Proper Classification of Workers – A Growing Problem

The Proper Classification of Workers is a Growing Problem

Independent Contractors
Independent Contractors

In the US an employer has several obligations to their employees and must provide them with a variety of benefits in accordance with state and federal laws. In recent years there has been a growing trend in which employers are classifying their workers as “independent contractors” instead of employees in order to avoid having to provide them with these benefits and therefor save a bit of money while increasing the gross profit of their business. This growing practice has become controversial however, and the IRS has been taking measures to ensure that workers are properly classified. This has led to a clash between the IRS and businesses over the issue.

Benefits of Outsourcing
Benefits of Outsourcing

How Much They Really Save

Independent contractors, also known as freelancers, give up a lot of benefits in order to maintain their freedom and ability to choose who they work with on a job to job basis. The benefits that employers don’t have to pay a contractor includes: Social Security, unemployment, minimum wage, vacation time, and more. They also don’t have to take into consideration the Affordable Care Act since contractors are responsible for obtaining their own health insurance. Ultimately a business can save a lot of money by treating workers as contractors rather than employees. In fact, some business models are based entirely around being able to do this and are only able to remain profitable if they do so.

IRS troubles
IRS troubles

Trouble with the IRS

With the practice of classifying workers as contractors growing, the IRS and many states are beginning to take matters into their own hands. Aggressive in their assertions, the IRS has objectively reclassified many business’ workers as employees. This has lead to a variety of problems for businesses who have classified their workers as contractors. Not only do they have to pay all the taxes they owe, they also have to pay interest and a variety of penalties. With this being applied to each employee that was reclassified by the IRS, the tax liability can cripple a business almost overnight in some cases.

In other cases contractors have taken matters into their own hands. Not every contractor is happy with their status, such as the drivers at FedEx. They launched a civil case against their employer stating that they should be reclassified as employees instead of contractors due to the amount of control that FedEx exercised over them and how they did their job. Ultimately the case of Alexander v. FedEx Ground Package System Inc. was ruled in favor of FedEx by California. However, this was only a civil case and it may not be long before the IRS or California itself decides to get involved.

Getting Caught
Getting Caught

Getting Caught

While FedEx may be off the hook temporarily, the price for getting caught by the IRS or state when it comes to miss-classifying workers isn’t a pretty picture. In many cases a company will be scrutinized by the IRS when submitting their tax reports. This is due to the fact that many accountants don’t have a good understanding of what dose and does not legitimately classify a worker as an independent contractor due to how murky and complex the laws surrounding this issue truly are. One slip up on a tax report can trigger a full investigation by the IRS.

When the IRS decides to force a business to reclassify their “contractors” as employees they have been extremely successful in doing so. This is due to the fact that they use a standard of 20 common law factors to make their judgment on whether an individual is a contractor or employee. The issue here is that the 20 common law factors are extremely vague and open to interpretation. This essentially allows the IRS to nearly have free reign on their position as to whether a worker is an employee or contractor.

Legal Defense
Legal Defense

A “Bulletproof” Defense

Despite the fact that the IRS, and the state and Department of Labor, seem to wield absolute power in this situation, there is a way for businesses to defend themselves if they feel they are being unfairly targeted and forced to reclassify contractors as employees. This defense, called “bulletproof” by Knoxville, Tenn., CPA Edward Gee, can be a life saver for businesses in many cases.

The core of this defense is the reliance upon three principals of the Section 530 of the Revenue Act of 1978. The requirements are: the employer must file all applicable tax returns, the employer must have a legitimate reason for not treating the worker as an employee, and the employer must have treated all similar workers as independent contractors.

Due to the vague nature of the second requirement, it is advisable for a business to take into the account the advice of a lawyer or tax professional when classifying its workers as contractors. This will lend much more credibility to the argument.

Like most CPA’s or tax pros, you may have clients with sub-contractors and employees dispersed everywhere. If you’re sending out paper tax forms, cut that work down by 80% with this simple step. Use eFile4Biz.com to efile 1099 forms, and use the spare time to find new clients. Watch the video below to see what I mean. I just love the fact that after I file 1099 online for a client, they will also do the printing and sending out of the clients forms to their employees.

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