By Jason T. Giordano
In recent years, the Internal Revenue Service has engaged in a rigorous series of audits specifically targeting businesses that classify members of their workforce as independent contractors.
This initiative, put forth by the Obama administration under the Fair Playing Field of 2010 Act, allows the IRS to investigate the validity of businesses”™ application of independent contractor status for their workers and imposes strict financial penalties on companies that have misapplied the status ”“ whether intentionally or unintentionally. Hudson Valley businesses are seeing an increasing number of audits caused by growing staff levels at IRS offices.
The problem stems from the fact that there are gray areas when it comes to distinguishing an employee versus a contractor. The financial difference to an employer, however, is tremendous. By designating a worker as an independent contractor as opposed to an employee, a company is no longer obligated to withhold taxes on the worker”™s behalf or provide any sort of benefits package. The employer also no longer needs to contribute to Social Security, Medicare or unemployment for that worker.
The incentives for an employer to misapply the designation are understandable, but the penalties can be ruinous. Any business that is found to have misapplied the independent contractor status is liable for all taxes that should have been withheld through Federal Insurance Contributions Act (FICA), as well as Federal Unemployment Tax Act (FUTA) taxes on up to $7,000 in earnings for each worker who was incorrectly classified.
Special consideration resulting in reduced penalties will be applied in cases where the employer made an honest mistake. However, in cases where the employer knowingly misapplied the designation, the additional penalties can be extreme.
The New York State Department of Labor has begun to address the concerns and misinterpretations surrounding contract workers by interpreting the factors that classify independent contractors as opposed to employees. These factors must be addressed precisely, however, because even demonstrated proof that a contractor has an entire portfolio of clients and is a member of the Freelancers Union might not be sufficient to prove employee status. In an effort to create clear designations, New York state agencies have begun to evaluate employee status in much the same way the IRS does.
The IRS estimates that more than $7 billion in tax revenue will be reclaimed through its enforcement methods in just 10 years. Individual states are steadily devising additional financial penalties for misapplication of the independent contractor status.
There are also some tangible benefits to this IRS crackdown for both employers and workers.
Employers whose competitors have misclassified their employees as independent contractors stand to gain a competitive advantage as competing businesses adjust to the increased cost of operation. In addition, employers who correctly apply the status and have complied by all federal and state regulations have nothing to worry about. Doing things right the first time is a big plus.
Workers who are identified as being misclassified stand to gain the benefits to which they are properly entitled. Employers, in response to the crackdown, are less likely to intentionally deprive workers of employee status in order to reap the benefits that are rightly due to their personnel.
In order to avoid this legal issue, it is important for businesses to understand the criteria governing employee status and independent contractor status. The IRS issued a 20-point check to determine if an employee warrants independent contractor status. In short, if the employer has the right to control the manner in which a worker executes the tasks of the job, if the employer is in control of all business aspects of the job or if the worker is the subject of employee benefits contracts, the worker should most likely be designated as an employee.
Employers who fear that they may have misclassified a worker may be eligible for the IRS”™s Voluntary Classification Settlement Program, through which organizations may reclassify workers and self-report in exchange for substantial relief from financial penalties. This must occur prior to contact from the IRS itself, however. In determining eligibility for this program, employers are encouraged to seek advice from financial and legal professionals.
Employers that have already been approached by the IRS regarding the classification of their independent contractors are strongly encouraged to seek professional advice, even if it is just to be on the safe side.
[stextbox id=”info” caption=”The IRS”™s 20-point check:”]1. Level of instruction
2. Amount of training
3. Degree of business integration
4. Extent of personal services
5. Control of assistants
6. Continuity of relationship
7. Flexibility of schedule
8. Demands for full-time work
9. Need for on-site services
10. Sequence of work
11. Requirements for reports
12. Method of payment
13. Payment of business or travel expenses
14. Provision of tools and materials
15. Investment in facilities
16. Realization of profit or loss
17. Work for multiple companies
18. Availability to public
19. Control over discharge
20. Right of termination
Jason T. Giordano is a shareholder of Judelson, Giordano & Siegel, CPA, PC in Middletown. As a tax specialist, he provides strategy, tax planning, compliance, tax return preparation, and representation for companies in several industries. He can be reached at giordano@jgspc.com.
