Watch out for misclassified workers — Uncle Sam is
Many small business owners try to “save money” by paying their workers as independent contractors when they should have been classified as employees. With low state and federal revenue in 2009-2010, the government entities want their money and are aggressively pursuing businesses that are misclassifying workers.
Here’s some information to keep you and your business out of trouble.
The Internal Revenue Service has stepped up its enforcement efforts in recent years because of billions of dollars in lost revenue to the federal government. The IRS has agreements with 37 states to share data from employment tax audits.
The State of Colorado also has stepped up its enforcement efforts. Legislation enacted in 2009 increases the fine for misclassified employees for the first misclassification with “willful disregard” to $5,000. For the second and subsequent misclassifications with willful disregard, an employer can be fined up to $25,000 per misclassified employee. It can even be worse if, upon the second violation, the company that misclassified employees and independent contractors can be prohibited from contracting with the state or receiving funds from contracts with the state for up to two years.
OK, let’s go back to the IRS. Businesses that unintentionally misclassify an employee as an independent contractor face the following penalties.
For not withholding federal income tax, the penalty assessed is 1.5 percent of wages. This penalty can double to 3 percent if a business didn’t file a 1099-MISC. For not withholding the employee’s share of Social Security and Medicare taxes, the penalty assessed is 20 percent of the employee’s share of the tax. Again, this penalty is doubled to 40 percent if the business didn’t file a 1099-MISC.
If, as an employer, you intentionally misclassify a worker as an independent contractor even after determining an employer-employee relationship exists, the employer is liable for the full amount of federal income taxes that should have been withheld and 100 percent of the employee’s and employer’s share of Social Security and Medicare taxes.
Remember, too, that as an employer, you’re also subject to all the penalties that can be assessed for failing to file returns and pay taxes.
The IRS has several different methods to determine if companies are misclassifying employees as independent contractors. The IRS uses a 1099 matching program that specifically targets individuals who receive only one 1099-MISC in any given year.
Generally, a person receiving only one 1099-MISC will be an employee, rather than an independent contractor, of the company that issued the 1099-MISC. The IRS also looks for individuals who receive both a W-2 and 1099-MISC from the same employer in the same year.
The IRS has an employment tax examination program and examiners assigned to specifically concentrate on employers suspected of worker misclassification based on information received from other federal and state government agencies. If you’ve had an unemployment audit and the Colorado Department of Labor and Employment determined you had misclassification issues, look for the IRS to come knocking on your door.
The question of whether or not your worker is an independent contractor usually hinges on how much control you have over that worker. The more control you exercise over an individual, the more likely he or she should be classified as an employee. You really have to dot your “I’s” and cross your “T’s.”
There are a lot of business owners who’ve been getting away with this. Because of the new attention the government is focusing on this issue, that might change.
If you have questions about how you are classifying independent contractors, you can find additional information on the Colorado Division of Labor and Employment website at www.coworkforce.com or the IRS website at www.irs.gov.
If you’d like to receive an independent contractor checklist, give us a call or come by the office. The checklist offers a straightforward way to take a look at your business practices and keep you out of trouble. We would be happy to answer any questions you might have.