Worker Classification Audits
Misclassification of a worker as an independent contractor can create serious problems for business owners. Under federal and state employment tax laws an individual can be classified as an independent contractor or an employee. Generally, when a worker is classified as an employee the employer must withhold and pay Social Security taxes and Medicare taxes, pay unemployment insurance taxes, and withhold income taxes on the wages paid to the employee. Additionally, pursuant to the Patient Protection and Affordable Care Act employers of a certain size must provide their employees with health insurance or pay a substantial fee to the federal government. When an individual is hired an as an independent contractor the employer is not responsible for withholding taxes or providing these benefits: the independent contractor must generally pay a self-employment tax (Social Security and Medicare tax) along with income taxes.
Employee or Independent Contractor?
The determination as to of whether a worker is an employee or independent contractor for federal tax purposes generally focuses on the extent to which the worker is subject to the control of the business owner. The more control a business owner exercises over the worker, the less likely the worker will be found to be an independent contractor.
The factors used by the IRS to evaluate an independent contractor classification are commonly referred to as the “IRS 20 Factor Test.” The control factors set forth in the IRS worker classification test range from instructions, training, and integration to continuing relationships, set work hours, and payment schedules. The IRS cautions that the degree of importance of any factor will vary depending upon the occupation and the specific circumstances under which the services are performed. Additionally, other factors may come into play when making a determination.
States use different tests to determine whether a worker has been properly classified as an independent contractor or employee for state tax purposes. While some states such as Virginia defer to the IRS criteria, other states have established their own tests to decide whether an employer-employee relationship exists. Businesses should exercise extreme caution when classifying their workers and consult with a skilled employment law attorney who can help identify potential misclassification problems.
When a company misclassifies its workers as independent contractors serious consequences can arise at both the federal and state levels. The IRS has specifically warned businesses and individuals about certain questionable employment tax practices, including “misclassifying worker status.” If a company misclassifies an individual as independent contractor, the company may have to pay years of back employment taxes on the worker, along with interest and penalties. Additionally, in the most egregious situations the company may face criminal prosecution.
A Virginia Tax Attorney Can Help
If you have concerns about a worker classification or believe you may be subject to an IRS worker classification audit, Thorn Law Group can help. We are a skilled team of tax law professionals that counsel and defend businesses throughout Virginia and around the world in IRS audits and criminal investigations. Our attorneys will carefully evaluate your situation to determine the best path for successfully resolving your problems, including whether participation in the IRS Voluntary Classification Settlement Program (VCSP) may be appropriate. The VCSP allows employers to voluntarily come forward to reclassify their workers as employees for future tax periods in exchange for partial relief form federal employment tax liabilities.