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Employee or Independent Contractor? Being Wrong Could Mean Stiff Penalties

The recent congressional testimony of Blackwater, a private military contractor receiving federal contracts, brings to light the controversy of classifying a worker either as an employee or independent contractor. Also, the recent $319 million IRS assessment against FedEx, for just the 2002 tax year, demonstrates that the IRS is targeting this classification in their audits (the total for FedEx could exceed $1 billion after all years are audited).

The benefit for a company that classifies a worker as an independent contractor is that there is generally no payroll tax withholding requirement. Companies are required to withhold payroll taxes for employees.

In addition to these substantial tax savings, independent contractors are ineligible for participation in company retirement plans as well as other fringe benefits, resulting in additional savings for a company. For Blackwater, that allegedly amounted to a savings of an estimated $50 million. If Blackwater is found to have incorrectly classified security guards in Iraq as independent contractors, they could be penalized for tax evasion. Some financial experts believe that Blackwater’s current classification practices result in annual savings of up to $400 million.

When evaluating whether to classify a worker either as an employee or independent contractor, companies need to look at the degree of control and independence they have over their workers. There are three categories that companies need to consider in their evaluation: behavioral control, financial control and type of relationship. In evaluating the relationship, a company might want to consider where, when and how work is done; what training the worker receives; how a worker is paid; the extent to which a worker can realize a profit or loss; what, if any, written contracts exist; and benefits the worker receives. The answers to these questions should help you form an opinion as to how the worker should be classified.

Please contact your Blackman Kallick representative with questions. While this is still a grey area, you can also review IRS publication 1779 or publication 15-A for additional background information. There is also an option to file Form SS-8 and have the IRS determine the worker classification.

Please note that the IRS has introduced Form 8919 for 2007. Individuals who believe they are incorrectly classified as independent contractors can file this form and, by doing so, will not be liable for their portion of payroll taxes, which they believe should have been paid by their employer. Workers can file this form with their individual returns.

Also, many unions are helping workers misclassified as independent contractors sue their “employers” in state and federal courts. Additionally, it has become commonplace for businesses to blow the whistle on their competition for misclassification of workers.

For further information, please contact Jason Parish at 312-980-2959 or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.