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Beware: IRS to Conduct 6,000 Audits of Employee/ Independent Contractor Classifications

Starting in February 2010 IRS officials will start random audits of approximately 6,000 US employers for employment tax compliance and proper worker classification.  These random audits are intended to help close the estimated $15 billion "tax gap" that the  GAO believes is attributed to workers being misclassified as independent contractors versus company employees.  The IRS will also be reviewing for the proper issuance of Form 1099-Misc for any workers classified as independent contractors.
  
These audits will be conducted on employers of all sizes and types, including non-profit organizations, and will concentrate on workers classification, fringe benefits, non-filers, officers' compensation and employee expense reimbursement.  Not only is this misclassification lowering the government’s  tax revenue but it also effects the employees  who are misclassified as independent contractors by denying them health benefits, overtime pay, retirement contributions and unemployment insurance.  From a practical point, the larger cost to the employer could be the cost of having to provide retroactive health insurance and/or retirement benefits for misclassified “independent contractors.”

A study conducted by the Department of Labor in 2000 revealed that 10 to 30 percent of firms that were audited in nine states had misclassified some of their employees.  Even though the IRS and most other agencies do not exchange information due to the restrictions in the tax code, some 34 states and the IRS share information on misclassification-related audits as permitted under the tax code.

There are also penalties for the failure to issue a Form 1099-Misc when required to independent contractors.  A $50 penalty per 1099 that should have been issued and was not may be assessed.  Also, if the business does not have the taxpayer identification number of the independent contractor (generally the social security number of an individual), they would have been required to subtract “backup withholding” from the payment.  Upon audit, the IRS may find the business liable for the “backup withholding” amount if the taxpayer identification number can not be located.

What does this mean for you and your business?  Be aware that these random audits will be in effect in the near future and review the classification and documentation maintained for any “independent contractor” associated with your business.  In a future tax highlights, we will discuss many of the factors utilized to clarify the differences between an “employee” versus an “independent contractor”.

For further information, please contact Jennifer Peetz at 312.980.2952, Michael Calahan at 312.980.2996 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.