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Employee? Independent Contractor? New Laws and IRS Auditing Want to Know

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Money’s tight, so we are always looking for ways to augment our income.  So are our governments.  That’s why the 1099 requirement was added (and why, even though it is going to be a royal pain in the neck, it will be VERY difficult to remove this provision without a tremendous turnaround in the economy, an imposition of a  big new tax, or cutbacks that will hurt).  It’s also why the “Independent Contractor” (Section 530) misclassification is a hot topic.  (It has been one since 1984!)

The government believes that there are about 10 million fake independent contractors.  And, 60% of Federal revenue comes from employment taxes (that alone is a scary number).  Couple that with the estimated 30% of those NOT issued W2’s (and probably 1099’s) who never report said income (see line 1 above, now).  Now, the biggest contributors to this problem are small businesses, as opposed to illegal alien employment, which is the favorite of the larger firms.  It not only cuts employment taxes, but it also saves retirement benefits, health benefits, unemployment, etc.

Here’s the rub: telecommuting, flex time, and non-brick-and-mortar employment are not contractor employment.  They are still honest-to-goodness employees, and if you get caught, the penalties are big.  Moreover, you can’t file bankruptcy and have these go away and immediate, no notice levies can be imposed by the IRS; they consider your non-payment and non-filing a continuous breach, that must be addressed immediately.  Also, your state government may immediately perform an audit to insure that wage and hour regulations were not breached.

The IRS has begun “non audit” audits, called National Research Project exams. Six thousand entities will be examined, two thousand  a year in 2010, 2011, and 2012, supposedly spread among large/medium employers, small/self-employed businesses, and tax-exempt entities.

At the same time, Congress is getting into the act.  At least FOUR bills, 2 Senate: 2882 and 3254, and 2 House: 3408 and 5107, have been proposed to cover this situation, upping the penalties dramatically. The first of two for each house, 2882 and 3408, will eliminate Section 530 Safe Harbor provisions, unless there has been an IRS determination.

Here are the requirements:

1.  A reasonable basis exists for not treating the subject as an employee

2.  No similar subjects exist in the enterprise that are not similarly classified

3.  Forms 1099 have been issued and Federal tax forms also complete.

Additional reasons to bolster the case:

1.  A previous determination by the IRS has proven this case.

2.  Judicial precedent or published rulings that describe the situation obtaining in this case.

Once the IRS begins its audit, it will examine the case employing the 20 tests covered in Revenue Ruling 87-41.  These tests address the matters of behavioral control, financial control, and interparty relationships.

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About RAAckerman

  • dharma55

    As an accountant, I can tell you this is an issue I’ve personally had to deal with over the years. I’ve had to “fire” clients who refuse to file the appropriate forms, either W-2 or 1099. And you are correct, the most frequent abusers are not the ones hiring so-called “illegal” aliens – although we call them migrant workers – but the ones hiring bone fide US citizens in good standing who would otherwise be paying their taxes just like everyone else and chose to be paid under the table instead.