As if tax season wasn’t going to be confusing and overwhelming enough, small business owners are now being cautioned to spend a bit of extra time with their returns this year. There are a couple of reasons as to why this could be the best decision they make this year when it comes to their accounting. One of those reasons has many small business owners concerned: Uncle Sam is going to be closely monitoring worker classifications on those owners’ tax returns. The reason being many are classifying their employees as independent contractors.
One Primary Goal
According to the IRS, it has one goal that many of its agents will be dedicating time to. Because so many are now being classified as independent contractors versus the traditional hourly or salaried employee, and because it has everything to do with minimum wage laws and later this year, health care laws that are sure to affect a company’s bottom line and other financial considerations, it’s become a priority. Further, some say by classifying workers as contractors, companies can bypass having to pay payroll taxes, Social Security, unemployment and Medicare.
So far this year, 6,000 companies have already been or are in the process of being audited. The crackdown has spread to the state level too as fourteen states that have reiterated their commitment of working alongside the IRS are well into their own investigations to ensure compliance.
Many Americans Misclassified
According to the IRS, approximately 30% of American workers are not classified properly. President Obama reiterated his commitment to the investigations and said there is potentially $7 billion in revenue that’s not being funneled to the government. Penalties are high, too, and can easily hit the 100% mark in terms of what’s owed to the IRS.
Companies are looking for ways to save money as they continue to struggle in the weak economy. The fact that the country is facing tremendous new taxes, Obamacare, still-growing unemployment and a host of other expenses that have kicked in since Obama went into office is only worsening the situation. By classifying some as independent contractors, it shifts the burden from the company to those contractors. The IRS will be looking to ensure everyone is classified properly.
So what exactly will the IRS be looking for? Many are wondering if there are telltale signs that will alert the government. During these audits, the focus will be on compliance with the law. This mean companies, and certainly small businesses, are looking for ways to reclassify their employees if they believe they’re at risk. To accommodate those efforts, a new program was designed.
The Voluntary Classification Settlement Program (VCSP) was created to assist business owners in their efforts of double checking the statuses and then reclassifying where necessary for tax purposes. Not only that, but it also allows these companies to bypass those penalties provided they come into compliance. It’s the one way they will be able to finally right the wrongs, whether they were made in good faith or deliberately made to bypass the taxes and other costs associated with their payrolls.
The IRS reminds business owners that it’s a voluntary program and that the companies must make the effort to seek it out. There are eligibility requirements, specifically, filing of Form 8952, Application for Voluntary Classification Settlement Program. Once that’s been submitted, the company must agree to enter into a contract with the federal government and remain in compliance. It’s also important that the distinction is made between an income tax audit versus an employment tax audit. Under an income tax audit, outside services or independent contractor categories are under the microscope. Auditors examine 1099 forms to ensure they’re properly classified.
It’s not surprising, then, that many are confused when it comes to how independent contractors are classified and what those distinctions are that make them different than a traditional employee. Anyone who offers the same service or work load that your firm offers should be considered an employee. For instance, if you own an ice cream shop and you have people who keep the ice cream machines filled and operate your cash registers, they’re considered employees. Not only that, but just because you and your independent contractors agree to the classification, you aren’t able to bypass the law – even if they agree to handle their own tax filings. The business owner is the one will be penalized by the IRS.
So what happens if you hire someone to design, say, a new logo? They can be treated as an independent contractor. They’re providing a service that you or your other employees can’t provide and they’re not obligated to account for their time. Their only obligation to you is to provide the service in the timeframe you specified. Throw in a contract, an office that the contractor works out of and his own clientele and that only further cements the fact that you’re working with an independent contractor. Does the employee/contractor come to you for a day off? If so, it’s an employee. Does the employee/contractor negotiate what it’s going to cost you for her services? If so, you have an independent contractor.
Then, there’s the occasional toss up. An example used by the IRS includes the masseuse who has his own business, clients, license and perhaps even business cards and a website. If a company commits to paying a fee for each massage, that eliminates the possibility of it being an independent contractor and makes that masseuse an actual employee. Sound confusing? That’s more the reason to seek out the Application for Voluntary Classification Settlement Program.
If, after you’ve applied for the program and approved, you’ll have to pay at least 10% of the liability you owe in the current year. The IRS will agree to not audit you during those years you had misclassifications. A payment arrangement is then defined if necessary, allowing you to right the wrong with no fears of long term problems. Finally, if you have questions, such as whether you can use a credit card to pay the past due penalties and taxes, you’re encouraged to contact your CPA or the IRS.
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