California law requires outside investigators to be either a licensed private investigator or an attorney.
  • Whether creating a legal privilege around the investigation is important.  If it is, the investigation must be conducted by an attorney and conducted in a manner that maintains the privilege.
  • The scope of the investigation.  The investigator should find the facts and assess the credibility of the witnesses and information obtained.  The investigator should not make legal conclusions or suggestions on what actions to take, even if he is an attorney.

It is important to understand that the investigator or investigators cannot follow a set formula or pattern in every investigation and expect success.  A specific and strategic plan is always advised.  The plan will include consideration of who will investigate, who will investigate which parts, what order witnesses will be interviewed in, where they will be interviewed, what kind of record will be created and who will be responsible for communications.   As important as it is to have a strategic plan, it is even more important to not follow it blindly.  As facts are uncovered and circumstances change, the plan may need to be adjusted.  By definition, a good investigation will be flexible enough to ensure that all of the relevant facts are uncovered with a minimum of collateral damage.

Review the Investigation and Respond

The employer bears the ultimate responsibility for responding to the complaint.  Doing so appropriately requires a clear and complete understanding of the facts.  If the employer is uncertain about any facts contained in the investigator’s report, they should be clarified.  If the employer is not confident that the investigation was thorough, further investigation should be ordered.  With all the facts and confidence in them, the employer will decide what actions to take on the complaint.  This is the point where an employer should be interested in legal conclusions, particularly if the complaint is serious.  The deliberations about what actions to take and why should be protected against disclosure.  Often, it is advisable to have such deliberations protected by the attorney-client privilege.

While the deliberations may be secret, the decisions resulting from them are not. They will need to be communicated to the complaining employee and other interested employees and communicated effectively.  Once again, a strategic plan is critical.  How something is communicated is often as powerful as the content of the communication.   The effort put into the investigation and the problem-solving potential of the complaint process can all be lost by careless final communications.

Employers cannot escape the duty to investigate employee complaints.  Nor should they want to.  Employee complaints can be healthy for an organization.  They can uncover problems before they cause significant damage.  They can also be a vehicle for increased employee morale and productivity.  But the positive aspects surrounding employee complaints can only be achieved with a properly handled complaint process.