Brown Moskowitz & Kallen partners Kenneth L. Moskowitz and Steven R. Rowland recently collaborated on an article that published in the 2019 “Points of Fact” newsletter produced by certified public accounting and consulting firm Sobel & Co. The article focuses on the New Jersey Department of Labor & Workforce Development’s July 2019 task force report that maintains “misclassification of employees as independent contractors is prevalent. The article notes that “anyone who classifies or who has classified workers as independent contractors should understand they now have additional audit exposure.” Here is the full article:
THE NEW JERSEY DEPARTMENT OF LABOR IS TAKING AIM AT THE INDEPENDENT CONTRACTOR MODEL OF BUSINESS
By Kenneth L. Moskowitz, Esq. and Steven R. Rowland, Esq.
Brown Moskowitz & Kallen, P.C.
On July 19, 2019, the New Jersey Department of Labor and Workforce Development (“DOL” or “Department”) issued a task force report which concludes that misclassification — classifying “employees” as “independent contractors” — appears to be “prevalent” in numerous industries including “construction, janitorial services, home care, transportation, trucking and delivery services, and other labor-intensive low-wage sectors, where employers can gain a competitive advantage by driving down payroll costs.” The task force made numerous recommendations to deter misclassification, including the threat of criminal prosecution of those who misclassify, and the revocation/suspension of their business licenses.
In light of the DOL’s task force report and enforcement initiatives, businesses that rely on independent contractors must be cognizant that DOL enforces the state unemployment compensation system, including its taxation provisions. Accordingly, due to the Department’s administration of state employment taxes, putative employers must pay careful attention to the State’s efforts to expand the classification of who is an “employee” — for whom the employer must pay the state unemployment tax — rather than “independent contractors” — who are outside its coverage and for whom no state unemployment tax is owed. Audit risk is very real and can result in crushing liability. To make matters worse — indeed much worse — the DOL in its audits is not only now applying a broader definition of “employment” than it previously had, but is applying the broader definition retroactively.
By way of background, in December 2017, at the close of the Christie administration, the DOL Commissioner issued a final determination in Big Daddy Drayage, Inc. v. Department of Labor and Workforce Development (a matter prosecuted by BMK on behalf of the petitioner) that confirmed the Department’s obligation to apply the IRS’s 20 factor, common law test of employment in an employment tax audit of a motor carrier, as statutorily required by N.J.S.A. 43:21-19(i)(7)(X) and implemented by regulation, N.J.A.C. 12:16-23.2(a)(4). The Big Daddy case is significant because the Commissioner acknowledged that there are different tests of employment and that, with respect to state unemployment taxes, some work relationships are covered by one rule — the common law test of employment — and others by New Jersey’s statutory ABC Test. Notably, the common law test of employment, if properly applied, should result in a determination that an owner-operator that leases its large truck to a motor carrier is an independent contractor as the Commissioner found in Big Daddy — resulting in the overturning of an employment tax assessment that, with interest, was approximately $500,000. Since the common law test of employment is also used by the IRS, the independent contractor model is widely used in interstate trucking, and may fairly be described as the backbone of that industry.
The ABC Test, on the other hand, potentially can be read in the same context to find that the owner-operator is an employee, and its application was urged by the DOL in Big Daddy notwithstanding the aforementioned statute and regulation. In making the assessment against Big Daddy, the DOL had applied the ABC Test. Under the ABC Test as interpreted by the Department, a worker is deemed to be an employee simply because he/she receives the bulk of his earnings from a single source and, consequently, is considered to be economically dependent on that party and, therefore, employed by it. The DOL is, by statute, generally supposed to apply the ABC Test in unemployment tax audits, except where the state legislature has chosen otherwise — such as for large trucks leased to motor carriers and the laundry-list of other exceptions set forth at N.J.S.A. 43:21-19(i)(7)(A-Z) (and elsewhere), which include real estate brokers, court reporters, travel agents and approximately two dozen other work categories. The central issue in Big Daddy was DOL’s failure to apply the exception to the ABC Test.
What is significant about Big Daddy is that the Commissioner recognized the statutory dichotomy and the DOL’s obligation to enforce each test faithfully. In the decision, the Department recognized that it was responsible to determine whether or not the owner-operators were “employees” under the common law standard used by IRS and expressly incorporated by the State of New Jersey in N.J.A.C. 12:16-23.2(a)(4) where the statutory test of employment, the more stringent ABC Test, did not apply. In doing so, the Commissioner rejected the DOL’s argument that only the IRS could apply the common law standard.
Under Governor Murphy, the DOL repealed N.J.A.C. 12:16-23.2(a)(4) effective September 2018, and now applies the ABC Test even where the work category is statutorily excepted. In the rule-making that resulted in the repeal of the regulation, the DOL took the position that, because N.J.A.C. 12:16-23.2(a)(4) required the application of the federal standard of employment, it could not apply it: the exact opposite position that the former DOL Commissioner took in Big Daddy. The legality/validity of the repeal is now the subject of litigation in the Appellate Division in Farruggio’s Bristol and Philadelphia Auto Express, Inc. v. New Jersey Department of Labor and Workforce Development, Appellate Division Docket No. A-4932-18.
For better of worse, the current audit environment reflects the DOL’s view that the independent contractor model is inherently abusive and denies the state payroll tax revenue. Indeed, in current audits, not only does the DOL assert that it cannot apply IRS’s common law test of employment because N.J.A.C. 12:16-23.2(a)(4) has been repealed, but it is now applying the more stringent ABC Test standard retroactively.
The DOL under Governor Murphy has changed course, and its repeal of N.J.A.C. 12:16-23.2(a)(4) reflects a stark reality: if you are audited, the DOL will apply the ABC Test (regardless of whether you are supposed to be excepted from it) and then will almost certainly find the worker to be an “employee” rather than an “independent contractor.” Simply put — for anyone who has previously classified a worker to be an independent contractor, a DOL audit may result in an assessment, requiring the payment of state unemployment tax for those who were classified as independent contractors, as well as statutory interest.
Anyone who classifies or who has classified workers as independent contractors should understand that they now have additional audit exposure and ought to take steps to minimize it. In particular, such a company should consult and work with accountants and/or attorneys who have experience in responding to DOL audits. There are practices that the company may now be using with independent contractors that may be considered to be the type of red-flag conduct that the DOL deems to be indicative of employment. Additionally, there may be steps that you can take with IRS — such as the SS-8 process — that may benefit you in a subsequent DOL audit. Also, risk may be mitigated/avoided by contracting with workers who are either S or C corporations, as opposed to sole proprietorships or LLCs.
In light of the DOL’s forceful initiative and the repeal of N.J.A.C. 12:16-23.2(a)(4), a company that engages independent contractors should assess the propriety of doing so and, perhaps more importantly, the risk of a DOL audit in the current environment. With the aid of experienced accountants and legal counsel, a company that utilizes independent contractors in its business can assess the risks of continuing to do so and take actions that potentially may mitigate those risks.
©Copyright 2019, Brown Moskowitz & Kallen, P.C. All rights reserved. This article is for informational purposes only and is not intended to constitute, and does not constitute, legal advice.
For further information please feel free to contact either Kenneth L. Moskowitz, Esq. (firstname.lastname@example.org) or Steven R. Rowland, Esq. (email@example.com), or call either at 973-376-0909.
Mr. Moskowitz is a former prosecutor and is a founding partner of Brown Moskowitz & Kallen, P.C., in Summit New Jersey. He represents clients in diverse business disputes, commercial litigation, internal investigations, “corporate divorce” matters, insurance coverage litigation and other business related disputes.
Mr. Rowland is a litigation partner at Brown Moskowitz & Kallen, P.C. He represents corporate clients in complex litigation matters including business disputes, commercial litigation, insurance coverage, and construction. Mr. Rowland represented Big Daddy Drayage, Inc. and obtained the December 2017 final determination from DOL that IRS’s 20 factor test provided the standard for employment determinations under New Jersey’s unemployment statute pursuant to N.J.A.C. 12:16-23.2(a)(4). In addition, he represents Farruggio’s Express, which has challenged the repeal of N.J.A.C. 12:16-23.2(a)(4) as well as DOL’s retroactive application of that repeal in a matter now pending before the Appellate Division in Farruggio’s Bristol and Philadelphia Auto Express v. Department of Labor and Workforce Development, Appellate Division Docket No. 4932-18.