Make Sure Your Employment Taxes Are in Order

Labor & Employment Department

Do you employ independent contractors? If so, you should be aware that the IRS is focused on you. The IRS just began its first comprehensive audit of employment tax issues in over 25 years. The IRS plans to audit 6000 companies in total over the next three years. These employment tax audits will focus on three areas: worker classification, executive compensation, and taxable fringe benefits.

Why IRS audits of employment taxes?

The main focus of the IRS’ audits will be worker classification. The recession has left many employers unable to support the costs associated with full-time employees. As a result,more employers have utilized independent contractors. When workers are classified as employees, the company pays employment taxes or withholds income taxes. Misclassification affects the ability of the IRS to collect all taxes that should have been paid, and it denies workers the ability to participate in employee benefit plans and receive legal protections to which they may not otherwise be entitled. For example, independent contractors are not entitled to unemployment, retirement and health benefits offered through the hiring company or many of the protections afforded to employees through the various federal acts that protect employees.

What risks do employers face?

Employers who misclassify workers as independent contractors face numerous types of actions, including federal and state agency audits and enforcement actions, individual employee actions, and possible class actions. If the IRS makes the finding that an independent contractor should have been classified as an employee, an employer could face potential liability for: unpaid taxes; unpaid Medicare and Social Security contributions; unpaid workers’ compensation premiums; unpaid unemployment compensation contributions; Pension payments or 401(k) plan contributions; medical benefits; overtime pay; and related penalties and interest.

What should an employer do?

With increased scrutiny of independent contractor classifications and the current economic climate, now is a good time for employers to review their worker classifications. Performing such a review now could reduce the risk of a full-blown audit and costly penalties for employers found to have misclassified their employees as independent contractors.

To conduct an effective audit, the auditor must understand how to weigh various factors — none of which are controlling. There is not a clear test for determining independent contractor status. Instead, the determination of whether the individual is an employee or an independent contractor is determined by applying various factors to each arrangement.

Therefore, it is prudent to engage knowledgeable employment counsel to conduct an internal audit of your independent contractors. Employment counsel can:

• Identify potential misclassification issues
• Recommend remedial measures
• Provide you with the measures to fix any existing problems in addition to puttinga process in place to ensure that — going forward — you are properly classifying employees.

The Business Department at MacElree Harvey has attorneys who can perform audits and advise you on properly handling independent contractors as part of your workforce.

The following article is informational only and not intended as legal advice. Speak with a licensed attorney about your own specific situation. © Copyright 2011 MacElree Harvey, Ltd. All rights reserved.