The IRS recently announced a three-year audit program under which it will review the employee/independent contractor status of workers at 6,000 companies, with the bulk of the audits aimed at small businesses. The audits are set to begin February 16 and will include an examination of executive/officer compensation and fringe benefits.

For Federal tax purposes, there are two classifications of workers: an employee of the service recipient or an independent contractor. The distinction is significant, as it determines the employer’s FICA (Social Security and Medicare), FUTA and income tax withholding obligations. For service providers classified as employees, the employer is responsible for a portion of the employment taxes and must properly withhold the employee’s share from the employee’s wages. For service providers classified as independent contractors, however, the employment tax burden is entirely on the service provider.

Since the employment tax liability and obligations are significantly less for independent contractors, employers have an incentive to classify service providers as independent contractors. In addition, classification as an employee may require inclusion in employee benefit plans (such as retirement plans). Failing to properly classify service providers as employees, however, can be a costly mistake; one that the IRS would be more than happy to reveal.

Improperly classifying an employee as an independent contractor can result in the IRS assessing significant penalties and interest in addition to the original employment tax liability. Being overly conservative by classifying all service providers as employees (rather than as independent contractors) can be an expensive mistake as well, however, as such a classification may result in the employer paying additional employment taxes for which it would otherwise not be liable.

Therefore, properly classifying service providers is important in order to provide protection from IRS audits while avoiding unnecessary tax obligations. Because there is no bright-line rule on what constitutes an employee or an independent contractor, however, it is important to know the employment classification rules so that the employer is protected.

Whether you need guidance through an IRS audit or if you need assistance in properly classifying your workers, the attorneys at Polsinelli Shughart PC are experienced in income tax and employment issues.

For More Information:

If you have any questions regarding this information or how an audit may affect you, please contact:

• William J. Sanders | wsanders@polsinelli.com | 816.360.4240
• J. Harlan Stamper | hstamper@polsinelli.com | 816.374.0544
• S. Patrick O'Bryan | pobryan@polsinelli.com | 816.360.4237

or your regular Polsinelli Shughart attorney.

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