Should Your Independent Contractors Really Be Employees?

About a half year ago, I wrote about some mistakes that small business owners make https://mycpajay.wordpress.com/2012/03/19/mistakes-small-business-owners-make-that-can-cost-themdoh/. One of the items that I briefly discussed was classifying employees as independent contractors, which has become an issue that IRS and state unemployment funds have zeroed in on, in recent past. This article will discuss the issue in a little more detail, and give a few tips on how to stay on the right side of the law.

Here are some interesting stats:

-a 2005 Bureau of Labor Statistics report indicated that contractors made up only 7.4% of all workers, or about 10.3 million workers

-a 2011 study found that 16 million workers were classified as independent contractors, and predicted a higher use of contractors in the next ten years

-a 2000 Department of Labor study found that 10-30% of all employers misclassified workers, and in 2008, IRS found that when employers asked IRS for proper classification, only 3% of workers in question were actually independent contractors, and not employees. You don’t need to be a math whiz to see that most workers are employees!

Considering that it can be about 30% cheaper to call somebody an independent contractor, you can understand why people would want to take that route, even if a person really should be considered an employee. To throw a little fear into you, a 2009 Government Accountability Office report said that 71% of IRS worker misclassification examinations resulted in a change of the worker status. Based on that, the odds are not on your side if you misclassify an employee as a contractor, and you’re called in for an audit. So what can you do to better your odds of classifying correctly?

Review Form 1099s for proper classification-Form SS-8 (Determination of Worker Status For Purposes of Federal Employment Taxes…) is a great guide for determining who has control over the worker, which is one of the main determinants of whether the worker is independent or not. Figure out whether similar workers are categorized differently.

Review workers who received Form W-2 are now treated as contractors-If there’s a reason why somebody who had been an employee is now considered independent, make sure you’ve got a clear, documented explanation for the change.

Review your vendor list, check register, and accounts payable-you can add to your troubles if you were required to file Form 1099-MISC for people who actually are independent, but you didn’t. Penalties can add up. Starting with 2011 business returns, there are now two specific questions about this, so if you have 1099 filing responsibilities, don’t forget to do it.

As I mentioned at the beginning, the employee vs independent contractor issue is something that’s receiving more and more attention, and probably won’t go away any time soon, so make sure you’re doing the right thing, to save yourself from potential major headaches in the future.

Please pass this article on to any small business owner you know, who may benefit from this information, and leave a comment if you’ve had any experiences with this issue, or were audited.

Jay E Reiner CPA PLLC, 1400 14th St N, Arlington, VA 22209

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