Companies in Texas and elsewhere that have incorrectly classified workers as independent contractors now have a chance to avoid tax litigation and the wrath of the Internal Revenue Service. A new IRS “forgiveness” program lets businesses that have classified workers as independent contractors avoid federal taxes to rename those people employees.
Independent contractors and employees are treated differently under the law. An employer’s financial obligations are fewer for contractors than classified employees. Businesses can avoid paying Medicare and Social Security taxes, workers’ compensation insurance premiums and overtime to workers who are listed as independent contractors.
The IRS admits the definitive differences between contractors and employees are not all financial. The fine line between what qualifies a worker to be a contractor or a regular employee is thin and sometimes confusing. In general, the IRS considers an employee a worker in which a company has much more control over through behavior expectations, contracts and benefits.
To enter the IRS worker reclassification program, an employer must apply using an individual worker’s tax information. To get around penalties and interest, businesses who reclassify independent contractors as employees must submit about 1 percent of the worker’s wages over the last year.
In exchange for a business’s honesty, the IRS will not audit a company’s payroll taxes pertaining to the worker. The IRS has not set an end date for applications.
The federal tax forgiveness is not applicable at the state tax level. Businesses already being audited cannot participate. IRS officials also say the reclassification program excludes companies who hire under-the-table workers.
The IRS warns businesses who do not take advantage of the reclassification compliance program that misclassifications of workers can result in unpleasant consequences. A company could end up paying three years of back employment taxes, along with IRS penalties and interest.
IRS officials say they are not certain how extensive the problem of worker misclassification has become. The last government report related to the subject was published in 1984, when an estimated 15 percent of businesses misclassified employees as contractors.
Source: Associated Press, “IRS offers break to employers who come clean about avoiding taxes on misclassified workers,” Stephen Olemacher, Sept. 21, 2011