Hiring independent contractors instead of employees can save a lot of money in employment taxes and employee benefits.  And it can be a mine field of tax problems if workers are misclassified as independent contractors when they should have been treated as employees.

The three primary characteristics the IRS uses to determine the relationship between businesses and workers are behavioral control, financial control, and the type of relationship.

  1. Behavioral Control– Covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.
  2. Financial Control– Covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.
  3. Type of Relationship– Relates to how the workers and the business owner perceive their relationship.

If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.  If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

This issue has been heating up recently as the government looks for ways to reduce the deficit.  A recent study by the IRS estimates there are 3.4 million workers misclassified as independent contractors, causing a loss of $2.7 billion in tax revenue.

The IRS initiated an expanded focus on this issue in 2010 and continues to ratchet up enforcement with increased audits, and now the IRS and the Department of Labor have begun to share information and collaborate on this issue.

The IRS just recently announced a Voluntary Classification Settlement Program (VCSP) that allows employers to come into compliance by making a minimal payment covering past payroll.  Employers wishing to participate in this program must apply for the program at least 60 days before they want to start treating the workers as employees.  To be eligible, the employer must have filed the required 1099 forms for the workers in the previous three years and not be under audit concerning the employees.

If you have questions related to worker classification, please give this office a call.