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IRS Cracks Down on Small-Biz Contractor Payroll Abuses
Small businesses that should be treating certain contract help as payrolled employees will have the opportunity to reclassify those workers under a new Internal Revenue Service program.
The initiative signals an era of heightened federal vigilance as the government seeks to rein in
misclassification, a practice that the government said cost the United States $2.72 billion in unpaid federal taxes in 2006 alone.If accepted into the reclassification program, a small business can move contractors onto its regular payroll with no interest or penalties other than a one-percent tax on the wages that have been paid to that person over the previous year.
During the first three years of the IRS program, the employer will be exempt from audits on payroll taxes for those employees reaching back for a period of six years, the IRS said.
"This settlement program provides certainty and relief to employers in an important area," said IRS Commissioner Doug Shulman. "This is part of a wider effort to help taxpayers and businesses to help give them a fresh start with their tax obligations."
The trick, of course, is figuring out who should be a contractor and who should be an employee because the law is considered vague by many small businesses. One of the key provisions is the extent to which the employer has control over how someone completes a task or project -- not just the final product.
"Despite the IRS's program, the law remains unclear," Bill Rys, tax counsel for the National Federation of Independent Businesses told The Wall Street Journal. "For some firms there are three different sets of rules defining who is an employee."
The reasons why a small business would want to work with an independent contractor are pretty clear: They aren't required to pay Social Security or Medicare taxes on these workers. It is up to the contractor to keep current on their self-employment taxes. Employees have more legal protections, including minimum wage and overtime statutes, and their wages are subject to payroll taxes.
The Wall Street Journal article cites White House figures suggesting that 10-30 percent of companies may have misclassified employees.
Earlier this week, the Department of Labor along with the IRS and seven states agreed to "improve coordination" on employee misclassification issues. "We're standing united to end the practice of misclassifying employees," said Secretary of Labor Hilda Solis. "We're taking important steps toward making sure the that American dream is still available for all employees and responsible employers alike."
Even though the classification rules may be vague, one thing is crystal clear: Small businesses should scrutinize any contractor relationships -- especially long-term ones -- that could be questionable. If a reclassification is required, now is probably the time to do it or risk a possible bigger penalty in the future.