Club Independent Contractors: These are the People in Your Neighborhood

By Kerri Rawcliffe, CPA, Partner; Brooke Rossi, CPA, Director; and Amber Stone, CPA, Director

As clubs engage workers in various capacities, including employees and independent contractors, it is essential to distinguish between these classifications to ensure compliance with laws and regulations at both the federal and state levels. There are many pros and cons of using independent contractors versus employees, as well as a slew of legal and tax considerations to evaluate. To further complicate things, the rules are under heavy scrutiny, and just this month the Department of Labor (DOL) issued new guidance, as outlined below.

Clubs may misclassify employees as independent contractors as it is often easier and more favorable to the club; however, to avoid penalties and other errors, the club must identify and evaluate applicable federal and state rules engaging a worker.

There are several positions in the club where there is controversy as to whether they should be considered and treated as employees or independent contractors. Perhaps the most common is caddies, and – spoiler alert – the answer to the employee vs. contractor debate is: it depends. The classification relies on the specific details of the working relationship, subject to different tests and criteria as further described below. Golf and tennis professionals are often treated as a blend of contractor and employee, which can further complicate matters. In all situations, the club should be sure to document its decision-making process.

Classification Challenges and Risks

When it comes to utilizing independent contractors in private clubs, the biggest hurdle is worker classification. There are some roles that clubs may assume are automatically independent contractors due to industry practices; however, this is not always correct and could leave the club open to penalties and fines since industry practices are not a substitute for authoritative guidance. It is not always black and white as to the proper classification of a worker. As a result, the club needs to go through its due diligence in determining the proper classification.

Other than the regulatory challenges surrounding workers, there are additional aspects of using contractors that present challenges. Club employees receive education on the service and quality levels expected in the club environment, while a contractor may not be focused on those soft skills. Since, by definition, the club does not have control over a contractor’s schedule, they may not be readily available when the club requires their services. Additionally, if a project takes longer than expected, the contractor’s schedule may already be booked causing additional delays.

Benefits: Contractor or Employee Classification

There are various benefits to utilizing contractors instead of employees, including cost effectiveness, flexibility and obtaining specialized skills and expertise. For employees, the club must consider various costs, such as insurance, payroll taxes, vacation, retirement benefits and overtime, while a contractor will not be eligible for those items. Further, contractors typically have their own resources and tools so the club will not be responsible for purchasing these items.

From an administrative standpoint, there will be time saved because there is no need to train or onboard a new employee, nor human resources paperwork. Contractors are typically well known in their industry for their specialized skills and expertise, making it easier to find a worker. A skilled, qualified contractor is able to draw on their years of experience to provide solutions and get the work done properly and efficiently.

Committing to a year-round, full-time employee may not be feasible based on the club’s requirements, but a contractor can help to fill the gaps as needed. The use of independent contractors can also provide significant flexibility to clubs for temporary solutions to labor shortages or to fill an immediate need during peak season.

Regulations for Worker Classification

If a worker is not properly classified, there may be significant legal implications as well as negative tax consequences.

The Department of Labor issued new guidance on how to classify workers that becomes effective March 11, 2024. The new regulations address six factors that will assist with the analysis of a worker’s relationship with an employer. The six factors are the:

1. Opportunity for the worker’s profit or loss depending on skill.
2. Financial stake and nature of any resources a worker has invested in the work.
3. Degree of permanence of the work relationship, including exclusivity.
4. Degree of control an employer has over the person’s work (such as price setting, scheduling).
5. Whether the work being done is essential to the employer’s business.
6. Worker’s skill and business-like initiative.

The IRS agent training handbook, although it cannot be cited as authoritative guidance, is our best resource for understanding how the IRS will classify workers. Agents are instructed to examine 20 common law factors, which are divided into three broad categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer?
3. Type of Relationship: Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

The IRS further commented that there is no magic number of factors that determine classification, and factors that are relevant in one scenario may not be relevant in another.

At the state level, many states have adopted the “ABC test” for worker classification which considers a worker an employee (and not a contractor) unless all three of the following conditions are true:

1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work;
2. The worker performs work that is outside the usual course of the hiring entity’s business; and
3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

Other than the official tests provided by federal and state governments, there can be tell-tale signs that a worker may be an employee as opposed to a contractor. This can include characteristics, such as being paid on a set schedule similar to payroll, using a company-provided email address, receiving expense reimbursements or participating in company training, just to list a few.

Impact of Misclassification

Misclassifying workers can lead to severe penalties and legal repercussions. Fines and unpaid wages levied on companies for misclassification can be substantial – in the tens of thousands of dollars and up, depending on the size of the club and extent of the issue. If a worker is misclassified, they may bring legal action against the club for unpaid wages, benefits and job-protected leave. Legal battles can be costly and negatively impact the public perception of the club, driving away members and potential members.

If the DOL finds that an employer willfully violates wage laws, there can be penalties of up to $10,000 per violation in addition to any unpaid wages. Outside the misclassification, the employer could be found to have violated other regulations, such as overtime and minimum wage, for example.

From the IRS perspective, the penalty for failing to withhold federal income tax is 1.5% of wages paid and 20% for not withholding the employee’s share of FICA taxes. These penalties are doubled if the employer failed to properly file Form 1099 for the worker. If the employer is found to intentionally misclassify a worker, then these penalties are increased to 100% of the tax.

There are various similar penalties at the state level, which will be unique to each state. After the spike in unemployment claims during the pandemic, many states are dedicating resources to rebuilding unemployment reserves by increasing unemployment audits. As previously mentioned, states often have their own criteria for worker classification and a state may find that an employer must pay state unemployment on a worker even if they are classified otherwise at the federal level.

Takeaways

Proper worker classification can easily become a complex process for clubs and other employers; however, the penalties are too substantial to be ignored. The various regulations ultimately focus on the same factors, primarily the extent of control exerted by the club over the worker, the method of compensation and the nature of the work performed. Having safeguards in place, such as conducting regular reviews of the workforce, seeking professional advice on classification requirements and implementing strong internal policies that comply with regulations can all help to protect the club.

Contact Us

If you need additional guidance on worker classification, please feel free to contact your PKF O’Connor Davies client service team or any of the following:

Kerri Rawcliffe, CPA
Partner
krawcliffe@pkfod.com

Brooke Rossi, CPA
Director
brossi@pkfod.com

Amber Stone, CPA
Director
astone@pkfod.com