Your Crossfit Coaches are employees, not contractors, and misclassifying them is not worth the risk. Seriously. I have spent the last eight years informally advising gym owners on business issues. I’ve heard a lot of incorrect rationalizations for hiring “contractors” instead of “employees.” One gym owner told me that her CPA had advised that her Coaches fell into a “gray area.” Huh? Another was advised by an attorney that the IRS rules on classifying employees were a “balancing test” and that their Coaches were more like contractors than employees. Therefore, classifying them as contractors was okay. Yet another was simply told employees are too expensive. This is harmful advice. Here’s why:
According to the IRS, an employee is anyone who performs services for an employer if the employer controls what and how it is done. All state governments have similar rules but the key factor, regardless of the enforcing agency, is control. If your answer is yes to any one of these questions, you are exercising control, and your Coach is an employee:
At my gym, San Francisco CrossFit, the answer to ALL of these questions is YES. Our clients pay the gym directly for classes, memberships and private appointments. I in turn pay the Coach. Control. We have a set class schedule and Coaches are scheduled to coach classes at specific times. Control. If we need new dumbbells or other equipment for the gym, I buy it. Control. Our Coaches make a flat or hourly rate for coaching a class. Control. It is understood and expected that my Coaches will be teaching Crossfit in classes and private appointments, not Zumba or Spinning. Control.
The IRS also considers the “nature of the relationship.” The important factor here for CrossFit gyms is whether or not you have hired your Coach for a determined period of time, or indefinitely. I’m not sure about your Coaches, but all of my Coaches expect the relationship will continue indefinitely.
The bottom line is that unless your Coaches are free to coach whatever they want, unless their clients pay them directly, unless they don’t coach any classes that are scheduled, unless they are hired for a set period, and unless they provide all their own equipment, they are EMPLOYEES.
The Consequences of Misclassification
I understand and appreciate that converting contractors to employees is expensive. It is a serious administrative undertaking. Employing people triggers federal and state tax withholding, anti-discrimination, health care, pension, worker’s compensation and unemployment insurance obligations. You may think you are avoiding these entanglements by hiring independent contractors. But, if they are really independent contractors, labels aren’t enough, and, the penalty for misclassifying them far outweighs the cost of paying for them as employees.
Disputes about the status of employees are common — even at gyms. There are many different agencies that will second-guess your decision — the IRS, state tax authorities, labor departments and insurance companies. Notably, workers who accept their pay and sign contracts as independent contractors can still sue, claiming they are really employees. Signing a contract does not prevent the worker from suing and winning.
I interviewed “Jeff” (who prefers not to use his real name), who is also a client of my attorney. He owns a gym in California that offers both group classes and private training. He classified his trainers as contractors because he wanted to save money. He figured he could fly low on the radar screen as a small business.
One of his trainers consistently didn’t show up for scheduled classes and appointments. Jeff fired him. The trainer felt he was wrongly terminated and sued the gym (and Jeff individually) for being misclassified as a contractor instead of an employee. The lawsuit settled for an undisclosed, but in Jeff’s words, “significant” amount. The former Coach then filed for unemployment, triggering yet more legal fees and costs.
Several weeks later after the lawsuit was settled, and based on an anonymous tip (which Jeff assumes was from the former trainer), a group of auditors and investigators from the California Employment Development Department showed up at the gym unannounced. They spent an entire day combing through Jeff’s company files and interviewed every member of his staff. Because Jeff did not have workers’ comp insurance, he was fined $1,500 on the spot.
Faced with fines and penalties he could not afford, Jeff had no choice but to declare bankruptcy and close the doors of his gym. He estimated his attorney’s fees alone were $70,000.
In California, the penalty for willfully misclassifying an employee is between $5,000 and $15,000 per violation. One violation is a single misclassified employee; multiply that by the number of coaches you have. And, if the employer is engaged in a pattern or practice of violating the law, the fines are increased to between $10,000 and $25,000 per violation. If you have 10 Coaches, the fines alone would be in the range of $50,000 to $250,000.
California state law also imposes tax penalties for misclassifying workers. These penalties include repayment of back payroll taxes, subject to interest and a 10 percent penalty on the unpaid taxes. Add that to the $50,000 to $250,000 in fines and you are potentially facing hundreds of thousands of dollars, back taxes and attorney’s fees.
Failure to withhold and pay payroll taxes can also result in a misdemeanor charge, and the employer can be fined up to $1,000 or sentenced to jail for up to one year — or both.
Every other state has similar fines and penalties.
The IRS also imposes strict penalties for misclassifying workers, whether intentional or unintentional. For unintentionally failing to withhold federal income tax, the penalty is 1.5 percent of the wages paid. That penalty is doubled to 3 percent if the employer did not file a Form 1099 with the IRS for the worker.
The penalty for unintentionally failing to withhold the employee’s share of Social Security and Medicare taxes is 20 percent of the employee’s share of the tax. The penalty is doubled to 40 percent if the employer did not file a Form 1099 for the worker with the IRS.
If the misclassification was intentional, the employer is liable for the full amount of both the federal income tax that should have been withheld plus the employee’s and employer’s share of Social Security and Medicare taxes.
It doesn’t matter if you can’t envision what these percentages mean in actual dollars. I’m telling you, it’s a lot of money.
Think You Won’t Get Caught?
Think again. The IRS along with pretty much every state in the union has been cracking down in recent years on small businesses that are misclassifying employees. The government is extremely motivated because of the billions of potential dollars of lost revenue. The IRS has agreements with about 37 states to share data from employment tax audits which means if you get caught by your state, its only a matter of time before the IRS will be investigating you.
In addition, all it takes is ONE disgruntled Coach or staff member to alert the IRS, your state’s labor department or state tax authority, or your insurance company. Then, expect a knock at your door.
I have a pretty good sense of how much revenue a gym makes. Between the legal fees and penalties, getting caught misclassifying employees is enough to propel most CrossFit gyms into bankruptcy and closure. Make a better decision, people.
Photo by Brian Slaughter