I am writing to let you know of an important and disturbing development that is threatening the yoga community in California.
The Threat To Your Yoga Studio
The California Economic Development Department (the “EDD”) has been aggressively targeting yoga studios in California to determine whether they have properly classified yoga teachers and other workers as independent contractors rather than as employees. The EDD targets industries that are abusing the tax laws, audits and forces re-classification of workers from independent contractors to employees. The EDD may have set its sights on the yoga industry in California.
I know of eight studios that are being audited in the Bay Area alone. I know of several more which are under audit in Southern California. Although some audits are ongoing, substantial fines have been imposed against yoga studios. I do not know of any studios that have won their audits. If you hear of any audits in your area, please let me know.
The EDD has an agreement with the IRS where they share information about companies that have misclassified their workers. If a studio is audited by the EDD, it may be audited again by the IRS. I have seen this in other States.
If you are audited and lose, you will pay back taxes and penalties. You may be forced to change your business model to employer-employee and your cost of doing business will increase. Your relationship with your teachers will change. You must comply with a large body of employment and tax laws.
Penalties For Misclassification
If you misclassify your workers and lose your audit, you may be liable for state unemployment taxes, worker’s compensation insurance, unpaid payroll taxes, penalties and interest. The EDD can look back three years. If you are audited by the IRS and lose, you may be liable for federal tax withholding, FICA and Medicare payments, federal unemployment, penalties and interest. In 2012, California passed a new independent contractor law. It imposes harsh civil penalties. For each violation, you may face a penalty of between $5,000 and $15,000 in addition to back taxes and other penalties. These may increase if there is a “pattern or practice” of violations.
What Can Yoga Studios Do?
You have three choices:
1. Do nothing and hope you do not get audited.
This is an unwise strategy. Your chances of being audited have now increased. If a studio in your town has been audited and converts to employer-employee, it may report your studio to the EDD because it is at a competitive disadvantage. Audits have been triggered when workers have mistakenly filed for unemployment compensation. The EDD randomly audits businesses. If you do nothing and are audited, you may be following business practices that may cause you to lose your audit.
2. Build Your Case That Your Teachers Are Independent Contractors
Take a very conservative position on classifying your workers as independent contractors and build the strongest legal case to defend yourself. The basic steps are to research and understand the law, complete the IRS and California independent contractor worksheets to assess whether you have properly classified your workers, change your business practices, use professional independent contractor agreements and avoid red flags.
The law in this area is too complex to discuss in this letter but the key legal test is control. The more you control your teachers, the greater the chance they are employees. The less you control your teachers, the greater the chance they are independent contractors.
You should consult with your tax expert, accountant or employment lawyer to get professional guidance on whether you have properly classified your workers.
3. Convert to the Employer-Employee Model
Studios are beginning to convert to the employer-employee model as a way to cut-off the accrual of additional liability and to stop worrying about an audit. This is more common for larger studios or studio chains. Some smaller studios are beginning to convert. You should consult with your tax expert, accountant or employment lawyer to get professional guidance if you want to convert.
Avoid Red Flags
Make sure that you do not have any red flags. Some of these red flags are: (i) failing to get invoices from your teachers; (ii) not using professional independent contractor agreements or using “do it yourself” agreements (or none at all); (iii) supervising your teachers; (iii) requiring teachers to follow a studio manual which makes them do odd jobs around the studio and controls the way they teach; (iv) requiring teachers to open and close the studio and collect money from students; (v) paying benefits or business expenses of the teachers; and (vi) not requiring teachers to run independent businesses.
What Should Yoga Teachers Do About The Independent Contractor Problem?
Many yoga teachers think this is not their problem because the studios are liable for properly classifying their workers. However, yoga teachers have an important stake in this issue. If a studio is audited and loses, it may be driven out of business. This devastates the yoga community and you will lose your job. If the studio survives and converts to employer-employee, taxes will be deducted from your paycheck and you will lose your tax deductions for that studio.
Yoga teachers should bring these issues to the attention of the studio owners and encourage them to make intentional, informed decisions as to the business model they wish to follow. If you work at a studio and see the red flags, provide the studio with a copy of this article and encourage it to get professional help.
My Role In This Situation
My intention is to educate the California yoga community about the alarming actions of the EDD and the effect that an audit and potential tax liabilities may have on the viability of yoga studios. I hope to empower you to understand and comply with the tax laws to reduce your chances of tax liability. I want to see yoga studios build strong businesses so they can continue to provide the benefits of yoga.
I am not a member of the California State Bar, I do not specialize in employment law and this letter is not legal advice. I am not soliciting or accepting any legal representation of yoga studios in California on matters involving classification of yoga teachers.
Here is how I can help:
1. You can buy a copy of my book Light on Law For Independent Contractors. It has 200 pages of discussion and resources on both the federal and state law of independent contractors and employees. It has a chapter on California law. It has both the IRS and EDD worksheets to use for classifying workers. It has model independent contractor and employment agreements. Here is the link if you are interested:
2. You can consult with me from a business point of view to discuss your situation and assess the best way forward. I will be happy to provide you with the EDD Information and Worksheet, the Tax Audit Guidelines, the EDD Worksheet and the IRS Guidelines.
3. You can contact me and I will be happy to refer you to a California lawyer who specializes in this area of the law.
I am very sorry to bring these unpleasant developments to you but I have seen the results of these audits and they are heartbreaking. We cannot continue under the conventional view that teachers are independent contractors because “everyone else does it that way.” Both the IRS and the States are auditing businesses nationally over this issue. They view using independent contractors as abusive and want the tax revenues. I view this is a result of the success of yoga. As money has flowed into yoga and the mainstream media has embraced yoga in everything from advertisements to movies, it has caught the attention of the tax collectors and they are following the money. They want our tax revenues.