Accounting Today - August 16 2010

By GeorGe G. JoneS and Mark a. LuScoMBe
Stakes grow higher
for worker classification

The Congressional Research Service re- cently commented in its report, “Tax Gap: Misclassification of Employees as Independent Contractors,” that tackling the problem of misclassification of workers “would reduce federal, state and local tax gaps and provide other important benefits.” While the issue of worker misclassification is not new — a 1984 report had identified it as a growing problem — the current economic downturn has created new cause for alarm. Because a solution to worker misclassification would generate much-needed tax revenues while doing so under the banner of “fairness” to compliant businesses, the government appears poised to pursue “ misclas-sifiers” with a new sense of purpose.

The statistics in favor of tighter enforcement are convincing. According to the Government Accountability Office, approximately 10 million workers are classified as independent contractors, while as many as 20 percent of employers misclassify workers as independent contractors. Recent estimates peg more than 60 percent of federal revenues coming through the employment tax system. Classification of a worker as an employee immediately raises wage reporting by the worker by way of Form W- 2 reporting and withholding. Another estimate reveals that reporting by workers increases by 25 percent over those issued Form 1099s as independent contractors. Also in play for the Internal Revenue Service is statistical evidence that up to 30 percent of workers who are not issued either W-2s or 1099s do not report either all income or a portion of their income.

While the
issue is not
new, the
current
economic
downturn
has created
new cause
for alarm.
“
”

several additional incentives to hire certain new workers as employees, rather than independent contractors —namely, payroll tax forgiveness and the worker retention credit under the HIRE Act, and the small-employer health insurance tax credit under the health care package. These benefits are only available with respect to employees. Nevertheless, many businesses, especially small businesses, continue to prefer the flexibility typically provided by using independent contractors for at least a portion of their workforce.

Trends such as telecommuting, bottom-up innovation, flex time, fewer brick-and-mortar operations that require a worker to be “in the office” or “on the assembly line,” and productivity innovations that allow workers to “own their own jobs” only reinforce characterization of many workers in today’s economy as independent contractors when measured against traditional “control” factors used to distinguish them from employees. The economic downturn, too, has increased pressure on workers to accept positions as independent contractors, since the negotiating position of workers, who as a class generally prefer employee status, has been weakened by the current oversupply of available workers.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.

IMPACT OF RECENT TRENDS

There is a growing bias, particularly among small-business owners, toward hiring at least part of the business’ workforce as independent contractors, rather than employees. In addition to removing the employer’s direct share of FICA tax and unemployment insurance from the equation, independent contractors may be excluded from health and retirement benefits, as well as more easily terminated under state employment laws.

Recent tax laws admittedly have created

USING SECTION 530

In addressing worker classification issues involved in the employment tax audit, the IRS examiner generally first determines whether the Section 530 safe harbor applies. The Section 530 safe harbor gets its name from Section 530 of the Revenue Act of 1978, which provided relief from what Congress then saw as the IRS’s overzealous application of worker classification criteria. The Section 530 safe harbor allows employers to classify certain workers as independent contractors, even though they may be common-law employees. In fact, if the employment status of any individual performing services for the taxpayer is going to be the subject of an audit inquiry, the IRS must provide the taxpayer with written notice of the Section 530 rules before or at the start of the audit.

The Section 530 safe harbor provides that
an individual who has not been treated as
an employee will not be reclassified as an
employee if:
The taxpayer had a reasonable basis for
not treating the individual as an employee;