Since I started publishing about the new Virginia laws regarding independent contractors (see the 4-part series: Part 1, Part 2, Part 3, Part 4) there have been lots of questions. I want to answer some of them here and in the video.
Do the laws apply retroactively, before July 1, 2020?
No. The July 1, 2020 statues relate to the use of the Virginia court system for employees who think they are misclassified as independent contractors. It appears that s hiring company found to have wrongly classified an individual that way would be responsible for back taxes and benefits back to that effective date. The next batch of statutes that take effect on January 1, 2021 also do not apply retroactively to before that date. Those statutes allow the Virginia Department of Taxation to fine companies for misclassification beginning that date.
So, when do I need to address this issue?
Right away! You need to tell those individuals whom you have independent contractor agreements with that you want to cancel that agreement and enter into a new agreement with their (new?) LLC by January 1, 2021. That’s when the State Dept. of Taxation will begin assuming that payments to individuals for services make those individuals employees. Your current agreements with the independent contractors may have a notice period for cancelation, so check that and get to work on this right away.
Does this apply to individuals who live in other states and individuals who live in VA but work in other states?
Virginia applies this law to individuals acting as independent contractors when those individuals are Virgina residents who work anywhere (even outside Virginia), and to individuals who are residents of other states but perform their work within Virginia.
Does this apply to companies only in VA or also companies in other states?
These laws apply to companies that are domiciled ANYWHERE if those companies hire individuals who are residents of Virginia or who do work in Virginia. The company might not even be required to register as a foreign entity in Virginia (for example, if you hire a freelancer in Virginia, your company might think it is not “doing business” in Virginia so it does not register as a foreign entity).
Can an individual get a statement from the state that it is an independent contractor for all companies it deals with? What if you use a standard IC contract?
There does not appear to be any process for this approach in the statues. In fact, the statues specifically state that when there is a paid relationship between a company and an individual that relationship is assumed to be employer-employee unless you can demonstrate that it is not. Every contract establishes a new relationship, so I can imagine the State would look at every relationship uniquely.
Once a company and independent contractor demonstrate that their relationship is appropriate, is that the end of the issue?
I doubt it. You could have more than one contract, or one contract with multiple task orders, between any company and an independent contractor. As I stated above, every contract (and every task order) establishes a new relationship, so I can imagine the State would look at every contract as having the potential for creating an employer-employee relationship.
What does the state department of taxation do to prove our relationship is not an independent contractor relationship?
This is actually an inappropriate question. The State ASSUMES that the relationship between any individual and the company that pays him/her is an employer-employee relationship. The company or the individual must prove otherwise.
What if I fill out the IRS Form SS-8 and get an IRS determination that I am an independent contractor, is that good enough?
The IRS form SS-8 asks a lot of questions regarding the relationship between the individual and the paying company. Based on that information the IRS issues a determination letter stating whether it thinks that individual is an employee or independent contractor. But the Virginia statue gives the power of determination to the State Dept of Tax or to the Virginia court (if an individual sues the company for misclassification). It’s not clear that the Department or the court would defer to a decision by the IRS, and anyway neither is required to defer its decision to the IRS.
In order to demonstrate that our relationship is an independent contactor relationship, surely all we have to do is produce a contract that says the relationship is an independent contractor relationship, right?
No. Neither the courts nor the Department of Taxation will consider a statement in your contract that your relationship is one of independent contractor. Other facts dictate the true nature of your relationship.
So if I am a single member LLC, that should be enough to make me not subject to this law, right?
A single member LLC is disregarded for taxation purposes at the IRS, that is, the owner of a single member LLS is treated for federal taxation is if the owner is a sole proprietor (an individual). I have written that I wonder whether the Virginia Department of Tax or the Virginia courts would thus treat single member LLCs as individuals. Since then, other lawyers have told me they think this is not likely to happen, and as long as the independent contractor agreement is between the company and the contractor’s LLC, the new Virginia statutes will not apply. I can understand their reasoning, but I still wonder if there will be a risk that the owner of single member LLCs will be treated as an individual. You can decide whether that risk is worth taking.
What should my company do to make sure my independent contactors are actually LLCs, and even taxed as S-Corp or C-Corp?
Make sure you have a written contract, that the party of the contractor is clearly stated to be an LLC, and put a representation and warranty in the agreement that the contractor will maintain its LLC status with the state (and S-Corp or C-Corp taxation status if you decide that is important).
What is the penalty for non-compliance?
If you cannot prove that your individual service providers are really independent contractors, then your misclassification of those individuals as independent contractors will cost you a penalty of $1,000 for the first instance, $2,500 for the second instance, and $5,000 for each instance after that, PLUS back taxes and benefits, PLUS debarment from contracts with the State.
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