ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – FRANCHISE TAX BOARD (FTB) ISSUES ITS FIRST GUIDELINE FOR AB-5
By Robert S. Schriebman
On February 4, 2020, the FTB issued its first response to newly enacted AB-5. While the information presented is somewhat basic, I do want to keep you informed of inter-governmental comments and guidelines on the enforcement of AB-5.
The FTB issued its guideline for purposes of The Labor Code, the Unemployment Insurance Code, and the Industrial Welfare Commission (IWC) wage orders.
The guidance offered by the FTB press release relates to reporting requirements for the treatment of workers for both federal and California purposes. This article will set forth the FTB guidelines.
Classification as Employee for Both Federal and California Purposes
Workers, who are classified by employers as W2 wage earners for federal and California purposes, will receive a Form W2. The FTB also reminds employees that they cannot deduct out-of-pocket costs for being an employee except for unreimbursed employee business expenses required by the employer.
After AB-5 was signed into law, people had questions about the ability to deduct work-related out-of-pocket expenses on income tax returns. Under the Labor Code, an employer must reimburse employees for required out-of-pocket expenses that are work related. If a worker is a true employee, the employer must reimburse the worker for required out-of-pocket expenses. For example, if an employee is required to travel out of town and incur the usual expenses, including lodging and meals, the employer is required to pay those expenses. On the other hand, a daily expense for lunch is usually not reimbursable.
Employers are also required by law to withhold, account for, and remit withheld income taxes, Social Security and Medicare taxes. The failure to comply with these laws is an ever increasing problem especially when the economy takes a downturn. Employers can be held personally responsible for non-compliance by both the IRS and the EDD.
Classification as Independent Contractor for Both Federal and California Purposes
This has been and will continue to be a major cause of tensions in the California economy. If a worker is classified as an independent contractor, the worker must receive a 1099-K or 1099-MISC. The worker is required to provide his/her taxpayer ID number. Such as a Social security number or Employer Identification number (EIN).
An independent contractor is allowed to deduct ordinary, necessary, and reasonable business-related expenses, pursuant to IRC §§ 162 and 274. These laws were established in the 1954 Internal Revenue Code and have not been significantly altered or amended by legislation. This is the big advantage to being an independent contractor. There are pros and cons to being independent. It is nice to get a larger paycheck, but at the same time, it requires great discipline to put away money for the future. Sole proprietors are required to file a Schedule C on the 1040 and 540 returns. The downside is that sole proprietors are more at risk for the tax audit than people who do business as corporations or LLCs.
Classification as Independent Contractor for Federal Purposes and Employee for California Purposes
If a worker is classified as an independent contractor for federal purposes and an employee for California purposes, the worker should receive both a 1099 and a W2. The worker can deduct business expenses for federal purposes, but is limited, under W2 rules, for deducting only unreimbursed employee business expenses on his/her California income tax return. With the enactment of AB-5, there are several lawsuits pending in federal courts to determine whether a worker can retain independent contractor status on both federal and California returns. This may be an area of future contention with the EDD. This is especially true with EDD audit settlements that require all workers to be treated as W2 wage earners.
AB-5 may create more problems than it seeks to solve. I cannot begin to imagine the positions that the EDD will take relating to industries that are not exempt under AB-5. Even exempt industries must now be governed by the Borello test. Anyway you look at it the classification dog-fighting has just begun. It’s all about money for the State Treasury.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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