Episode 22

Labor Law Lineup Ep22 -  Where Tax Meets the Workplace, What HR Needs to Know

Hosted by Mark G. Eskenazi, Doug Charnas and Meeren Amin.

This podcast explores the intersection of tax law and labor law, covering topics like independent contractor classification, new tax deductions for tips and overtime, IRS enforcement on employment taxes, and the Employee Retention Credit — with a focus on what HR professionals and employers need to know to stay compliant.

The views expressed in this podcast are those of the participants and should not be considered the views of Fox Rothschild LLP or its attorneys. This podcast is for informational purposes only, is not legal advice, and does not create an attorney-client relationship.

The views expressed in this podcast are those of the participants and should not be considered the views of Fox Rothschild, LLP, or its attorneys.

This podcast is for informational purposes only, is not legal advice and does not create an attorney-client relationship.

Welcome back to the Labor Law Lineup.

I'm Mark Eskenazi, and today we're doing something a little bit different.

We're bringing together the worlds of tax law and labor law because it turns out there's a lot of overlap, especially for HR executives who are managing

payroll, classifying workers, and trying to stay compliant on multiple fronts.

I have two guests from Fox Rothschild with me today.

Doug was Charnis and Meen Amman.

Who are tax lawyers?

Meeren.

Doug, welcome.

Thanks, mark.

Great to be here.

Thanks for having us.

Mark.

This is gonna be a fun one.

So we have a full agenda today.

We're gonna compare how the tax world and the labor law world think about independent contractor classifications, because that's one of

those perennial challenges for any company using contract workers.

Then we're gonna get into a couple hot topics that came out of last year's big budget bill.

This includes the new deductions for tips and overtime pay and what they actually mean for employers.

And then we'll discuss some IRS enforcement trends that HR teams and business owners should have on their radar, including employment

tax returns and what's going on with the employee retention credit.

So let's dive right in with the independent contractor classification.

This is an issue I deal with on the labor law side, so I'm gonna talk for a moment about that.

And I know both of you see it on the tax side.

For our listeners, many of whom are HR professionals, this matters because getting it wrong can expose your

company to liability for multiple directions at once.

So let me quickly lay out how the Labor and Employment law side works, and then I want to hear from both of you on how the IRS approaches it.

On the labor side, the implications are significant for employers because independent contractors lack the right to organize and form a

union under the NLRA, the National Labor Relations Act under the NLRA.

The current test comes from a Biden era, NLRB decision involving a performing arts venue.

The NLRB went back to a common law test that looks at multiple factors, things like how much control the company has over the work that's done, whether the

worker is engaged in a distinct occupation or business, the skill required in the occupation, and whether the worker has entrepreneurial opportunity.

This is a highly fact intensive test.

It's worth noting that this particular test could potentially be revisited by the new NLRB, so it may not last, but it is the current framework.

On the employment side, misclassifying workers could potentially result in failure to pay required overtime, and

failure to provide required benefits among other things.

This can result in significant costs to employers.

Misclassification under these employment laws can be complex and we're not gonna cover that area in depth today.

So Doug, on the tax side, how does the IRS decide whether someone is an employee or an independent contractor?

That's a great question Mark.

IRS uses what's commonly called the common law test as well, and historically looked at what used to be called the 20 Factor test.

Those factors have been consolidated into three main categories, behavioral control, financial control, and the type of relationship between the parties.

Behavioral control asks whether the company has the right to direct and control how the worker does the work, not just what gets done, but how.

Financial control looks at things like whether the workers have unreimbursed expenses, whether they have an opportunity for profit or loss, and

whether they've made significant investment in their own equipment.

And the relationship factor considers things like, written contracts, benefits, and the permanency of the arrangement.

Okay, so there's some overlap with the labor law test.

Both are looking at control and other factors.

Yeah, that's right, mark.

The interesting thing is that even though the factors sound similar, the outcomes can differ because the agencies weigh them differently.

And even with a similar analysis, that doesn't mean two different agencies will come to the same conclusion.

So on the tax side, the IRS tends to focus heavily on the behavioral and financial control test, whereas on the labor

side, as you described, the entrepreneurial opportunity factor may play more of a role than it would in the tax context.

So you can have a situation where someone is classified one way for tax purposes and a different way under labor law.

That's gonna be a real compliance headache for employers.

And I can say that on the IRS side, that if you present them with a determination by the NLRB, there's no

guarantee that the IRS will respect that for tax purposes.

That brings us to an important practical point for our listeners.

You can't just do one analysis and assume you're covered everywhere.

If you're using contract workers, whether they're in the gig economy, doing project work, what whatever it is, you need to be thinking about

classification under multiple legal frameworks, the tax rules, the labor rules, the employment law tests, they can all reach different conclusions.

Douglas, do you have anything to add on that?

Just just that the IRS has been paying closer attention to worker classification issues in recent years,

particularly in industries that rely heavily on contract labor.

If you're an employer and you've been using workers and classifying them as independent contractors, make sure that you have a solid

factual basis for that classification under the IRS framework, because the penalties for getting it wrong can be substantial.

Back employment taxes, penalties, and interest.

Okay.

And it's similar on the federal labor law side.

If workers are misclassified, they may have rights under the National Labor Relations Act that the company did not

account for including the right of employees to organize.

Other laws have independent contractor tests too that we're not gonna cover today, such as under the FLSA, the Fair Labor Standards Act.

So let's move on.

Well wait Mark, before we move on, I wanna note that the IRS has a voluntary classification settlement program that allows employers who have

misclassified workers to reclassify workers as employees for future periods.

The cost of participating in this program is significantly less than what the past taxes, penalties, and interest otherwise would be.

I'll also add that on the tax side tax opinion on classification for tax purposes can also be really helpful for penalty protection.

Okay, great.

Next topic, no taxes on tip and no tax on overtime.

These made it into last year's budget law.

Doug, you've done a deep dive on both of these.

Give us the plain language version.

Did the law really eliminate taxes on tips and overtime?

Well, the short answer is sort of, but it's a very qualified sort of, the law did not exclude tips or overtime from income.

Instead, it created a limited tax deduction, and that distinction has especially importance for the employers.

Okay.

Can you walk us through why that matters?

Sure, because it's a deduction and not an exclusion.

Tips and overtime pay are still included in gross income for employment tax purposes.

That means employees are still paying their share of FICA taxes, 6.2% for social security, and 1.45% for Medicare on every dollar of tips and overtime.

And employers are still paying their matching share plus federal unemployment tax.

So the phrase no tax on tips is really sort of misleading.

There is still employment tax on tips and overtime the income tax de deduction just reduces what employees owe on their individual tax return.

Having said that, there's a benefit to employees for paying employment taxes.

The tip income and overtime pay are counted towards their future social security benefits.

Okay, so Meeren, from a practical standpoint, what does this mean for an HR team that's processing payroll?

So it means new reporting obligations that weren't required previously for employers.

So prior to this year, tips were included in box one and didn't have to be reported separately.

Now they're still combined in box one, but they also have to be reported separately under a new code in box 12 of the W2.

And the IRS recently released a draft W2 that shows these changes.

And the same goes for overtime, still have to be reported in box one, but it also has to be reported separately in box 12.

So that's the extra halftime amount under the Fair Labor Standards Act as distinct from regular wages.

Okay.

And are there caps on the deduction?

Yeah, mark.

That's right.

So for tips, the annual deduction cap is $25,000.

That means a single individual can claim the full $25,000 deduction.

Spouses, however, must file a joint return to claim the tip deduction and the deduction on the joint return is still limited to $25,000.

On the other hand, for overtime it's $12,500 for a single filer and $25,000 for joint filers and both deductions phase out for higher earners.

The phase out starts at $150,000 of modified AGI or $300,000 for joint filers.

And these deductions are also temporary.

They're only in effect for tax years, 25 to 28.

But who knows, they could potentially be extended in 2028.

Okay.

That's super interesting.

And of course, AGI adjusted gross income.

So Doug, this isn't permanent, right?

Correct.

No, it's, it's not permanent.

And there's another important wrinkle to claim either deduction, the taxpayer must include a social security number on their return.

An individual taxpayer identification number, which is also referred to as an I 10, won't do.

That's significant because many workers in the tip industry may have an I 10 rather than a social security number.

Those workers are not eligible for the deduction.

Okay, that's an important detail.

Meeren, what are the key steps you'd recommend for employers right now?

So there are a few things that employers should be doing.

First, identify which of your employees are in an occupation that customarily and regularly receive tips before 2025.

This conversation is really timely because the IRS has just released their final regulations, listing 68 categories of qualifying occupations.

Second, update your payroll systems to separately track qualified tips and overtime premiums.

Third, make sure your W2 and 10 99 reporting is set up to capture the new data fields.

And lastly, communicate with your employees so they understand what they're eligible for and what documentation they need.

We need to be really careful that you're not providing them with tax advice as to what is and isn't deductible.

After all, you're their employer, not their CPA.

But generally, this is one of those situations where getting out in front of it now will save you a lot of headaches at year end.

Recently there's been some news on how this is all playing out.

That is, the number of individuals claiming the new deductions for tip and overtime income has surged well past expectations.

According to the Department of Treasury, over 4.6 million taxpayers have claimed the TIPS deduction, and nearly 20 million have claimed the

overtime deduction since these breaks were created by the 2025 budget bill.

That unexpected surge has raised serious concerns about potential fraud with some taxpayers likely overclaiming,

whether by accident or by exploiting ambiguity in the guidance.

The IRS has stated that it will be diligent in scrutinizing the claims to make sure everything is appropriate.

It's hard not to draw a parallel to the employee retained retention credit from the COVID era relief legislation,

which was plagued with widespread fraud and abuse.

The IRS clearly wants to avoid a repeat of that experience.

Okay, great.

Thanks for that Meeren and Doug.

So now let's shift gears to IRS enforcement, because this is something that directly affects employers.

Meeren, I understand the IRS has been putting a sharper focus on employment tax compliance.

What are you seeing?

Yeah, that's right, mark.

So the IRS has been increasingly focused on making sure employers are properly filing their employment tax returns.

So that means your form 941, your quarterly returns and actually remitting the taxes that were withheld from employee paychecks.

Employment taxes are tricky because there are a huge administrative burden since you have to file 941s every quarter.

And because of that, it's really easy for employers to fall behind on both filing and paying.

So Doug, what happens if employers do fall behind on that?

Well, the IRS has a very powerful tool called the Trust Fund Recovery Penalty.

Under the Internal Revenue Code, the IRS can assess a penalty equal to 100% of the unpaid trust fund taxes.

Not against the company, but against the individual person responsible for collecting and paying over those taxes.

That typically means the CEO, the CFO, the controller, the HR director, anyone who has the authority to direct payment of the

company's bills and choose to pay other creditors instead of the IRS.

It's personal liability and it's dollar for dollar.

Super interesting.

So Meeren, if you're an HR executive listening to all this and your company is struggling financially and maybe falling behind

on payroll tax deposits, you could personally be on the hook?

Exactly, and the IRS has made this an enforcement priority.

We're seeing more civil and even criminal enforcement since the IRS's bar for proving willful conduct is so low.

And we're also seeing more cases where individuals are being personally pursued.

The takeaway is payroll taxes should always be treated as a first bill you pay, not the last.

And like Doug said, the consequences of not paying those taxes fall not on the businesses, but potentially

personally on the responsible people at the business.

And I add, if you're in a situation where your company has fallen behind, get professional help immediately.

There are options, but they narrow quickly the longer you wait.

Yeah.

And there are also a number of collections options that can help stop the bleeding as well.

And you wanna make sure you keep your civil liability from turning criminal, which can happen pretty quickly, unfortunately.

Okay, so now next we're onto the last topic before we wrap up.

This is the employee retention credit, the ERC.

This was the pandemic era credit that generated a huge amount of activity.

So, Doug, where do things stand right now?

Well, the ERC situation has reached a critical juncture.

The IRS has essentially shut down processing of new ERC claims.

There was a moratorium on processing that has been in place.

Now the IRS has been issuing disallowance letters, formally rejecting claims for businesses that find ERC claims and haven't received their refund.

So if they filed and haven't received their refund, this is a very important moment.

Why is it so urgent?

Because of the statute of limitations.

If your ERC claim has been rejected.

The IRS will send you a letter.

1 0 5 dash C. You have two years from the date of that letter, that 1 0 5 dash c to file a lawsuit in either US District Court.

Or the US Court of Federal claims to challenge the denial of the credit.

If you don't take action to preserve your right, you could lose your claim entirely.

The clock is ticking.

And I wanna emphasize, mark, that this isn't just about businesses that file frivolous claims pushed by aggressive promoters.

There are plenty of businesses that filed legitimate ERC claims that are now unfortunately, caught up in this backlog.

If you're one of those businesses, you need to be monitoring your mail, checking for disallowance letters and talking to your tax advisor about

whether you need to file a protective suit to keep your claim alive.

Like Doug said, there are statutes you need to consider and you don't wanna miss your deadline to file suit if you need to.

And even if your statute hasn't expired, that doesn't mean you can't be proactive and file suit to force the government's hand.

We're actually seeing a lot of people doing that since CRS is just sitting on so many of these claims.

Okay, so the action item for our listeners is if you filed one of these ERC claims, check the status.

If you received a rejection, talk to counsel right now about preserving your statute of limitations.

Yeah, that's right, mark.

Especially if you have a claim that is based on the gross receipts test and the IRS is just sitting on your claim.

In that case, it may make sense to be proactive.

Okay, great.

So let's wrap it up.

We covered a good amount of ground today.

Independent contractor classification across tax and labor law, the new deductions for tips and overtime.

IRS enforcement on employment taxes and the employee retention credit.

The common thread running through all of this is that tax compliance and labor compliance can be related and HR professionals should be thinking about both.

Meeren, Doug, any final thoughts for our listeners?

Yeah, just that these are areas where a little bit of proactive planning goes a long way.

You don't wanna be reactive.

You want to get advice, get written opinions, and make sure you're insulated in case the IRS wants to take a look.

Yeah and don't be afraid to bring your tax and employment lawyers into the same room.

These issues don't exist in silos, and the best outcomes often happen when you're getting coordinated advice.

That's great.

Okay, well, Meeren Amin, Douglas Charnas, thank you both for joining me on the Labor Law lineup.

For our listeners, thanks for tuning in.

If you have any questions about any of the topics we covered today, please reach out.

Okay.

Until next time.