Independent Contractor vs. Employee Status
Five key steps to ensure that your documents are in order in case the IRS comes after you.
October 29, 2009
As part of the National Research Program, the Internal Revenue Service will be focusing audit attention on employment tax issues. One area of concern is expected to be worker classification as independent contractor or employee. Businesses hoping to reduce payroll taxes and fringe benefits may think that using independent contractors is the answer. However, the Internal Revenue Service (IRS) is looking for ways to increase revenue and compliance in this area as there is tremendous opportunity for abuse through misclassification resulting in employment tax understatement.
Since 1987, the IRS has used the “20-factor test” in Revenue Ruling 87-41 in determining worker classification. It recently combined the factors into three general groups: behavioral control, financial control and relationship of the worker to the firm. The determination of status is made based on the degree of control the employer can exercise over the worker in terms of how, when and where the job is completed. An indefinite relationship would indicate an employee relationship, whereas a project-based relationship over a specific time period indicates an independent contractor relationship. Industry practice, the intent of the parties and the presence of a written agreement or benefits provided are also considered. The use of independent contractors for work that is part of the employer’s regular business is especially susceptible to challenge. If an accounting firm uses an independent contractor for janitorial services in the office at night, the IRS is not likely to question the position upon audit, with proper documentation. If the firm treated some of their part time accounting staff as an independent contractor, however, a challenge should be expected. It is difficult to justify two people performing the same job under the same business enterprise with one treated as an employee and one treated as an independent contractor.
There are steps to document your taken positions, in the event that an independent contractor status is challenged. Conduct your own audit of your files before the IRS descends upon you.
The detailed employment tax audits are planned to begin in November 2009, will last for three years and include at least 2,000 examinations per year. There’s still time to complete the review of the status of your independent contractor files.
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Mary F. Bernard, CPA/MST is a tax principal and director of state and local tax services at Kahn, Litwin, Renza & Co., Ltd. in Providence, RI.