IRS Targeting Independent Contractor Versus Employee Claims

Businesses need to be aware of a tsunami of pain coming there way. The IRS is aggressively targeting the issue of employees incorrectly being claimed as independent contractors.

The federal government is currently running a deficit in excess of 13 trillion dollars. [See CurrentUSANationalDebt.com]. That may sound like a lot, but it is a drop in the barrel compared to the total unfunded liabilities we face in the next 30 years. Medicare and Social Security are underfunded by an estimated $60 trillion dollars. To meet just the payments on this debt, we would need to raise the tax rate on the rich to 88 percent and 65 percent on the middle class. It doesn’t look good.

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The IRS is charged with collecting the tax revenue that Congress spends so horrifically. The Agency believes there is a tax gap of roughly $400 billion dollars a year. It is trying to eliminate this tax gap by going after tax evaders and businesses playing funny. One area that is now being focused on is the situation where employees are classified as independent contractors by businesses.

The employee versus independent contractor situation has long been a challenging one for businesses and the IRS. Why? Well, a business has to pay for a host of administrative costs [insurance, health care, etc] for employees, but not for independent contractors. Perhaps more importantly, the business must pay half of the employee’s taxes to the state and must collect the rest from their paycheck. This makes tracking and collecting the tax so much easier for the IRS if the person is claimed as an employee.

As you might imagine, businesses try to classify people providing them services as independent contractors whenever possible. The IRS suspects many businesses push the envelope on this and the Agency is undoubtedly right. Since it is much more difficult to track payments to independent contractors and collect the income, the Agency has launched an “intensive and intrusive” audit campaign against businesses reporting payments to numerous independent contractors.

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So, what will happen to businesses found to be wanting in this area? If they have a reasonable basis for classifying the contractor as independent, they will usually be forced to simply reclassify them for future payments. If, however, there is no reasonable basis, the business will be liable for back taxes, penalties and interest. In really bad cases, the former employees might be able to sue the business for back benefits.

The government needs money. That means the IRS is going to be on the war path again. This new audit focus is only one of many coming down the road. You can count on that.

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