The GAO estimates that 38% of the employers the IRS examines have misclassified workers as independent contractors.
The IRS is responsible for determining whether an individual who provides services to a business is an independent contractor or an employee. Although many independent contractor relationships begin at the request of the service provider, this is no guarantee the IRS will not challenge the classification in an audit.
Some service providers prefer independent contractor status because of the tax benefits not available to employees, including being able to contribute significant dollars to their own qualified retirement plan and deducting legitimate business expenses. Whatever the provider’s reason for wanting to be classified as an independent contractor, the business remains the entity the IRS and the courts will go after for any misclassification.
Some of the obvious tax and financial benefits to the contracting business of avoiding classifying a service provider as an employee include
No need to provide medical insurance.
No payments of retirement benefits.
No employee payroll taxes.
Obtaining services at a fixed rate, no matter what the time required to complete the assignment.
Employee recordkeeping, clerical and other administrative cost savings.
However, if the IRS or the worker is successful in having the IRS reclassify him or her as an employee at some later date, the contracting party (employer) faces certain risks:
Liability for back payroll taxes, plus penalties and interest.
Court time and costs for any related litigation.
Out-of-court settlements to make the issue go away.
Unwelcome attention and embarrassment.
Criminal sanctions, including imprisonment and fines.
Personal liability for corporate officers of up to 100% of the amount the employer should have withheld from the employee’s compensation in payroll taxes.
Invalidation of benefit plans.
As a CPA, our advice for clients to avoid miss-classification issues is to rigorously apply the 20 common-law IRS guidelines for determining whether a service provider is an employee or an independent contractor.
Companies should not depend on industry norms alone but practice safe harbor provisions to avoid independent contractor reclassification. Recent legal decisions point out that even traditional independent contractors such as golf caddies can potentially be reclassified as employees.
When in doubt, IRS Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding should be filed to avoid future problems and tax consequences.
In part, The Journal of Accountancy