Worker Misclassification Still ‘Hot Issue’ for the IRS

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The misclassification of workers as independent contractors rather than employees is still an ever present issue for the IRS. Recently, the IRS issued another reminder for employers about the importance of correctly classifying workers for purposes of federal employment taxes (Fact Sheet-2017-9). Generally, employers must withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to employees. However, employers with employed independent contractors avoid these tax obligations but have an additional IRS-related responsibility as far as information reporting on amounts of $600 or more paid to a contractor.

Determining the Worker Status

Whether a worker is classified as an employee or an independent contractor depends on a number of factors which fall into three categories: behavioral control, financial control and the type of relationship between the worker and the service recipient. Within these categories, the IRS has further identified 20 factors that can be used to establish whether an individual is an independent contractor or effectively an “employee.”

One must look at all of the facts and circumstances surrounding the relationship to determine between independent contractor versus employee status. No one factor alone is decisive in concluding this relationship and not all factors are present in all employee or independent contractor relationships. Frequently, the relationship of a worker is clear cut using these factors; but sometimes a worker can fall into a gray area.

Taking the Form SS-8 Route

An employer who is unsure of how to classify its workers can request a worker classification determination by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Many employers opt for this no-cost determination route, because worker classification has become such a “hot” audit trigger, and penalties on top of back employment taxes can result from a classification misstep.

After-the-Fact Relief

Misclassification of employees as independent contractors exposes the employer to employment tax liability. Two IRS programs for employers to escape or ameliorate liability, even for an after-the-fact classification are: “Section 530 relief” and relief under the Voluntary Classification Settlement Program.

Section 530 relief: An employer that classifies its workers as independent contractors using a reasonable basis may be entitled to special relief under Section 530 of the Revenue Act of 1978. “Section 530 relief” protects taxpayers who have consistently treated workers as independent contractors using a reasonable basis. Careful – this rule covers workers who are common law employees, but does not cover certain third-party-arranged technical service workers.

A reasonable basis classification for purposes of Section 530 relief generally includes an employer’s treatment of the worker based on any of the following:

  • judicial precedent, published rulings, technical advice to the employer or a letter ruling to the employer;
  • a past examination of the taxpayer by the IRS in which there was no assessment attributable to the treatment for employment tax purposes of individuals holding positions substantially similar to the position held by this individual; or
  • long-standing recognized practice of a significant segment of the industry in which the individual was engaged.

Voluntary Classification Settlement Program (VCSP). Entry into the VCSP can provide an opportunity to reclassify workers as employees for future tax periods with partial relief from federal employment taxes. Under the program, the employer accepts all of the following:

  • Agrees to prospectively treat the class of workers as employees for future tax periods;
  • Will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under reduced rates;
  • Will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years; and
  • Will not be liable for any interest or penalties on the liability.

Under the VCSP, an employer may reclassify some or all of their workers. However, once reclassified, all workers in the same class must be treated as employees for employment tax purposes.

Worker Initiative Also Available

The latest IRS Fact Sheet on employee misclassification noted that workers can also have indirect input on whether an audit will take place rather than employer-based initiatives described above. “Workers who believe an employer improperly classified them as independent contractors may use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee’s share of uncollected social security and Medicare taxes,” the IRS Fact Sheet concludes.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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