IRS Stepping Up Misclassified Worker Investigations

IRS worker carefully inspecting stack of paperwork

The IRS plans to step up investigations into businesses that may wrongly classify employees as contractors. Employment tax law deals with employee-employer relationships in terms of tax obligations.  Employers can classify people they hire as “employees” or “independent contractors”. There are several cost benefits to labeling someone an independent contractor, leading to an incentive to do just that even when the relationship and dynamics of day-to-day work are similar to an employee-employer situation. The IRS is working with many state employment agencies to review the tax classification of independent contractors (ICs). The Questionable Employment Tax Practices Program (QETP) is a result of lengthy consultation and discussion between public and private tax attorneys. As of today, thirty-seven state employment agencies have submitted memorandums of understanding (MOUs) regarding the Federal government’s QETP initiative. These MOUs will allow the IRS to access detailed employment data compiled by state-level employment agencies. This information will be relevant in civil cases that often center on questionable tax reporting practices. The rule of thumb is that legally classified “employees”  and “independent contractors”  are determined as such based on their relationship with the employer/client work hour regularity and overall obligation.  If an employee agrees to work as an IC yet behaves as an employee the employer-IC agreement is insufficient defense against misclassification liability. These liabilities trigger substantial penalties. Businesses that hire employees and IC’s need to be aware of the latest IRS and state employment regulations in light of the QETP program.  The IRS has a tentative schedule to implement and enforce QETP provisions sometime in early 2014. This gives employers some time to go over several tools to help them properly classify employees for tax purposes. The IC Compliance Scale is one such tool employers can be used to verify if hired help in a business is technically an “employee” or “independent contractor”.

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