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IRS Pairs Tax Forgiveness Offer With New Initiative to Identify Employees Misclassified as Contractors

    Client Alerts
  • September 30, 2011

Employers commonly misclassify employees as independent contractors, resulting in failure to withhold income taxes from pay as well as matching employer payroll tax contributions. According to the Department of Labor and Internal Revenue Service, this practice has become so widespread, it will increase the federal budget deficit by $8 billion over the next ten years.

In response, last week the two agencies and a number of states announced a joint effort to coordinate enforcement and education efforts intended to identify and address misclassifications. Presumably, the IRS will provide information on persons receiving 1099 compensation to DOL and to state tax and labor agencies to aid in investigation and confirmation of appropriate classifications.

In conjunction with this effort, last week the IRS also announced a limited amnesty program intended to encourage companies to voluntarily correct misclassified contractor designations. Companies not currently facing tax audits can receive up to a 90% reduction in federal payroll taxes and waiver of all penalties and interest if they have filed proper Form 1099s for the workers for the past three years. Details on the amnesty program can be found here.

Employers often misunderstand the legal differences between contractors and employees. The classification decision has little to do with worker preferences or the duration of the business relationship. Instead, the IRS looks to a number of factors centering on the employer's control of the means and methods by which the work is accomplished. If the worker's day-to-day activities are supervised, monitored or controlled by the company, there is a good chance that he or she is an employee, regardless of any purported independent contractor relationship.