Misclassification of Independent Contractors in IRS Crosshairs

Don Tennant

If you're an independent contractor who's settled in to some comfy gig at a company that makes you feel like one of its own, and you like it that way because you're able to command a higher hourly wage than the guy in the next cube who's on the payroll, you might need to brace yourself for a change.


According to Rick Dacri, a Maine-based human resources consultant and author of the book, "Uncomplicating Management," state and federal agencies are cracking down on the practice of misclassifying workers as contractors when in reality they carry out the same functions as full-time employees. Dacri noted that the Internal Revenue Service last year launched a three-year program to audit 6,000 companies to determine their compliance with employment and tax laws. The IRS has the misclassification issue in its crosshairs not only because contractors are denied such employment benefits as unemployment compensation, but because no payroll tax is levied on those workers.


That the feds are paying attention to all this is nothing new. Dacri cited the situation commonly known by the associated case name Vizcaino v. Microsoft, which stemmed from a 1989 IRS audit of Microsoft's employment practices. The IRS determined that Microsoft had misclassified thousands of workers as independent contractors, and after protracted and costly legal wrangling, Microsoft eventually settled the case for $97 million.


What's changed is the substantially higher level of cooperation between state and federal agencies, and the fact that the skyrocketing unemployment compensation claims that have been one of the hallmarks of the recession are triggering audits. It seems there are a lot of unemployed IT workers who had been classified as independent contractors and who didn't realize that they're not entitled to unemployment benefits. So when they apply for those benefits, their companies get an unpleasant phone call from the tax collector.


Dacri says there are a lot of gray areas, but in about 80 percent of cases, worker classification can be determined by asking three questions:


  • Does the worker perform services that are at the heart of the company's business? If he does, then he's an employee. For example, if you're a Web designer working at a Web design company as an independent contractor, you're likely to raise a red flag.
  • Does the employer control what the worker does and how he does it? "If I set you up in an office, provide you with my own tools, tell you that you have to be in between 8 and 5 Monday through Friday," Dacri says, "you're an employee."
  • Has the individual worker really set himself up independently as an established entity, such as an LLC? If you work for various organizations, do your own billing, bring in your own people, all independent of the employer, you're a legitimate independent contractor.


Dacri notes that the safest route for the employer in handling the other 20 percent of workers who are in the gray areas is to put them on the payroll. "To be perfectly frank," he says, "the laws are old, and they don't necessarily recognize the new workplace. That's where the confusion comes into play for a lot of organizations."


Also complicating the matter is that even if a company is willing to put contractors on the payroll, many contractors want no part of it, preferring instead to keep their independent status. "I see that a lot within the IT industry," Dacri says.

Add Comment      Leave a comment on this blog post
Oct 28, 2010 10:52 AM Alice Flanders Alice Flanders  says:

I deliver the morning paper. It is considered an independent contractor position. that has been the case for many years. I also sell Avon. I see the difference between the two. With Avon I find my own customers. With the paper I am given my customers. I am supposed to add to them, but am given the ones in the area I am to cover. I have no choice, if I have a customer I have to serve them. With Avon I can choose. I can serve a customer if I want to. If I don't want to, I don't have to. With the paper I am given a delivery time. I am fined if I am late or if the paper is wet or if I forget anyone or if someone complains for some other reason. With Avon delivery is between me and my customer. So are complaints. With the paper I am told where to put it etc. With Avon, again, it is between me and my customer. So I see delivering the paper as really an employee situation being called an independent contractor. With Avon I am an independent contractor.

Oct 28, 2010 12:07 PM Joe Mastriano, CPA Joe Mastriano, CPA  says:

It's about time. The Killer IRS CPA has successfully defended taxpayers on this issue. For valuable free info, please visit www.taxproblem.org

Nov 1, 2010 11:52 AM AC53 AC53  says:

As someone who's been an independent contractor (IC) and hired them for over 20 years, it's frustrating to see this issue get mangled in the media. The truth is, the vast majority of ICs are happy with their arrangements. But for some reason, this key piece of the story is missing in the countless articles on the topic.

We, this majority, are self-employed business people, not duped. We are sole proprietors, just as much as someone running a mom-and-pop store who doesn't incorporate. My primary work as an IC has been as a graphic designer and writer. I love the autonomy and other benefits of being self-employed; I have nearly zero interest in being someone's employee.

Unfortunately, the "chilling effect" of this ramped-up enforcement is no small deal. As employers take a beating from the IRS become more reluctant to use ICs, where will my livelihood (and that of the millions of other legitimate ICs) go? Will I effectively be forced into employment or to expensively incorporate my business?

Furthermore, those of us in creative fields can lose the rights to our creations if we are not producing them independently; our employers hold these intellectual property rights.

Lastly, none of these articles point out the benefits to the unions of this movement; more members = more power and more money. So, the unions are behind this in a huge way.


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