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A Rose by Any Other Name...Calling an Employee a "Contractor"

Payroll Taxes are just a cost of doing business…unless you declare that all of your “employees” are no longer employees, but rather independent contractors, reported on Form 1099. Sounds like a great strategy but it doesn’t work.

The IRS has been cracking down on employers who erroneously classify their employees as independent contractors for tax purposes. The idea is for the employer to dodge its obligation to match FICA withheld from the employees’ checks, as well as various other taxes and insurance requirements that apply to employees but not to contractors. The employees buy into the misclassification because they either do not know that the tax burden is merely being shifted to them by virtue of Self Employment Tax or they are sold on the idea that they can deduct a lot of expenses on their Form 1040 which are otherwise not deductible (this is a complicated matter which is beyond the scope of this article).

But calling a pig a princess doesn’t make it so. The classification of employee v. contractor depends upon the facts of the relationship, not upon the label applied to the worker, or even an agreement between the business and the worker as to how they will be treated for tax purposes. The IRS has published its guidelines as to when it will consider a worker an employee v. an independent contractor in Revenue Ruling 87-41 (the factors can be found here). These factors are the IRS guidelines, and the courts are not necessarily bound to agree with those guidelines, but they give an idea of whether the classification might cause problems if the IRS decides to look into the matter.

There is statutory relief for businesses that have misclassified employees and wish to voluntarily “confess their sins” to the IRS and agree to reclassify its workers as “employees”. There is also relief for certain business who have their workers reclassified upon examination by the IRS. This relief can be found at Section 530 of the Internal Revenue Code. The voluntary compliance program and the IRC 530 relief are discussed in this article from The Tax Advisor, published by the AICPA.

Part of the General Counsel services provided by Penzien & McBride, PLLC to business clients involves dealing with employment issues and guidance regarding the proper classification of workers. If you feel your business may have a potential problem with worker classification matters, or if you have questions about the rules, as pertain to your business, give us a call at (586) 690-4400 and we can set up a meeting to discuss your concerns.