Independent Contractor Classification
The classification of workers as an independent contractor is often misused by many small businesses. In order to avoid some of the costs related to having employees, such as payroll taxes, workerâ€™s compensation, unemployment taxes, and employee benefits, some businesses will attempt to classify workers as independent contractors, but often times these workers would actually meet the IRS guidelines defined as employees.
In response to the growing number of workers being classified as independent contractors, the IRS is increasingly concentrating on the auditing of employers that utilize independent contractors in order to determine if they have correctly classified their workers. If an employer is audited for employer classification and deemed to have incorrectly classified their workers as independent contractors, there can be major financial consequences including the requirement that the employer pay back taxes, as well as potential penalties and interest. In addition, they can be required to pay past unemployment insurance.
State revenue departments are also implementing independent contractor classification audits more frequently as well. In order to increase the coffers of state unemployment funds and workerâ€™s compensation funds that became depleted during the recent recession, they are looking at independent classification audits as a way to build revenues. In order to assist their efforts, the US Department of Labor has notified state agencies that the Consolidated Appropriations Act of 2014 has provided $10 million in grant money to assist agencies in addressing the mis-classification of workers.
In order to reduce exposure to any potential independent contractor audits, companies must protect themselves by making sure that they are correctly classifying their employees. They also must make sure that they avoid some of the actions that may trigger an audit. Some of the red flags that may trigger an audit include:
- W-2s and 1099 overlap: This occurs when a company changes the classification of a worker from an employee to an independent contractor. The issuance of a 1099 and a W-2 to the same individual within the same calendar year can cause the IRS to look further into a companyâ€™s operations.
- Multiple SS-8 Form filings: Multiple workers filing SS-8 forms with the IRS can also be an audit trigger. This form is used by workers to request that the IRS make a determination if they should be classified as an employee or an independent contractor. Workers often will file this to avoid having to pay taxes that they feel an employer is responsible for.
- Filing of unemployment or workerâ€™s compensation claims: Workers that are classified as independent contractors that file claims that are reserved for employees only can also trigger an audit. (Erenburg, 2012)
Although it is best to try to avoid an audit, if a company finds themselves subject to one, the best defense is a good offense. If there is a need for independent contractors within an organization that has employees, it is best to have written policies and procedures that separate the two groups. In addition, the duties between the two groups must not overlap. Finally, the independent contractor must meet the independent contractor guidelines as defined by the IRS.
If you are an employer that uses independent contractors within your organization and you are not completely sure about how they should be classified, talking to one of our qualified Los Angeles tax attorney may be beneficial. Our southern California tax attorneys are available in San Diego, and Irvine to assist you with your independent contractor reclassification audit. Contact us online or call (619) 595-1655 today.Â Â Corporate and Transactional
Erenburg, K. R. (2012, August 22). Crain’s Cleveland Business. Retrieved from Crain’s Cleaveland Business website:
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