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Independent Contractor or Employee? IRS Guidance for Startups and SMBs

Posted on Edited on
Sylvia F. Dion, MPA, CPA
Sylvia F. Dion, MPA, CPA

As I just mentioned, I'm an avid tax blogger. In addition to blogging on my own blog, The State and Local Tax "Buzz" and for SalesTaxSupport.com, I'm also a tax contributor to the "AllBusiness Experts" blog on AllBusiness.com.  My contributions to the AllBusiness blog cover a variety of tax issues, with a focus on the start-up/SMB/middle-market business.  In my recent AllBusiness post, I focus on a topic that the IRS has been highly scrutinizing - worker classification! Here's an excerpt from my recent post, "Independent Contractor or Employee? IRS Guidance for Startups and SMBs."   

"Here’s a strategy you see employed by many startups – hiring “independent contractors” to fill temporary or permanent positions. From an economic standpoint, this may seem wise as a company in startup mode may be testing the viability of its product or service, or be in the process of securing funding and may not have the funds to commit to permanent hiring, which would mean not only paying employees’ salaries, but incurring the cost of the employee benefits it offers. And so, it may seem that the safest economic route for many startups and growing SMBs is to simply hire “independent contractors” in lieu of employees.

But this strategy is not without risk. This is because the IRS has been scrutinizing situations where workers are treated as independent contractors by the employing company, but are 'de facto' or 'in fact', employees. Proper 'worker classification', as it is often referred to, is a major focus for the IRS. The primary reason the IRS has upped its focus in this area? Payroll taxes!"

You can read the rest of my post, "Independent Contractor or Employee? IRS Guidance for Startups and SMBs" here -> http://experts.allbusiness.com/independent-contractor-or-employee-guidance-for-start-ups-and-smbs/4975/#.UdrofPkcd8k

 

Replied on
Mae Chapman
Mae Chapman

Perhaps this sounds naive so please bear with me: Why doesn't the IRS simply require proof of 1099 issuance to IC and then follow up with the purported IC to ensure they have claimed the income on their Schedule C (and paid 100% of their taxes as a self-employed person)? The follow-up with the IC could include a survey to verify they are in fact, and actual IC, rather than a shadow-employee.
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Replied on
Brian Huber
Brian Huber

Mae, the IRS receives the original 1099s and presumes that copies were issued to the independent contractors. An IRS matching system definitely assures that every IC reports the income and pays the correct tax. The problem is that the IRS would have already collected the tax amounts if the IC were an employee. Therefore, misclassified workers are slowing the tax collection process. Small business owners need more professional assistance to comply with payroll tax withholding, remittance, and reporting. Moreover, income tax returns are compared to payroll tax reports for matching figures. This is a trap for unwary small businesses. More tax preparers are therefore needed to increase their expertise and services to business owners. CPAs specializing in tax are even having difficulty hiring knowledgeable staffers that can help more business clients. A good way to advance or get started in the tax field (even for individuals who plan to study for the CPA exam) is to consider Enrolled Agent certification. More information about the designation and examination is available at http://fastforwardacademy.com/enrolled-agent-exam-prep.htm.
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Brian Huber
Brian Huber

Thanks for adding the new comment, Sylvia. You are certainly correct about state unemployment insurance assessments becoming a big concern in cases of misclassified workers.  Several CPAs have informed me about businesses they represented in audits by state employment commissions that uncovered workers who were improperly classified as contractors. Large tax bills from the state followed.

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Replied on Edited on
Sylvia F. Dion, MPA, CPA
Sylvia F. Dion, MPA, CPA

Mae, Here is another issue.  In the post I wrote, I focused on the IRS' focus, but states are just as interested in the misclassification. For instance, employers are required to make State Unemployment Insurance (SUI) contributions on the wages of their employees (depending on the state, contributions are made on the first XX amount of state wages at the percentage that applies to that particular employee.) Note, these are employer contributions, NOT withholdings. So, if a worker is improperly classified as an independent contractor, but is really an employee - then the state is deprived of the SUI contributions that would have been due on the employee's wages. 

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