It’s scary keeping an eye on Washington and tax-related legislation that has been introduced in Congress these days. Because of large and growing annual federal budget deficits, it seems bill after bill has been introduced this year to attack what are perceived to be major tax gap components. And many of these bills are directed at subject areas that are of particular interest to smaller businesses.
The latest rumblings that are cause for concern and awareness involve legislation that has been introduced to take aim at the mis-classification of employees as independent contractors, and the curtailment of the long-standing “safe harbor” provisions of Section 530 of the Revenue Act of 1978, which provided some objective guidance and protection for businesses in this area.
The back taxes and penalties that could be assessed upon reclassification of independent contractors as employees by the IRS could be expensive, and in some cases catastrophic, to a small business. And with the knowledge that President Obama’s budget for the 2011 fiscal year includes $25 million for the hiring of 100 new “enforcement personnel” focused on misclassification, it reinforces the fact that well run small businesses should take at least the following initial steps to reduce the risk in this area if they use independent contractors:
- Review with your CPA and/or attorney the IRS 20-factor common-law test, which the IRS utilizes for classification purposes. Determine that you are comfortable with your classifications based on the test. Where you have the ability to “tweek” relationships (as per the 20- factor test) to more clearly reflect the fact that you have independent contractors versus employees, do so.
- Execute a written independent contractor agreement with all contractors. The agreement can be very simple, should mention the treatment of the individual or entity as an independent contractor, not an employee, and all language should be consistent with the independent contractor relationship.
- Obtain a Form W-9 from all independent contractors, and file timely Form 1099′s on an annual basis.
- Finally, if you have individuals you are treating as independent contractors who should clearly be employees, then change your relationship accordingly. That will be the best and cheapest decision in the long run.