As reported in the ABA Journal, the Internal Revenue Service will randomly audit 6,000 businesses over the next three years to determine whether they misclassified workers as independent contractors when they should be treated as employees for tax purposes. When properly classified, using independent contractors as opposed to employees allows businesses to escape unemployment, Social Security and Medicare taxes and overtime pay.
These benefits may not outweigh the risk. If a business is caught misclassifying workers, they will be subject to taxes, interest and penalties after a lengthy and expensive audit. Determining whether a worker is an employee or independent contractor for tax purposes is a fact intensive inquiry involving the weighing of (count ‘em) twenty factors. Some factors may be more important than others in the context of the services the individual is performing. Because there is no cut and dry test, the audit process can get heated.
What triggers a potential IRS audit of your business? Issuing the same individual a W-2 and a Form 1099. The most common scenario occurs when retiring employees cuts back on hours and, as a consequence, are changed to contractor status. While this is not against the rules per se, be careful—if your new independent contractor is performing the same exact job and holds the same duties and responsibilities as they did during their “employment,” the classification could be challenged.
A great way to protect yourself is to put it in writing. Draft up an independent contractors agreement setting forth your contractor’s duties and detailing policies and procedures. This way you will have a concrete agreement to show the IRS when they knock on your door.
If you have questions on whether your workers may be classified as employees rather than independent contractors, talk to your tax attorney, financial adviser or Certified Public Accountant.
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