Although hiring independent contractors can reduce the paperwork, tax burden and hassles associated with bringing on employees, Christopher Ezold, a business attorney and tax partner with the Ezold Law Firm P.C., a Philadelphia-based employment and business boutique, warns that employers can expect contractor classification changes by the IRS in 2012.
The IRS and the U.S. Department of Labor are partnering to uphold an information-sharing memorandum with 11 states that ensures employers are not misclassifying employees as contractors, and employers in all states can face random audits throughout the year.
According to the IRS, it intends "to end the business practice of misclassifying employees in order to avoid providing employment protections." In fact, a report by the U.S. Government Accountability Office finds that more than 80 percent of workers at inspected construction sites were misclassified as independent contractors in one particular region. The IRS estimates that misclassifying workers could cost $7 billion in taxes and penalties, which could add to federal coffers during the next 10 years.
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"Regardless of current practices, employers need to carefully examine IRS guidelines on what constitutes an employee versus a contractor, and they must ensure that they meet the federal standard or face penalties and interest for failing to do so," Ezold says. "For employers who have misclassified workers, there may be relief for companies that act promptly. The IRS has instituted the Voluntary Classification Settlement Program, offering partial amnesty to offenders."
The IRS will waive fines and penalties for employers that mistakenly categorized employees as independent contractors, and those participating in the settlement program must pay just more than 1 percent for the wages paid to misclassified workers during the previous year. The IRS also will not conduct audits on employers from previous years.
"The clock is ticking for every employer who has misclassified contractors," Ezold says. "Make sure you're in compliance. If not, it's worth examining the benefits of the partial amnesty program. The program has downsides that aren't published, so a thorough review is necessary. Delaying could cost you significantly more money down the road and added IRS scrutiny."
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