Making Lease-Purchase Work
Many lease-purchase plans have unsavory reputations among drivers. The IRS and other agencies have a dim view of such plans too. But there are ways to do it right.
July 2013, TruckingInfo.com - Feature
Short of holding a square dance in a minefield, there can’t be many situations as fraught with risk as establishing a lease-purchase program to help build your capacity with grow-your-own owner-operators. The same applies to the driver participating in a lease-purchase program.
Selling used equipment to an independent contractor is a good way to boost recruiting potential and recapitalize used trucks, if you’re very careful how you proceed.
For fleets, the major challenge is navigating the complex and often contradictory morass of state and federal regulations that seek to define and determine the employment status of the lessee or driver in such programs.
Defining independent status, in these lean-revenue years for government, has taken on a new importance. Some estimates put losses to the federal government due to misclassification of employees as independent contractors at $3 billion to $4 billon annually. To close that gap, Internal Revenue Service misclassification audits are expected to generate almost $6.9 billion over the next decade.
A great deal more is at stake when you consider the states’ interest in that potential source of revenue.
According to the National Conference of State Legislatures, 26 states considered legislation on employee misclassification during the 2012 legislative session. Measures were enacted in 10 states. Several more high-profile actions are currently under way in New York, New Jersey, Michigan, Texas, Virginia and others. Not all apply directly to trucking, but have the potential to open further discussion.
In that light, it’s not surprising that there’s growing skepticism among regulators for trucking’s lease-purchase programs, according to Greg Feary, managing partner at the law firm Scopelitis, Garvin, Light, Hanson & Feary, during a recent Truckload Carriers Association webinar.
“The regulators have seen a few bad actors in the industry use these programs to evade substantial employer costs by renting company trucks to employees, signing them up as owner-operators and calling them independent contractors.
Those self-serving carriers may be a small segment of the industry, but regulators have taken notice, Feary says. “Unfortunately, those cases are often used as a poster child for broad assertions that all such programs may or are likely to be nothing more than a device to evade taxation or employer benefit obligations.”
In the past four or five years, Feary says, regulators have over-scrutinized and attacked legitimate programs in order to support federal and state financial shortfalls.
The IRS and state tax authorities have initiated several programs designed to catch employment tax fraud, among them the Questionable Employment Tax Practice initiative, or QETP. The IRS, Feary says, is showing states how to audit for suspected misclassified independent contractor issues, including lease-purchase programs.
“They are looking for the issuance of five or more 1099 forms [miscellaneous income other than wages] from businesses of $25,000 or more,” he says.
“The IRS has determined this signals a company is using independent contractors, which then becomes an audit target.”
On the upside, Feary says 14 states have enacted exemptions within the unemployment tax framework exempting owner-operators in the trucking and courier industries. In addition, 24 states have enacted similar exemptions within the workers compensation framework.
“However,” he cautions, “several of these statutes specifically address lease-purchase programs as disqualifiers to the application of independent contractor status.”
Feary singles out eight states he believes already have very difficult statutes to comply with when attempting to define owner-operators as independent contractors. Those states may also exclude owner-operators in a lease-purchase program from their already strict criteria. They include Illinois, Louisiana, New Jersey, Oklahoma, Oregon, South Carolina, Wisconsin and West Virginia.
If you’re based in or recruit drivers from any of those states, you need to have a serious look at your lease-purchase program.
Freedom to fail
With the exception of a few shady characters (see sidebar on p. 42), no carrier wants to see its independent partners fail. Yet the IRS looks closely at what you do to prevent such occurrences.
Independent contractors are supposed to be just that: independent. The closer the carrier gets to the owner-operator with training, coaching, instructing, etc., the more the line between contractor and employee blurs in the eyes of the IRS.
When you hire a plumber to fix your toilet, you don’t expect to have to show him or her how to do it. You can explain what you want done and what you expect when the job is finished, but that contractor should have the knowledge needed to do the job.
It should be the same under an independent contractor-carrier partnership, but fleets often go too far in offering things like business management courses.
David Strand, the president of Wholesale Truck & Finance, also presenting on the TCA webinar, said third-party programs can work if the carrier is careful not to involve itself directly. Wholesale Truck & Finance provides funding for prospective independent owner-operators and manages lease-purchase programs for carriers. In its arm’s-length position, Strand’s company can sometimes do what carriers can’t (or shouldn’t) do for their lease-purchase operators.
“If we see an operator getting into trouble, falling behind on a weekly basis, we can intervene and reach out to the operator to find out what’s happening,” he says. “We can offer advice or guidance to get them back on track. Since we started doing that, we’ve seen a noticeable decline in our rate of defaults.”
Feary says companies like Wholesale Truck & Finance that have triage programs to support owner-operators is good for the owner-operator and can be good for the carrier, but he strongly recommends against carriers establishing such programs internally.
“There are two problems, legally, with this approach,” he says. “First, it’s going to look very paternalistic, where [the carrier] is effectively being a Dutch uncle to a contractor. When you start telling owner-operators what to do and what not to do, that very quickly starts to look like an employer-employee relationship.
“The second problem, ironically, is that it takes away the risk of loss,” Feary explains. “Frankly, courts are looking to see if real risk of loss exists in these programs – whether a business can succeed or fail.”
Feary says while it’s fine for Wholesale Truck & Finance or a separate consulting company to seek to protect the interests of its clients, “it would be quite dangerous for a motor carrier to implement such a program.”
Third-party sales and financing companies can put some distance between the carrier and the oversight that is sometimes needed to keep errant independent contractors on track.
Depending on why you’re offering a lease-purchase program, there are a number of approaches that can not only minimize the curiosity from state and federal agencies, but also provide a better environment for the IC. If your intention is to recruit independent contractors, any attempt to make the program more attractive could hobble its success.
“Programs driven purely by a contractor recruiting mission statement...can result in a paternalistic, sweetheart deal for the contractors, which can weaken the independent contractor status of those owner-operators,” Feary says. “Conversely, a program focused on extracting the most profit out of equipment may not attract a significant number of contractors.”
One of the key features of ownership is the ability to get equity out of an asset – the ability of the contractor to sell the truck. Feary says that would be a key factor in determining independent contractor status. But that raises some issues at the fleet level, as does the issue of portability – the contractor’s ability to lease to a competitor with the truck your company has “sold” to that contractor.
Portability and the alienation of property (the ability to sell) certainly strengthen the position of the lease-purchase program, but might be at odds with the goal of growing the fleet.
These and other concerns are good reasons to work with third-party equipment providers, lenders and business development specialists.
Schneider National has a division called Schneider Finance Inc. that develops owner-operators by assisting its clients with equipment, financing, maintenance and business management solutions. SFI is at arm’s length to Schneider National, yet it provides contractor screening and in some cases training (beyond DOT and customer-specific required training), as well as truck and financing for its clients. The client buys the truck through SFI, partners with Schneider National and gets the support needed to be successful from SFI.
“Schneider National has several lines of business that offer different opportunities,” explains Grailing Jones, SFI small business owner-operator development manager. “Some clients move around within the group. Some leave and go their own way after a time. Some leave and then come back. Most of our clients stay and end up buying several new trucks or even start a small fleet of their own.”
Companies such as Strand’s Wholesale Truck & Finance provide direct financing for owner-operators and work with top-rung carriers managing their lease-purchase programs. Other companies, such as the American Truck Group, deal directly with owner-operators and bring them together with carriers known to have good business models for contractors.
In each case, the independent contractor is more closely aligned with the finance/leasing company than with the carrier, preserving the arm’s-length relationship.
Those companies are free to help the owner-operator manage his or her business without it looking or becoming paternalistic, and they can guide and direct the owner-operator in ways carriers really cannot without compromising the independent nature of the relationship.
For more information, the Truckload Carriers Association webinar cited in this article, Lease-Purchase Plans: What You Need to Know for 2013 and Beyond, is in the Truckload Academy On-Demand archive at www.truckload.org/TAO. It’s free for TCA members, $219 for non-members.
Why drivers are leery of lease-purchase
Over the years, so many tales of woe have emerged about lease-purchase programs run by unscrupulous carriers that it’s hard to talk about such programs without drivers rolling their eyes and walking away.
Typical complaints to the Owner-Operator Independent Drivers Association include:
• The truck needs constant repairs,
• The number of miles are cut just before the truck is paid off,
• I can’t generate any revenue, and
• The company refuses to let me move the truck.
OOIDA spokesperson Norita Taylor says drivers often get trapped in situations they can’t control.
“Our experience … tells us these programs almost never benefit anyone except the motor carriers and should be avoided,” she says. “The carrier holds all the cards, and the lessee is at their mercy.”
Taylor recalls one case in which a company levied unrealistically high repair charges on equipment they eventually took back after the driver defaulted.
“It turned out that the carrier never made the repairs the driver was billed for,” she says. “This same company continued to charge lease payments to the original lessee on equipment they had already taken back and leased to another driver, from whom they were collecting new payments as well.”
The first driver eventually stopped making the payments and demanded the return of his maintenance escrow. The company then turned the alleged debts over to a collection agency, all but destroying the driver’s credit score.
In other cases, carriers filed bankruptcy or simply closed their doors, leaving the equipment unsecured and not paid for – which meant the lessee lost the truck and all the money already paid toward it.
Tales like these wreck the reputation of legitimate lease-purchase programs as surely as the bad ones wreck a driver’s financial future.OOIDA cautions its members and drivers against entering such contracts, or advises them to have a lawyer review the contract before they sign on.
“Our message is that it’s risky to sign an agreement where the same entity with the title to your equipment also determines your income,” Taylor says. “We could put together a lease-purchase that would be good for the operator, but it may not be that good for the carrier. I think the best way a carrier could improve such an arrangement would be to simply follow ‘truth-in-leasing’ laws.”
That’s 49 CFR Part 376 - Lease and Interchange of Vehicles. This regulation is becoming increasingly relevant in the face of increasing employee misclassification challenges. The truth-in-leasing requirements are there to protect owner-operators, but they also help define an owner-operator’s independent status, which could help protect you from an employee misclassification case.