Employee focus comes with a cost

In 2015, federal agencies, at the urging of President Barack Obama’s administration, were proactive about expanding and enforcing federal protections for employees, a trend likely to result in increased costs and compliance requirements for employers. Specifically, the U.S. Department of Labor (DOL) undertook an initiative to combat what it perceived is a misclassification of employees as independent contractors and proposed new regulations that would, by its own estimation, entitle 4.6 million employees to overtime and minimum wage protection in the first year it is applied. Additionally, the National Labor Relations Board (NLRB) broadened and redefined which businesses are classified as joint employers, expanding the scope of employers that are legally responsible for unfair labor practices violations and making unionization of certain contract workforces easier.

These changes will result in a substantial increase in costs for employers in employee wages; taxes, if workers are reclassified from independent contractors to employees; and administrative costs associated with reviewing and complying with new and more complex requirements in classifying employees. Accountants in corporate and private practice are likely to be tasked with helping employers manage costs and deal with tax and operational complexities resulting from these expanded employee protections and other employment-law changes that may emerge in the last months of the Obama administration and afterward.

PROPOSAL FOCUSES ON OVERTIME

On June 30, 2015, the DOL proposed an update of regulations regarding exemptions from minimum wage and overtime pay requirements under the Fair Labor Standards Act (FLSA) for executive, administrative, and professional (“white-collar”) employees.

The proposed rules would keep the existing framework intact but increase the standard salary for the white-collar exemptions and the highly compensated employee salary threshold and would put a mechanism in place to update these thresholds annually. If adopted as proposed, the regulations would result in employees who were previously classified as exempt becoming entitled to overtime pay, unless employers significantly raise employee wages to meet the new salary thresholds.

Unless employees fall within an exemption, employees covered by the FLSA must receive overtime pay at a rate of at least time and half their regular rate of pay for each hour worked over 40 in a workweek and must be paid the minimum wage. One of those exemptions is the white-collar exemption, which exempts white-collar employees from overtime and minimum wage requirements.

For the white-collar exemption to apply:

• The employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed;
• The employee’s salary must exceed $455 per week; and
• The employee’s job duties must primarily involve executive, administrative, or professional duties as defined by the regulations.

Additionally, highly compensated employees are exempt from the overtime pay requirement if they receive total annual compensation of at least $100,000 (which must include at least $455 per week paid on a salary or fee basis) and if they customarily and regularly perform at least one of the exempt duties or responsibilities of a white-collar employee in the standard tests for exemption.

The proposal suggests a 113% increase in the standard annual salary level for the white-collar exemptions from $23,660 to $50,440, with a mechanism for increasing the salary threshold annually. Unless employers increase the salaries of currently exempt employees above the new $50,440 threshold, employers would be required to pay those employees overtime.

The proposal also suggests raising the salary threshold for the highly compensated employee exemption from $100,000 to $122,148 annually, with a mechanism for increasing the threshold annually. If employers fail to raise the salaries of employees previously classified under this exemption to the new $122,148 threshold, they would have to conduct a more detailed review of those job positions to determine if they meet the white-collar duties test.

Moreover, the proposal considers whether changes are necessary to the duties test for the white-collar exemptions. While this element of the proposal may be too vague to result in immediate changes to the law in early 2016, it suggests that the duties test may be separately modified in the not-so-distant future.

The complexities in classifying employees will persist if this proposal is adopted. Employers will need to continue to be diligent about classifying, reviewing, and documenting job positions subject to the white-collar exemptions. If the regulations are approved, employers will face difficult choices and will have to evaluate the following options:

• Increasing employees’ annual salaries to meet the new salary thresholds.
• Tracking and paying overtime to employees who fall below the new (and likely annually changing) salary threshold.
• For those employers who have not done so already, possibly outsourcing payroll functions to third-party providers and balancing the costs of using those services with the risk of noncompliance with the regulations.

MISCLASSIFICATION AS INDEPENDENT CONTRACTORS

The DOL is raising the bar for classifying workers as independent contractors. In July 2015, it released guidance that cautions that most workers are employees under the FLSA and that misclassification of employees as independent contractors is a widespread problem that is a focus of DOL enforcement. While the DOL did not announce a new standard, it promoted an expansive view of the “economic realities” test used to determine whether an individual is properly classified as an independent contractor. In addition, the DOL has entered into memoranda of understanding with 28 states and the IRS to combat worker misclassification.

Employers have traditionally financially benefited from classifying individuals as independent contractors because not only do they not have to withhold federal income tax for independent contractors, but they do not have to pay Social Security, Medicare, and unemployment taxes for their benefit or withhold and remit amounts from their wages for the worker’s share of Social Security and Medicare taxes. If companies convert a large number of independent contractors to employees, they will be required to undertake these additional financial and administrative obligations. If workers are improperly classified, employees may be entitled to back pay and benefits, and an employer may be required to pay back taxes and penalties.

Companies should be proactive in assessing and auditing their independent contractor relationships. Some of the factors that companies should consider in classifying workers as independent contractors include:

• Is the work an integral part of the employer’s business?
• Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?
• How does the worker’s relative investment in the facilities or tools used by the worker compare to the employer’s investment?
• Does the work performed require special skill and initiative?
• Is the relationship between the worker and the employer permanent or indefinite?
• What is the nature and degree of the employer’s control?

The goal of the economic realities test is to determine whether the worker is economically dependent on the employer (and therefore an employee) or is an independent businessperson. A company can support its position on the status of a worker as an independent contractor through the structure of its written agreements with the worker. For example, to support a finding of independent contractor status, an agreement should:

• Be for a fixed term or for a specific finished product;
• Avoid including provisions that permit termination of the agreement at any time by either party; and
• Avoid provisions directing the manner or means of performing the service.

These are just a few suggestions; the economic realities test is fact-specific, and the DOL will consider many factors in evaluating whether an independent contractor has been properly classified. Note that the IRS applies somewhat different factors in determining independent contractor status for federal tax purposes.

EXPANDED JOINT EMPLOYER STANDARD

The National Labor Relations Act (NLRA) is a federal law that applies to all private-sector employers and is intended to encourage collective bargaining. The act regulates collective bargaining and relations with unions but also protects concerted activity—activity by two or more employees to improve wages or working conditions to benefit multiple employees—even in nonunion workplaces. The NLRB has been proactive in recent years about safeguarding protected concerted activity under the act in nonunionized workplaces. Specifically, the NLRB has broadly interpreted the definition of “protected concerted activity” to find unfair labor practices by employers even where the speech in question is seemingly unrelated to union activity.

To be liable under the NLRA, a company must be deemed an employer, which includes joint employers. A joint employment relationship exists when more than one company is considered the legal employer of a group of workers. Previous NLRB and court decisions have held that, to be treated as a joint employer, an employer must directly and immediately exercise authority and control over employees’ terms and conditions of employment.

In 2015, the NLRB reversed long-standing precedent and ruled that a company may be a joint employer of another company’s workers if it has the right to control those workers, even if that right is not exercised. The new joint employer standard no longer requires an employer to exercise control over employees to be considered a joint employer but instead considers whether the company has merely reserved that authority for itself (referred to as “reserved control”).

The new joint employer test is a broader, more inclusive test that undercuts the advantages of using contingent workforces (temporary contract workers) via third-party staffing agencies, by expanding the companies that may be classified as employers for purposes of unfair labor practices. Companies will no longer be able to insulate themselves from NLRA liability by entering into agreements with suppliers that provide workers to user companies. As a consequence of the new, broader test, companies that were not previously subject to unfair labor practices charges may now be liable, and companies that were not required to participate in collective bargaining negotiations may now be required to do so. Because the new joint employer standard may increase the size of a company’s workforce to include its contingent workers, it may also make it easier for employees to unionize.

The joint employer standard requires a case-specific factual analysis, and as a result, it is unclear exactly how widespread the impact will be. For now, user companies should review the arrangements they have with their contingent workforces and closely examine instances of reserved control. User companies should consider whether they are required to participate in collective bargaining discussions and whether they may be exposed to liability for unfair labor practices of their supplier companies.

Following suit, on Jan. 20, 2016, the DOL released guidance signaling its intent to use a similar broad approach to joint employment issues, which may result in more employers being held liable for wage and hour violations committed by an employer’s third-party service suppliers, independent contractors, or affiliates.

CPAs HAVE A ROLE

CPAs should be alert to these expanded federal protections of employees and workers not only in their own workplaces but also in their clients’ workplaces. There may be an opportunity for accountants to work proactively with counsel to help clients avoid problems resulting from these new realities in the workplace. Companies that traditionally performed their own payroll functions may need to hire additional employees to perform these functions or may need to consider outsourcing to professional services firms. Cost-saving will become more important than ever, and many companies will be looking for creative solutions to balance increased payroll, tax, and administrative costs. In addition, given the Obama administration’s focus on employment law reforms, accountants—and all businesses—should be alert for more employee-friendly changes during the remainder of 2016.

About the authors

David Lindsay (david.lindsay@klgates.com) is a partner specializing in labor, and Kaitlin Dewberry (kate.dewberry@klgates.com) is an associate specializing in labor and employment, both in the Raleigh, N.C., office of the international law firm K&L Gates LLP.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at ktysiac@aicpa.org or 919-402-2112.

AICPA resources

JofA articles

• “From The Tax Adviser: Voluntary Classification Settlement Program,” July 2013, page 78
• “Worker Classification Still Troublesome,” March 2009, page 83