Employment Taxes
Worker classification has been a major concern for businesses for many years. Classifying workers as independent contractors when they should be employees can be costly for a business. If there is no reasonable basis for the classification, the business can be liable for the employment taxes that should have been paid, as well as penalties and interest.
Reasons a business would prefer independent contractor status include that it does not have to pay payroll taxes or provide employee benefits such as health insurance. For the worker, independent contractor status allows him or her to deduct various business expenses such as travel and to take advantage of various retirement plans.
Businesses have no bright-line test for making the determination. For years, the IRS has used a 20-question test to determine worker classification (Rev. Rul. 87-41). The importance of each question depends on the type of work that is being performed and the facts and circumstances of the situation. In other words, there is no way to definitively determine whether the IRS will rule that a worker is an employee or an independent contractor. In 2001, the IRS, in a memorandum (Field Service Advice 200127004 (7/6/01)), essentially consolidated the factors into three categories:
- Behavioral control: This category involves the degree of control the business has over the worker. If the worker controls the methods he or she uses on a project, the relationship looks more like that of an independent contractor.
- Financial control: This category examines whether the worker can make additional profit if he or she can control expenses and other efficiencies.
- Relationship of the parties: This category includes factors such as the duration of the relationship and whether the worker provides services for multiple recipients.
In 2009, the U.S. Government Accountability Office (GAO) reported that worker misclassification contributes to the “tax gap” (the difference between the revenue the federal government collects and what is legally owed) and identified 19 options for correcting it (see GAO Rep’t No. GAO-09-717). In 2010, a Treasury Inspector General for Tax Administration (TIGTA) report indicated the misclassification of workers was a considerable factor in the federal budget deficit and caused other costs to the general economy (see TIGTA Rep’t No. 2010-30-025).
The IRS is not the only federal agency that employers need to worry about. The fiscal year 2014 budget proposal for the U.S. Department of Labor (DOL) (available at dol.gov/dol/budget)
steps up efforts against worker misclassification, providing nearly $14 million to help identify misclassifications, recover unpaid taxes, and investigate violations, including $10 million in grants to States and $3.8 million for [DOL Wage and Hour Division] personnel. Misclassification deprives an increasing number of workers the benefits and protections to which they are legally entitled; such as minimum wage, overtime pay, unemployment insurance, and anti-discrimination protections. [ FY 2014 Department of Labor Budget in Brief , p. 3.]
While it is clear that government agencies recognize that worker misclassification is a significant problem, how to classify workers remains unclear. Furthermore, worker misclassification carries heavy potential costs for businesses and major revenue implications for the federal government. As the new DOL budget proposal suggests, the federal government intends to increase its enforcement efforts. This is especially true since large employers (with 50 or more employees) will be required to provide health insurance or pay a penalty for a failure to do so beginning in 2015.
EditorNotes
Michael Koppel is with Gray, Gray & Gray LLP, in Westwood, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com.
Unless otherwise noted, contributors are members of or associated with CPAmerica International.
