According to the U.S. Government Accountability Office (GAO), the IRS claims to lose millions of dollars in uncollected taxes each year due to independent contractor misclassification by employers. As such, as part of a national research project on employment taxes, the IRS is scheduled to audit 6,000 randomly selected companies ranging from large to small firms and even non-profits. The goal of the program, which is scheduled to last from 2010 to 2012, is to create a scoring system for employment taxes. The audit will focus on the following items: failure to file, fringe benefit issues, executive compensation (including stock options) and employees misclassified as independent contractors.
The IRS sets forth clear eligibility guidelines for what determines independent contractor status. The following is taken directly from the IRS website:
Common Law Rules
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Understanding the Implications of Misclassification.
Employers should understand the implications of misclassifying employees as independent contractors. Employers who misclassify employees as independent contractors may find themselves responsible for employment taxes and penalties, as well for various benefits that the misclassified employee may be eligible for such as health insurance, pension, vacation and sick benefits, worker compensation, unemployment, etc. It is important for employers to review their 1099s, identify independent contractors who may be misclassified and reclassify them appropriately.
The “Twenty Factor Test”
Perhaps the most famous determinant of independent contractor status is the IRS’s 20 Factor Test. The IRS created the test as a tool to help employers identify if their worker is an independent contractor or employee. Although, a worker does not necessarily have to meet all 20 factors to be considered either an employee or an independent contractor, it is important to view the circumstances of each individual case. You can download a copy of the 20 Factor Test here.
For more information on independent contractor classifications, please contact CPEhr for a complimentary qualification consultation.
Thi Ha, HR Account Manager at CPEhr, contributed to this post.
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