If your company is a staffing agency contracting with independent contractors to provide services to third parties or you regularly contract with independent contractors to fill staffing needs, be prepared for a new and aggressive attack by the Internal Revenue Service ("IRS").
As noted in the Kiplinger Tax Letter, dated August 2, 2013, and Bloomberg Businessweek dated August 14, 2013, the IRS has made it clear that the agency intends to devote major audit resources to investigate worker misclassification, and it appears the focus will be on small businesses. Much of the impetus results from a study the IRS began several years ago, as well as a report issued by the Treasury Inspector General for tax administration, dated June 14, 2013, detailing how employers do not always follow IRS worker determination rulings in response to the determination of the Worker Status Program, better known as the SS-8 Program.
The IRS's challenge to the classification of workers as independent contractors is not new but dates back to aggressive employment tax audits the IRS conducted in the 1970s, which culminated in Congress adopting Section 530 of the Revenue Act of 1978. Section 530 grants relief to businesses that have filed Form 1099 on the disputed workers, provided they have treated all similarly situated workers as independent contractors. For more information regarding the scope of Section 530, please contact Barry H. Frank, Esquire, author of this Tax Advisory, using any of his contact information below.
This latest IRS crackdown is based on several factors. First, starting in 2015, firms with at least 50 full-time employees must offer affordable health insurance to all employees or substantial penalties will be imposed. If independent contractors are converted to employee status, this may result in a company having more than 50 full-time employees. Second, based on a project to conduct 6,000 random audits over a period of three years with worker classification/misclassification as a key focus, the IRS anticipates that when the project is completed, it will pursue employment tax referrals from state agencies that deal with the classification of workers for both workman's compensation and unemployment purposes.
Unfortunately, the IRS, in its own training manual, states that IRS Agents should not be influenced by the results of audits by state agencies. One of the principal reasons for this is that many states do not follow the IRS common law factors for determining worker classification, but have other tests and standards for determining whether a worker is entitled to workman's compensation or unemployment benefits and should be reclassified for those purposes from independent contractor status to employee status.
Finally, as a result of the report completed by the Treasury Inspector General, the IRS has found that while it believes employers misclassify millions of workers as independent contractors instead of employees, those employers that receive IRS determinations under the SS-8 Program do not reclassify all similar workers to employee status. The Inspector General's report found that there is little, if any, follow-up under the SS-8 Program. However, it is clearly stated on an SS-8 determination that a purported employer is not required to convert workers to employee status if they qualify for relief under Section 530.
Another significant problem with the SS-8 Program is that too frequently Form SS-8s are submitted by disgruntled former independent contractors, who file despite the fact that they may have signed a contract clearly stating that they are independent contractors responsible for payment of their income tax, social security tax, etc., and are not covered by unemployment insurance or workman's compensation insurance. And, far too frequently, this disgruntled worker will complete the form on a far too one-sided basis with inaccurate information. Although a purported employer has the opportunity to respond to the SS-8 submitted by the worker, in my experience it is rare that an SS-8 submitter is held to be an independent contractor.
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