It seems like an easy way for an employer to save some money using an innovative HR approach: Classify a few employees as independent contractors and cut out some of the costs associated with employing full-timers. It is easy. And it is dangerous.
Let’s start with the fact that if there’s one thing the Internal Revenue Service knows, it’s numbers. And the IRS has noticed that the numbers of former employees who have been switched to independent-contractor (IC) status keeps going up and up every year.
That’s a red flag to the Tax Man. So the IRS has announced it’s:
- Planning to use 30% of its resources to audit IC classifications to see if they’re for real or just a bookkeeping tactic to save money, and
- Pushing a new bill in Congress, the Taxpayer Responsibility, Accountability and Consistency Act, which contains tougher rules for classifying ICs and tougher penalties for employers who misclassify.
That’s not all. A bunch of states have announced they’re going to step up efforts to catch and fine employers who classify ICs incorrectly. The list of states that have enacted tougher new rules or are considering them: CA, CT, MA, MN, NE, NH, NJ, NY, PA, RI, and UT.
The IRS offers three resources to make sure you’re in compliance when classifying employees as ICs:
- Tip 2008-24: Explains the three major factors IRS uses to evaluate an IC classification.
- Publication 1779, Independent Contractor or Employee?: Provides an overview of the IC rules.
- Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding: The official form and step-by-step process for figuring out, for taxing purposes, who’s and IC and who’s not.