The IRS is shifting it’s emphasis from income taxes to employment taxes, starting in three states: Wisconsin this month; Texas & Arkansas next month. At that pace they will be auditing employment taxes in every state with a year.
That is going to hit like an atomic bomb.
Despite the tone of the article, this is a fundamental shift in IRS audit focus and it is going to be far more dangerous than the typical tax audit. Particularly in California. This is going to rattle through California like a runaway freight train. In fact, this is going to raise more money for California than the UBER case.
You can be legal in California and still break Federal law.
Read the third paragraph in the Accounting Today article. That spells it out. The IRS can no longer afford to audit tax returns with limited success. Very few cheat on their tax returns, because the risk is to high. The constant threat of audit worked. But in most states, the contractor / employment laws are widely ignored. And there is little consequence to pay. Consider the Uber decision. In some states, like California, they are relatively easy to get around.
For every contractor making $130,000 or more, the IRS will net nearly $30,000. Plus penalties & interest. A single employee shifted from contract to employment under federal law reaps more tax than any audit I have ever been involved in.
To better determine how to properly classify a worker, consider these three categories – Behavioral Control, Financial Control and Relationship of the Parties.
Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Behavioral control categories are:
- Type of instructions given, such as when and where to work, what tools to use or where to purchase supplies and services. Receiving the types of instructions in these examples may indicate a worker is an employee.
- Degree of instruction, more detailed instructions may indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.
- Evaluation systems to measure the details of how the work is done points to an employee. Evaluation systems measuring just the end result point to either an independent contractor or an employee.
- Training a worker on how to do the job — or periodic or on-going training about procedures and methods — is strong evidence that the worker is an employee. Independent contractors ordinarily use their own methods.
Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker’s job? Consider:
- Significant investment in the equipment the worker uses in working for someone else.
- Unreimbursed expenses, independent contractors are more likely to incur unreimbursed expenses than employees.
- Opportunity for profit or loss is often an indicator of an independent contractor.
- Services available to the market. Independent contractors are generally free to seek out business opportunities.
- Method of payment. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time even when supplemented by a commission. However, independent contractors are most often paid for the job by a flat fee.
Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. This includes:
- Written contracts which describe the relationship the parties intend to create. Although a contract stating the worker is an employee or an independent contractor is not sufficient to determine the worker’s status.
- Benefits. Businesses providing employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay have employees. Businesses generally do not grant these benefits to independent contractors.
- The permanency of the relationship is important. An expectation that the relationship will continue indefinitely, rather than for a specific project or period, is generally seen as evidence that the intent was to create an employer-employee relationship.
- Services provided which are a key activity of the business. The extent to which services performed by the worker are seen as a key aspect of the regular business of the company.
Consequences of Misclassifying an Employee
Classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. Certain employers that can provide a reasonable basis for not treating a worker as an employee may have the opportunity to avoid paying employment taxes. See Publication 1976, Section 530, Employment Tax Relief Requirements for more information.