Latest News: Tennessee Court of Appeals Rules Against Independent Contractor Pet Groomers
Important Ruling by TN Court of Appeals (remember there is both federal and state IC rules).
Tennessee Court of Appeals Cleans Up Questions on Dog Groomers’ Employment Status
Executive Summary: Individuals performing the main function of your business cannot be classified as independent contractors in Tennessee. At least, that’s what the Tennessee Court of Appeals ruled recently when analyzing whether the Tennessee Department of Workforce Development properly held a pet groomer liable for unpaid unemployment taxes from 2006 through 2011.
The case involved a business in Knoxville, Tennessee, which, according to its owner’s testimony, was “in the business of grooming dogs.” In addition to canine cleaning, the company trained students to become pet groomers and sold certain pet products like shampoo. The company allowed pet groomers to determine their prices on a case-by-case basis, and paid the groomers a 50 percent commission on what they brought in at the end of each week. The company also provided the groomers with necessary grooming supplies, and the groomers sometimes participated in selling the company’s retail items. All grooming services took place at the company’s location in Knoxville, although groomers could work for other companies or themselves at other locations if they wished. Customers called the company to set up appointments rather than calling individual pet groomers, although customers could request to work with a particular groomer. On these facts, the Department of Workforce Development held the pet groomers were covered employees rather than independent contractors.
The Department’s ruling focused on the company’s failure to establish each of the three elements of the “ABC” test, which governs whether an individual is an employee or independent contractor for unemployment tax purposes. See Tenn, Code Ann. §50-7-207(e)(1). The test provides that an individual shall be deemed an employee, unless the employer can establish: (A) the individual has been and will continue to be free from control and direction in connection with the performance of the service, both under any contract for the performance of service and in fact; (B) the service performed by the individual is performed either outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which the service is performed; and (C) the individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed. The Department held that because the company could not satisfy the “B” prong of the test, the individuals were employees. The Court of Appeals agreed, relying on testimony from the company’s owner that the company was, at least in large part, a pet grooming business. Therefore, the individual groomers, in performing services which were a part of the usual course of the company’s business, and doing so at the company’s location, could not be considered independent contractors. As a result, the Court of Appeals affirmed the Department’s determination the individuals were independent contractors, making the company liable for unpaid unemployment taxes from 2006 through 2011.
Employers’ Bottom Line: This case highlights the strict approach taken by Tennessee agencies and courts in determining whether an individual qualifies as an independent contractor under state law. It also serves as a reminder of the many tests utilized by various state and federal agencies to determine employee/independent contractor status. Failure to comply with each of these tests may result in liability for unpaid taxes or wages, along with potential administrative or statutory penalties. Employers are encouraged to proceed with caution when making these determinations and to seek the assistance of experienced employment counsel to clarify any uncertainties.
Most Independent Contractor Pet Groomers Are Misclassified
Based on a survey of 150 pet grooming business owners, not one consulted with an employment law attorney to determine if their pet groomers were properly classified as independent contractors according to federal and/or state guidelines. In fact, 98% said they were unaware that their classification state laws can be different than federal’s. In other words, independent contractors may be properly classified at a federal level but not meet their state’s classification guidelines.
It’s a mess. The vast majority of independent contractor groomers in the United States are not compliant according to federal guidelines. Plenty of groomers have been notified of such, and we have talked with them and learned more. In a nutshell, some pet groomers renting a workstation within a pet grooming business or business and operating a separate pet care business from the landlord may be properly classified as independent contractors. Thousands of supposed I.C. groomers are actually employees. Factors for having their own business insurance, telephone, business name and other indications of self-employment are becoming more and more secondary to new stricter rules such as in Tennessee. Times have changed.
Misclassifying a worker as an independent contractor (I.C.) results in severe consequences, including back taxes, wages and benefits, and civil and criminal penalties. They can come from all sides, including individual and class action lawsuits, state and federal agency audits and enforcement actions, and even criminal prosecution.
What is Willful Misclassification?
The definition of “willful misclassification” is “avoiding employee status for an individual by voluntarily or knowingly misclassifying that individual as an independent contractor.” The new law also prohibits charging fees to or making deductions from the compensation paid to the misclassified workers if the fee or deduction would have been prohibited if the worker was an employee.
There are also steep civil penalties for each violation, and embarrassing to say the least. For example, any person or employer who willfully misclassifies a worker as a contractor must prominently display a notice on its website that states (1) it has committed a serious violation of the law by engaging in the willful misclassification of employees; (2) it has changed its business practices to avoid further violations; (3) that any employee who believes he or she is being misclassified may contact the Labor Workforce Development Agency; and (4) that the notice is being posted pursuant to a State order. The posting requirement lasts for one year and must be signed by an officer of the company.
Groomers classified as independent contractors are self-employed. They are not covered by employment and related tax laws or, typically, by benefit plans.
Employment law presumes that groomers are employees. Absolute determinations made by one firm rule just don’t exist. The classification is then based on “tests” to determine whether a groomer is correctly classified. According to Orrick, Herrington & Sutcliffe LLP, “…most tests center around three basic concepts:
Control: If the company exercises enough control over the worker and the work performed (e.g. closely supervises worker, sets work hours, assigns specific tasks, provides specific direction on how and when to perform work), the worker likely should be classified as an employee.
Contractor’s ability for profit and loss: If the worker cannot hire assistants or subcontract out the work, uses the company’s tools and/or equipment, is reimbursed for business expenses, cannot work for other companies simultaneously, and/or is paid an hourly wage or a salary as opposed to being paid by the project or job, the worker is more likely to be an employee.
Distinct Occupation: If the worker is performing the same type of work as the company’s employees, provides services that are integral to the company’s regular business, is working on the company’s premises, does not possess a specialized skill, and/or is working for the company for an extended period of time, the worker is more likely to be an employee.”
Contact with Grooming Business Owners Not Compliant
Discussions of independent contractor (I.C.) classification with groomers typically focuses on groomers hired as an independent contractors. Are these I.C.’s doing this, or that, and also this? While these qualifications are part of the determination process to make accurate classifications, rarely do you hear an I.C. groomer ask, “Is my employer compliant in their own right to employ an I.C.?” That’s the flipside and the I.R.S. is apparently asking that question. We know of actual incidents where employers of I.C.’s were told they must immediately convert their I.C.’s to employee status, even when the I.C.’s themselves were compliant. These employers feel like bombshells have hit and they can be liable for past taxes and other financial consequences that quickly multiply into thousands of dollars. Some over six figures!
Every I.C. groomer needs to realize that while they run their self-employment within compliance requirements their employers may not be compliant and should have never hired I.C.’s in the first place. When is this true? Let’s take a look.
The IRS publishes Publication 4902 Tax Tips for the Cosmetology Barber Industry. We believe pet grooming operations are so similar to hairstyling for people that the IRS would apply the content of this publication to grooming businesses. In the section Shop Owner, “Your business may have employees who work for you or you made decide to operate without employees. Another common arrangement is renting space to another individual who operates an independent business. This is commonly referred to as a booth renter…once you decide to hire workers you must make a determination if they are your employees or if they will operate their own independent business (as booth renters).”
Hello! Without stating a lot of tax code you can bet the “booth renting” test is a strong factor when examining pet grooming operations with independent contractors. Today very few grooming business owners with independent contractors are renting booths to them. Alone, this test may not overrule the independent contractor test, but it will certainly raise eyebrows and incite them to look closer at grooming’s typical I.C. operations. There’s more.
We spoke with two groomers in March 2013 wherein this scenario happened. The independent contractors were not booth renters. They met all I.C. qualifications shown on the previous page, and more. However, the IRS ruled against their employers, and ordered them to convert their I.C.’s to employees with payroll deductions. Both are awaiting fines, penalties and interest assessments. Now, why the bombshell rulings?
They related to us that the I.R.S. studied their financials and more important, the nature of the daily operations. They studied the control of the clientele, and who was performing the grooming for each business owner.
Here is where the unraveling began and why we are sharing this article as a warning to employers of grooming I.C.’s. Both employers were not renting booths. They assigned the services ordered by their clientele to multiple I.C. groomers. Both owners did some grooming for their clientele but the majority of their service demand was done by the I.C.’s. Some groomers loosely use the word “outsource.” For example, these owners outsourced what they couldn’t personally groom to their I.C. groomers, yet retaining ownership of their clienteles. They were not giving referrals of new clients to I.C.’s running their own booth operations. Uh-oh.
The owners’ abilities to meet the demand of their clienteles was then significantly “contingent” on other groomers. In this light without booth renter setups the IRS ruled these operations were more characteristic of employer-employee setups. Both were advised to immediately compensate their groomers as employees.
Generally where you have booth rentals business owners share and provide leads generated by their businesses to their I.C.’s. These referrals may become the clientele of the booth renters.
You don’t have to be in the grooming industry long before you realize that not only are booth rentals rare, but owners don’t give away the ownership of their clientele to other groomers very often. Owners are increasingly asking I.C.’s to serve their clientele without contacting the I.R.S. to determine their eligibility to do so.
At GroomerTALK℠ we have a special forum for independent contractor discussions. We hear of grooming employers ruled against by state and federal regulators facing severe financial consequences. Heads up!
Why Some Business Owners Improperly Classify Pet Groomers
It is possible for a pet groomer to be legally classified as an independent contractor in compliance with both state and federal guidelines. It just happens to be rare. However, it doesn’t seem that way when you read job offers stating you will be an independent contractor, yet act more like an employee. We are not going to go into the sordid details of the laws and actions taking place against employer misclassification. This time we want to remind employees to be careful.
Employees can become victims of employers when they blindly accept classification as an independent contractor. If you are an employed groomer, or a groomer wannabe, keep these warnings in mind during your job searches. Both employees and employers must be compliant with employment law. Your employer’s choice to hire you as either an employee or independent contractor is reliant on the employer meeting both federal and state guidelines. The employer’s choice does not override compliance. There are employers that truly don’t know better.
There is a money motive for not classifying pet groomers as employees. The illustration below says it all.
Employers can sound very confident when they offer independent contractor positions. Never assume they are correct or compliant. Verify. Your well-being is at stake. It’s that important. If you are not offered a written I.C. employment contract stating the working relationship in detail with evidence of why you are an I.C., something is probably wrong. You are working at risk. In an audit or challenge you are expected to know if you are properly classified or not, the same as your employer.
If you get a written contract, verify the employment status as correct with your own legal counsel. Does that scare you? Never hired an attorney? Remember as an “I.C.” you are self-employed, and all self-employed people rely occasionally on professionals such as attorneys. It’s far easier to mature into working with professionals than face the IRS claiming you did file your taxes correctly as a self-employed person. Penalties and fines can quickly reach thousands of dollars.
Keep in mind that state laws for classifying independent contractors may be different than federal guidelines. You can be federally compliant, and not state compliant, or vice versa. Most employers are not aware of this quandry. For example in many states if you employ pet groomers correctly classified as independent contractors, you must require all of your pet groomers to be independent contractors. You cannot fill the position with both employees and contractors. In some states pet groomers cannot be independent contractors if the owner is also working as a pet groomer. At a federal level these rules don’t exist so clearly.
Where pet groomers may be classified as independent contractors they typically must be renting a booth space from the business owner and running their own business, and not grooming the clientele of their landlords’ grooming businesses
Get Compliant Now!
Few groomers are correctly classified as I.C.’s. Grooming business owners need to act fast, especially if the wave of new additional legislation against misclassification of workers continues and echoes the severe responses of the State of California. One easy measure is to consult an employment law attorney to examine your I.C. classifications.
Have your attorney thoroughly examine the status of your I.C. based groomers. If your groomers do not clearly meet the criteria, adjust the working relationship to properly meet the existing classification, cease the relationships or change the relationships to employees. Your I.C. classifications should be thoroughly documented in an I.C. employment agreement prepared your attorney.
Don’t risk misclassifying groomers as I.C.’s without proof of your determinations. The risk of potentially losing your business and facing severe financial penalties and embarrassment is not worth the short-term benefit of lowering payroll expenses. Instead find other ways to lower operating costs or raise prices to compensate for the additional cost of employee-based relationships. ▲