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Independent Contractor Status Under Surveillance by IRS

by Darci Congrove

The IRS has recently announced plans to audit 6,000 businesses selected at random to determine whether they have workers improperly classified as independent contractors who should be treated as employees instead. When appropriately applied, i

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ndependent contractor status allows a business to escape paying unemployment, overtime, Medicare and Social Security taxes. However, when worker misclassification is caught, additional taxes, penalties and interest are likely to result.

Shifting from full-time employees to independent contractors is a measure that many businesses have used to cut costs during the recession. However, it is important to determine whether workers really meet the IRS standard to be classified as contractors. Written independent contractor agreements should be in place for each worker, which outline the day-to-day job requirements, who is in charge, who provides the equipment and supplies, etc. Individuals who report to an office every day and perform work solely for one company are unlikely to qualify as contractors and are exactly the type of arrangements that the IRS is targeting. Businesses should be especially cautious about laying off workers and then hiring them back as contractors.

When determining the appropriate classification of workers, facts that provide evidence of the degree of control and independence fall into three categories:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Further guidance can be found on the IRS website at www.irs.gov/businesses/small.

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