By: Jillian Markowitz, Esq.
Few things frighten business owners more than a notice from the New York State Department of Labor stating that they have been selected for an Audit. Not only do Audits require the preparation of voluminous documents to be reviewed by the Examiner assigned to the case, but they can also result in severe liability, including drastic penalties and fines that have the potential to put small companies out of business. Accordingly, it is imperative that an attorney or accountant retained to defend such an Audit ensures that their client is as prepared as possible.
Misclassification of employees as independent contractors is the most common reason that employers face fines and penalties in connection with a Department of Labor Audit. Further, the New York State Department of Labor has joined with the Federal government and other State departments to police misclassification resulting in a large increase in audits in the last several years. Federal and State agencies share information with each other and it is not uncommon for a Department of Labor Audit to spur a Worker’s Compensation Audit and an IRS Audit and so on. To complicate matters, the analysis regarding whether a person is an independent contractor or an employee is different for each agency and the results for Unemployment Insurance purposes and Workers’ Compensation purposes may be vastly different.
An Audit Notice will assign a specific Examiner to your client’s case. It is recommended that you reach out to the assigned Examiner as soon as possible in order to introduce yourself and establish a rapport. Many Examiners know from this first contact whether the Audit will be easy or difficult and the first contact colors their impressions of the client and informs them on the attitude they should take during the Audit. If a representative is hostile to an Examiner during the first contact, the Examiner may think they have something to hide and may take a harder tack when reviewing documents. Examiners have wide discretion with regard to the classification of individuals as employees or independent contractors based on numerous factors set forth by the Department of Labor, and, since their recommendations regarding an Audit are rarely overruled, it’s your job to make their job as easy as possible.
Documentation requested for an Audit includes copies of ledgers and journals, payroll records, disbursement records, copies of checks, corporate books, records relating to reimbursements, income tax returns, payroll returns and 1099s. Audits cover a span of 3 years and, depending on the number of employees at the company, these records can easily be in the thousands, or tens of thousands, of pages. Therefore, it is important that these documents are gathered in advance of the Audit and are well organized. Once again, your job is to make the Examiner’s job simple; you do not want them to have to scan through stacks of loose paper to find one particular document. Documents should be organized and tabbed by year and by type and pages should be bate-stamped for easy reference. Creating a Table of Contents so that the Examiner can easily find all documents is recommended; this will also enable you to gain familiarity with the papers so that you can assist in pointing the Examiner towards specific requested information.
At the Audit, the Examiner will first review the employee payroll records, or W2s. Examiners select a “test year” from the 3-year period. If no discrepancies are found, they may then choose not to proceed with a review of the remaining years. Again, it behooves your client to be organized. If all the information required by the Examiner is readily accessible and in good order, they may choose not to examine all the years of the Audit period.
Next, the Examiner will review the documents relating to independent contractors. Not only should you gather documentation relating to how the independent contractors were paid, but you should also request that your client outline the details of the employment of these individuals, specifically related to how they are supervised and controlled. While this information does not need to be immediately shared with the Examiner, unless requested, it is imperative that you have a working knowledge of the responsibilities and working situation of each independent contractor in the event that the Examiner asks you to defend a classification. Once again, misclassification determinations are based on many factors that often require subjective decisions. Examiners are rarely overruled and if you convince them, it is unlikely that you will have to convince someone higher up at the Department of Labor. The Department of Labor’s website provides a vast array of information relating to the factors used when classifying employees for both Unemployment Insurance and Workers’ Compensation proposes. Further, they maintain a searchable index of Appeal Board decisions that can be searched by industry and profession and are invaluable in preparing to defend a client’s classification of an individual as an independent contractor.
Once the review of documents is complete, the Examiner will let you know immediately if they believe that money may be owed. Back at the office, the Examiner will write and submit his report to his immediate supervisor who reviews same. Thereafter, the report is submitted to the Department of Labor for a final review and for the issuance of a final determination. This process typically takes 3-4 months. If a party wishes to appeal a final determination, they must do so in writing within 30 days.
The takeaway regarding the preparation for a Department of Labor Audit is twofold. One, be organized and prepared; make the Examiner’s job as easy as possible. If they see you have nothing to hide, your documents are well-organized, and you are trying to simplify the process, they will likely be less hostile and may rule on on-the-cusp classifications in your favor. Two, be kind to your Examiner from the first contact onwards. Examiners often make a decision regarding the tenor of an Audit from first contact and if you establish yourself as difficult or hostile, then the Examiner will approach the Audit in the same manner and may use their discretion to your client’s disadvantage.