Sole practitioners and new firms must consider the insurance, tax 
and employment consequences.

BY CHRISTOPHER J. GULOTTA

AND JAMES E. KELLETT

SPECIAL TO THE NATIONAL LAW JOURNAL

WHEN A SOLE practitioner commits to hiring an associate, that lawyer takes on a management role. Sole practitioners or small partnerships considering hiring new lawyers or other employees should first consider the significant issues-such as employment laws, malpractice insurance coverage and state and federal tax filing requirements-associated with becoming an employer and manager.

Most of the better known federal employment laws likely will not apply to a small law practice, based on the threshold number of employees required by statutory definition. For example, Title VII of the Civil Rights Act of 1964, as amended, is triggered at 15 employees, the Americans With Disabilities Act is triggered at 25 employees, and the Age Discrimination in Employment Act is triggered at 20 employees.

There are, however, many federal, state and local employment laws and ordinances-similar in scope and effect to federal laws-which would include a small law practice within their coverage. These laws and ordinances, administered by state, county or local agencies, may subject small firms to lawsuits or require certain employer actions, such as postings on bulletin boards and the promulgation of written policies. State and local laws often require small employers to respond to charges of discriminatory employment practices, including unlawful pre- employment inquiries, failure to hire, and sexual and other types of harassment and discrimination.

A prudent sole practitioner also should examine for applicability other state laws, including wage and hour laws concerning the timing and method of payment of wages; the making of deductions from pay; the requirement for lunch and break periods and related record-keeping; disability, workers' compensation and unemployment insurance laws concerning requirements for coverage; posting of notices and reporting of relevant incidents; and laws concerning health insurance continuation on termination of employment similar to the provisions of COBRA.

Certain federal laws will also be applicable to a small firm, including the Immigration Reform and Control Act of 1986, which requires that employers verify an individual's eligibility for employment by use of the 1-9 form at the time of hire; the Fair Credit Reporting Act, as amended, which requires written authorizations from employees or candidates for employment before certain background investigations can be conducted, and certain written notifications by employers prior to taking "adverse action" based on such investigations; and the Fair Labor Standards Act, or FLSA, which would apply to a small firm to the extent that the firm is engaged in "interstate commerce," and has an annual business of at least $500,000. The FLSA is of primary concern with regard to issues such as minimum wage and overtime payments to "nonexempt" employees.

More general principles of employment law must also be considered. For example, the at-will status of employees must be maintained by avoiding oral representations that may be considered promises of long-term employment. Documents relating to the employment relationship must be carefully drafted to avoid express or implied agreements of employment for a term or of discharge only for cause.

Safety and health issues in the workplace must be carefully monitored, beyond compliance with workers’ compensation statutes. For example, some states have a negligence or intent provision relating to workplace illness or injury that will increase an employer's liability.

The federal Occupational Safety and Health Act, which covers employers "affecting commerce," and similar state laws also may apply. Such laws contain posting, reporting and complaint procedures, in addition to setting standards for workplace conditions.

Firms that engage attorneys not as employees but as independent contractors in order to avoid certain obligations, such as tax withholding, disability, workers’ compensation and unemployment insurance liability, must be certain that such attorneys are not properly categorized as employees. This determination requires a careful analysis of related state and federal law including, for example, the "20-Factor Test" used by the Internal Revenue Service. The central issue in this analysis is whether the employer has the right to control both the results to be accomplished and the manner and means by which the purported employee brings about that result.

Sole practitioners and small partnerships already should have malpractice insurance coverage. When new associates are added, the firm should extend their coverage to these new lawyers.

First, small firms should contact the broker/agent that placed the malpractice coverage and notify him or her of the addition of a new attorney. An application form should then be submitted to reflect the addition of a new lawyer to the firm.

The application typically requires the following information: full name of the law firm; effective date of coverage desired; policy number; the name of the new lawyer; the new lawyer's number of years of practice; his or her year admitted to the bar; the new lawyer's area(s) of practice; and his or her status (i.e., partner, of counsel or associate).

The firm may also be requested to supply information about the new associate with respect to his or her prior professional liability insurers, policy numbers, claim limits and policy periods. If the effective dates and carriers are not provided, the new lawyer should check with his or her former firm to obtain the necessary information.

Other information typically requested includes whether the employer/partner of the firm is aware of any professional liability claim against the firm or any incident or omission which might reasonably be expected to be the basis of a lawsuit or claim; whether a carrier has denied, refused or canceled the firm's malpractice coverage; whether the new associate has been denied admission to practice, disbarred or suspended from practice or formally reprimanded by any court or agency; and the employment history of the new attorney for the past five years.

If the new associate does not provide either his or her past employment history or prior insurance coverage, there may exist the potential for serious liability. It is prudent to consider obtaining a "prior acts" exclusion endorsement which would exclude malpractice coverage for the new attorney for acts committed prior to the effective date of coverage under the firm's malpractice policy.

If the firm does not obtain such endorsement, its malpractice policy could be charged with providing coverage to the new associate employee for his or her acts, errors or omissions committed prior to employment with the firm-and costs would increase accordingly. Prior acts coverage, however. would be acceptable if the firm feels that the new lawyer would not present any risk of increased malpractice exposure.

The information on the insurance form must be accurate, because both the employer and the new employee are warranting that the answers to the questionnaire are true and are deemed incorporated into the original lawyers’ professional liability application. Any misrepresentation found in this new attorney form application could result in a carrier's denial of a claim or a rescission action, as the responses are incorporated into the original application.

If the application is submitted as a midyear addition to the policy, it is likely that the premiums will not change at the time the new associate is added. Be advised, however, that at renewal time, the insurance premium will be subject to recalculation.

Tax Considerations The addition of a W-2 employee brings new taxes and filing requirements, regardless of the firm's structure as a partnership or other entity. For example, each new employee must file a W-4 Employee's Withholding and Allowance Certificate. This form must be kept in the permanent payroll file, and a duplicate must be mailed or faxed to the state's new-hire notification unit. Further, if state withholding allowances are different from the federal withholding allowance, a separate state certificate- such as New York's IT-2104-must be completed.

The federal 1-9 Employment Eligibility Verification, commonly known as the "immigration form," verifies that the employee is eligible to work in the United States. This form must be kept with the personnel file for inspection in the event of an audit.

New employers also must make federal income tax and FICA withholdings. Social Security tax withholding is equal to 6.2 percent of gross wages and Medicare tax withholding is equal to 1.45 percent of gross wages. The combined rate of 7.65 percent is deducted from the employee's gross pay.

For 1997, Social Security is limited to the first $65,400 of salary per employee. Medicare does not have a limit. Employers must match the Social Security and Medicare portion when making their weekly, semiweekly, monthly or quarterly deposits. Federal income tax withholding is based upon IRS tables factoring pay period wages and W-4 withholding allowances.

The federal Social Security/Medicare deposit requirement is determined based on the prior year's liability. For example, if an employer has annual federal payroll tax liability over $50,000, it would file semiweekly. If an employer has an annual federal payroll tax liability under $50,000, it would file monthly. If an employer has federal payroll tax liability of less than $500 in any quarter, it can be paid with the quarterly tax return Form 941, when filed.

Employers also are required to file the Form 941 Quarterly Return. Form 941 is filed on the last day of April, July, October and January. Form 941 is a recap of the quarterly payroll information, including items such as gross wages, total federal payroll tax liability and federal tax deposits.

Form 8109 is used to make scheduled deposits at federal depository banks. Unless the firm's quarterly liability is less than $500, the firm must use deposit coupons or electronic federal tax payments-known as EFTPs-and cannot remit directly to the IRS.

Most of the better known federal employment laws don’t apply to a small practice, but many federal and state laws do.

Payment can be made electronically by phone or computer. Congress mandates that by July 1998 employers must make their federal deposit electronically, rather than via Form 8109 deposit coupons.

Firms also must annually provide employees and the IRS with Form W-2 Wage and Tax Statements by Jan. 3 1. The W-2 is a summary statement of wages paid to, and taxes withheld from, an employee for use in filing the personal income tax Form 1040. Form W-3 must be filed by Feb. 28 with the Social Security Administration, or SSA. This is a transmittal of wage and tax statements to the SSA.

Form 1099 Miscellaneous and 1096 Transmittal must be filed by Feb. 28 with the IRS. These forms furnish the IRS and recipients with a summary statement showing nonemployee compensation paid to any noncorporate entity, and to any attorneys, in excess of $600.

Form 940, the annual federal unemployment insurance return, is due annually, on Jan. 31. Taxes are due on the first $7,000 of each employee's annual wages and are remitted to the IRS quarterly via the Form 8109 or EFFP payment systems. If state unemployment insurance is paid timely, the rate of tax is 0.8 percent of gross wages. States impose additional filing requirements. For example, New York requires periodic returns (the WT-1 Coupon Voucher), quarterly wage filings (WT4A or WT4AE or WT4B), unemployment insurance filings, disability insurance and workers compensation. Practitioners should check all applicable state laws.

Employee benefits, such as vacation, sick and personal days and health insurance, are for the most part discretionary and clear-cut, but a change in retirement funding has occurred.

Beginning in 1998, if one spouse actively participates in an employer-sponsored plan and the other does not, the latter may make a fully deductible IRA contribution, provided the adjusted gross income on the joint return is $150,000 or less. The deductible amount is phased out when adjusted gross income reaches $160,000. In a change designed to treat self-employed individuals the same as employees, beginning in 1998 any owner of a partnership, limited liability company, limited liability partnership or S corporation who receives a matching contribution to a 40 1 (k) plan will not have that amount designated as a salary deferral. Prior to this change, matching contributions for owners were considered salary deferrals with respect to the $9,500 annual deferral limit.

As a small firm grows, significant legal issues arise with respect to new employees. Because of the complexity of federal, state and local laws, and other requirements, a prudent sole practitioner or firm should engage advisers to help determine the ultimate cost of such hirings, in terms of both time and capital, and to avert adverse consequences.

Copyright © 2001 The Gulotta Law Group, PLLC