1. Woods Hole Oceanographic Institution February, 2014 Worker Classification Training

2. PwC Today’s Presenters Kathy Mort Managing Director, PwC, Pittsburgh, PA WNTS, Tax Controversy and Dispute Resolution Christine Flohr Manager, PwC, Washington, DC WNTS, Tax Controversy and Dispute Resolution

3. PwC Agenda Introduction Overview of Rules Application of the Rules -Retired employees returning as independent contractors -Incorporated Entities -Highly skilled service providers Other Considerations -IRS Enforcement & Penalties -Potential “Red Flags” -Best Practices Q&A

4. PwC Worker classification Why is it important? Significant Employment Tax Implications Companies that classify workers as independent contractors (“IC’s”) are not responsible for withholding, paying and reporting the following: (1) FICA taxes; (2) Unemployment insurance taxes and (3) Federal income taxes. Companies do not have to adhere to minimum wage and overtime laws. IC’s are generally not entitled to fringe benefits such as health care, life insurance or retirement. Affordable Care Act (“ACA”) - the reclassification of workers could impact whether the employer is ultimately liable for the §4980H excise tax under the ACA. Increased IRS scrutiny – the IRS uses several different programs to detect worker misclassification (e.g., 1099 Matching Program, agreements to share info with state unemployment agencies, etc.).

5. PwC Worker Classification Overview of Rules Common Law Standard There is no definition of “employee” in the Internal Revenue Code or regulations; workers must be classified using the “common law test.” Following the common law standard, the Treasury regulations provide that an employer-employee relationship exists if the business has the right to direct and control the worker who performs the services. -In other words, the worker is subject to the will and control of the business as to how the work will be done (not just the type of work that will be done). -In contrast, if the worker is subject to the control or direction of another only as to the results to be accomplished, rather than the means or details by which those results are accomplished, the individual would be an independent contractor. -It is not necessary that the business actually direct or control the manner in which the services are performed; it is sufficient if the business has the right to do so. -The designation or description of the relationship by the parties is immaterial.

6. PwC Worker Classification Overview of Rules Common Law Standard To determine whether the control test is satisfied in a particular case, the facts and circumstances must be examined. A correct determination can only be made by examining the relationship of the worker and the business. When making a determination, consider the following: -Examine the entire relationship between the organization and the worker. -Weigh the evidence (i.e., some factors will indicate control while others will not). -Control is a matter of degree. -Consider the evidence of both autonomy and the right to control. Over the years, the IRS developed a list of 20 factors (commonly referred to as the “Twenty Factor Test”) to determine a worker’s status. While these factors may still be helpful in analyzing a particular situation, they are no longer the IRS's standard for determining worker classification.

7. PwC Worker classification Control test – Categories of evidence Currently examiners focus on the following three categories of evidence to ascertain the degree of control and independence exercised by an employer: Behavioral Control Financial Control Relationship of the Parties

8. PwC Worker classification Categories of evidence – Behavioral control Who controls how the worker performs the specific task? The goal is to determine whether the business has retained the right to control the details of a worker’s performance or instead has given up its right to control those details. Evidence may include: -Type and amount of instructions given (e.g., when to do the work, where to do the work, what tools or equipment to use, what order or sequence to follow, etc.); -Degree of instruction – the more detailed the instructions, the more evidence of control; -Training – How much and how often do workers receive training?; -Evaluation systems – how does the evaluation system influence the worker’s behavior?

9. PwC Worker classification Categories of evidence – Behavioral control Example – Types of Instructions Given Mr. Jones was hired by ABC Manufacturing Company as a management consultant for its sales department. Under the terms of their agreement, Mr. Jones’ responsibilities are: (1) to ensure that the sales department is fully staffed; (2) to ensure that all materials used by the sales agents are stocked and available and (3) to review all sales contracts. In addition, Mr. Jones must secure prior approval from ABC before he can: (a)Hire and/or fire employees within the sales department; (b)purchase additional materials and (c)accept any sales contracts. ABC’s requirement that Mr. Jones secure prior approval is evidence of control over Mr. Jones’ behavior in the performance of his duties. In contrast, if ABC did not require prior approval, it would demonstrate a lack of control as Mr. Jones would be permitted to take whatever actions he deemed necessary to perform his duties.

10. PwC Worker classification Categories of evidence – Behavioral control Example – Degree of Instruction Mr. Smith is an independent truck driver. On March 1, Mr. Smith receives a call from XYZ manufacturing company to make a delivery run from Boston to Washington, DC. Mr. Smith accepts the job and agrees to pick up the cargo the next morning. Upon arriving at the warehouse, Mr. Smith is given an address to where to deliver the cargo and is advised that the delivery must be completed within two days. The degree of instruction is consistent with independent contractor status because it is guidance as to what is to be done rather than how it is to be done. In contrast, consider the following scenario: Mr. Smith performs local deliveries for XYZ Manufacturing Company. Mr. Smith reports to the warehouse every morning. The warehouse manager tells Mr. Smith what deliveries to make, how to load the cargo on the truck, what routes to take, and the order in which the cargo must be delivered. This degree of instruction is consistent with employee status.

11. PwC Worker classification Categories of evidence – Financial control Who controls the financial aspects of the relationship? Evidence may include whether the worker: Has the opportunity to make a profit or incur a loss; Incurs significant unreimbursed expenses; Makes services available to the public; Is paid a regular wage or is paid by the job; Incurs a significant investment in tools, materials, supplies, equipment, etc.

12. PwC Worker classification Categories of evidence – Relationship of the parties How do the parties perceive their relationship? Evidence may include: Contractual provisions; Intent of the parties; Payment of fringe benefits; Right to discharge or terminate the worker; Permanency of relationship; Whether worker performs services that are a key aspect of the business; Have Forms W-2 been issued?

13. PwC Misclassification of Employees Penalties & Enforcement Tax Liabilities and Penalties The IRC provides special reduced tax rates for misclassification. However, the special rates are not available if misclassification is due to “intentional disregard.” Section 530 Relief Section 530 provides businesses with relief from federal employment tax obligations if certain requirements are met. It terminates the business’ employment tax liability, not the worker’s, and any related interest or penalties. Section 530 of the Revenue Act of 1978 is not part of the IRC. If a business qualifies for section 530 relief, it will not be liable for employment taxes with respect to that worker and those in similar positions either retroactively or prospectively.

14. PwC Worker Classification Application of the Rules Incorporated entities – do they really offer adequate protection? Retired employees returning as contractors – what risks does this create for the organization? What about highly skilled workers? -Evidence of financial control and the relationship of the parties tends to be especially important.

15. PwC Worker Classification Application of the Rules Example – Weighing the Evidence Dr. A owns and operates Z medical center, which provides a variety of medical services. To better serve her patients, Dr. A purchased an x-ray machine and hired Dr. B to read the x-rays. Dr. B is a highly skilled and highly trained professional in the field of radiology. Even though Dr. A does not instruct Dr. B on how to take and read x-rays, other evidence, such as financial control or the contractual relationship of the parties, may indicate a right to direct and control Dr. B to an extent consistent with employee status. On the other hand, a lack of financial control by Dr. A over such details of Dr. B’s practice such as fees, billings and collections may indicate Dr. B’s autonomy that is consistent with independent contractor status (notwithstanding Dr. B’s use of Dr. A’s equipment). This is especially true if their contract evidences an intent to create an independent contractor relationship.

16. PwC Worker Classification Application of the Rules – Case Study #1 An attorney is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research services, fax machine and photocopier. The attorney buys office supplies and pays bar dues and membership dues for three other professional organizations. The attorney has a part-time receptionist who also does the bookkeeping. The attorney pays the receptionist, withholds and pays federal and state employment taxes and files a Form W-2 each year. For the past two years, the attorney has had only one client, a corporation for which there has been a long-standing relationship. The attorney charges the corporation an hourly rate for services and sends monthly bills detailing the work performed for the prior month. The bills include charges for long distance calls, on-line research fees, photocopies, mailing costs and travel expenses for which the corporation has agreed to reimburse. What facts illustrate the attorney’s autonomy with respect to how the legal services are performed? What facts illustrate the corporation’s right to control how the legal services are performed? What facts are neutral (and, thus, should be disregarded in the analysis)? Weigh the evidence and make a conclusion.

17. PwC Worker Classification Application of the Rules – Case Study #2 A computer programmer is laid-off due to a downsizing at Company X. However, Company X agrees to pay the programmer $25,000 to complete a one-time project to create a certain product. It is not clear how long the project will take to complete and the programmer is not guaranteed any minimum payment for the hours spent on the project. The programmer performs the work on a new high-end computer, which cost him $5,000. The programmer works at home and is not expected or allowed to attend meetings of the software development group. Company X provides the programmer with no instructions beyond the specifications for the product itself. The programmer and Company X have a written contract, which provides that the programmer is considered to be an independent contractor, is required to pay federal and state taxes, and receives no employee benefits from Company X. What facts illustrate the programmer’s autonomy with respect to how the services are performed? What facts illustrate the corporation’s right to control how the services are performed? What facts are neutral (and, thus, should be disregarded in the analysis)? Weigh the evidence and make a conclusion.

18. PwC Worker Classification Red Flags Former employees returning as contractors Form 1099 & Form W-2 issued in same year Form 1099 - multiple years Industry Focus Leads - IRS Internal Database SS-8 Determinations

19. PwC Worker Classification Other Considerations What “best practices” should the organization consider adopting in order to reduce or mitigate its exposure? -Establish written corporate policies; -Draft contractual agreements carefully; -Minimize the factors demonstrating control; -Document differences between employees and independent contractors; -Train operations managers & decision makers; -Monitor the actual relationship; -Create “audit-ready” file; -Monitor legislation and current developments in the law; -Handle agency inquiries with caution;

20. PwC Questions?

21. PwC Contacts Kathy Mort, Managing Director – (412) 355-6064 Christine Flohr, Manager – (202) 346-5294 IRS Circular 230 Disclosure This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. This includes penalties that may apply if the transaction that is the subject of this document is found to lack economic substance or fails to satisfy any other similar rule of law. This document has been prepared pursuant to an engagement between PricewaterhouseCoopers LLP and Berry Petroleum Company, and is intended solely for the use and benefit of Berry, and not for reliance by any other person.