Are you classifying your Associate Dentists as “employees” or “contractors” in your agreements?
Shortly after engaging a client at the start of 2018, we received notice that our client – referred to as “the Taxpayer” by the IRS – had been selected for a random misclassification audit for the 2016 tax year.
According to the IRS documentation, the primary issue was that the Dental Associates working for the practice were classified as Independent Contractors (ICs) and issued a 1099 when they should have been classified as employees and issued a W-2 with all applicable taxes withheld by the Taxpayer. The secondary issues questioned whether the Taxypayer was entitled to Section 530 Relief or were otherwise eligible for a Classification Settlement Program (CSP) offer.
We met twice with the IRS Agent in 2018, once in our office without our client to submit the extensive documentation that had been requested and gather information to begin formulating a strategy. Bank statements, payroll reports, contracts and agreements, copies of communications, and the general ledger for the practice were included in the two 3” binders we handed over for review. The sheer volume of documentation required should be enough to deter any employer from guessing when it comes to compliance. During the several hours the IRS agent was present at our office, we learned that they were leaning toward the determination that the Dental Associates should be classified as employees, not independent contractors. Despite several lines of reasoning – long-standing industry practice, written agreements with the workers, etc. – the opinion of the IRS agent was unchanged.
A few weeks later we were present for the formal interview in our client’s office. Our client and the Practice Administrator both participated in this meeting. We had prepped them with the information discussed in the previous meeting and ensured everyone was on the same page with the understanding our assessment that the IRS was not leaning in their favor and why. The meeting went well, but we were left with the understanding that the IRS agent did not feel that the workers were sufficiently capable of experiencing a loss – something generally required to classify a worker as an independent contractor, and difficult to prove in this instance as the practice provided many of the tools, marketing, and team members necessary for the Associate Dentists to perform their job duties.
Due to administrative delays and a government shut down in January of 2019, it wasn’t until May of 2019 that there was any move toward a resolution.
The Government’s position in the Form 886-A Explanation of Items reads:
“In applying the relevant common law factors to the forgoing facts, it is the Government position that the Taxpayer exercised the requisite behavioral control, financial control, and relationship of parties over its Dentists creating an employer-employee relationship.
During the year under audit, the taxpayer treated one Dentist as an employee and issued them a W-2, meanwhile treated all other Dentists as independent contractors. During the initial interview taxpayer stated that due to the nature of the work and the Dentists’ expertise, the dentists were better defined as contractors. While the taxpayer determined the classification of one Dentist as an employee, that within itself may not be a proper worker classification. An analysis of the factors generally fall into three primary categories (1) behavioral control, (2) financial control, and (3) the relationship of the parties, are general used to determine worker status.”
Under the Common Law Standard section of Form 886-A, the IRS Agent noted the Dentists had been asked to fill out a Questionnaire regarding the relationship between the Dentists and the employer. Based on the answers the Dentists supplied, the Government concluded the following:
- “Although the Taxpayer stated…the Dentists have the flexibility to determine their workday, the Dentists explained…that they must work those agreed scheduled hours.”
- “The Taxpayer employs the staff who schedules the clients whom dental services are provided to.”
- “The dental services are performed at the taxpayer’s Dentistry Clinics.”
- “The Dentists represented themselves as though they were the Dentistry Practice…consequently, it is the Taxpayer’s reputation and business at stake.”
- “…all dental supplies and equipment are provided by the Taxpayer.”
- “The patient belongs to the Taxpayer.”
- “[The Dentists] are provided with dental assistants and staff who assist the Dentists with all the supporting duties they require to do their work. The Dentists do not have control of who the taxpayer hires to assist them.”
- “The Dentists are integral to the Taxpayer’s business, and without the Dentists the taxpayer cannot offer dental services.”
- “…some of the Dentists were provided employer-provided health insurance…”
The IRS Agent also noted that while the Taxpayer provided contracts for the Dentists, there were inconsistencies. Some contracts were unsigned; some Dentists did not have contracts at all. On the Questionnaire, several Dentists responded that they did not have a signed contract with the Taxpayer. One Dentist stated that there were relevant conditions the Taxpayer required them to uphold regarding restricted covenants based on location and length of time after leaving.
The Dentists responses seemed to be the main point of contention in this case. Despite what many practice owners believe, having a contract is not the only factor that determines the relationship of the parties when taking on an Associate Dentist.
The IRS concluded that our client did not meet the statutory requirements for Section 530 Relief on account of lack of reasonable basis and consideration of substantive consistency but was otherwise eligible for a CSP.
Could we have appealed the decision and continued to argue the matter? Possibly. Many of the Associates targeted for the audit had PLLCs and worked for other practices. We could have continued to argue these entities should have been excluded from penalty based on their corporate status.
Would we have won? Unlikely. Questionnaire responses from the Dentists, lack of consistency and/or documentation, and responses from the survey of similar dental practices were not working in our client’s favor. Ultimately, it was our client’s call and they opted to enter the CSP for a timely resolution.
The Cost of Misclassification
When entering to a CSP there is an agreement between the IRS and the Taxpayer that the Taxpayer will pay a certain percentage of the tax due for the audit year and the IRS will limit the audit to only the year in question. A payment plan for the amount due can be arranged in certain circumstances.
While this is likely an extreme case due to the position in question and size of the practice, the final figure required to resolve the issue of underpayment of federal withholding and FUTA as well as penalties was $142,044.60.
Bonus: Texas Workforce Commission (TWC) Involvement
It shouldn’t come as a surprise to hear the federal government shares audit information with the state. With our client entering the CSP with the IRS, there’s an increased likelihood that TWC will elect to audit our client’s account – not only for the year in question, but potentially for the maximum allowable 3-year period. Because our client had submitted timely forms and made timely SUTA payments for employees during that period, there would be no penalty, only taxes and interest on underpayment.
We proactively calculated the amount that would be due should our client be audited for the maximum allowable period if TWC were to start their investigation in May of 2019 and look back at the prior three years. The total of underpaid taxes and interest on that amount equaled an additional $5,808.16.
What Does This Mean for Dentistry in Texas?
Maybe nothing. However, with the case creating a precedent for workers categorized as Dental Associates to be classified as employees instead of independent contractors, it is possible we will see an increase in classification audits of dental practices.
Dental Associates are not the only misclassified workers we’ve seen in dentistry. It’s common enough to have a “part-time” or “temp” hygienist or dental assistant made a “contractor” when they should clearly be an employee of the practice. If the IRS does take a harder look at the dental industry, it would be advisable for practices to adhere to a pro-active policy of classifying these workers as employees.
Best Practices for Worker Classification
Know the difference. Is this worker doing “the business of the business?” If, for example, you’re a general dentist who is hiring an Associate to take on a portion of your patient load and they’re performing similar services using your practice, your tools, your team members, etc., then they’re likely an employee. If, however, you enter into an agreement with an anesthesiologist to perform supplementary services for you on surgical days, they don’t receive benefits, and this is a service they provide to other dental practices, it’s quite possible they could be classified as a contractor. More information on this topic here.
Have contracts with your contractors. This sounds obvious, but too many practice owners employ workers as “contractors,” have them fill out a W-9, then add them to their regular payroll cycle without another thought about it. You should always have a written agreement in place laying out the specific terms of labor, payment, behavior control, and completion deadlines for independent contractors. Ideally, this agreement is one constructed by the contractor that you sign, not the other way around.
Get a professional opinion. The IRS will look at behavioral control, financial control, and type of relationship when making a worker classification determination. If you strongly feel that the worker you’re engaging should be a contractor and want back-up documentation, the IRS provides Form SS-8 for employers to request an official decision. You can also seek advice from your CPA or other HR advisory professional; written documentation from these sources is considered by the IRS an audit.
What Does This Mean for You?
Worker classification is not black and white. However, most positions in a dental practice – regardless of full- or part-time status – should be classified as employees because of the behavior and financial control the practice has.
If you think you may be currently misclassifying workers in your dental practice, consider reviewing your employee and vendor lists with a Texas attorney who is experienced in employment law or a Human Resource Management consultant qualified to advise on such matters.