Organizations looking to reduce expenses by hiring contingent workers may ultimately pay more than anticipated if those workers are not properly classified on employer employment tax returns. A contingent worker is defined as a temporary or part-time worker, usually one working under contract for a fixed period or a specific project. The IRS began a three-year audit of 6,000 U.S. companies in February 2010, focusing on how employers classify independent contractors, to ensure correct payment of required employment taxes funding Social Security and Medicare benefits.
Additionally, federal and state officials are enacting stiffer penalties for worker misclassification and aggressively pursuing companies positioning employees as independent contractors as a way to help offset record budget deficits. President Obama's 2010 budget forecasted that the federal effort alone will generate at least $7 billion dollars over ten years.
In general, an employer/employee relationship exists when the worker is required to comply with the employer's instructions regarding when, where, and how to work. The IRS has established a 20-factor test to determine the right to control and direct a worker and identified three categories to assess in determining worker classification. These categories are behavioral (Does the company control or have the right to control what a worker does and how the worker performs the job?), financial (Are the business aspects of the worker's job controlled by the payer?), and type of relationship (Are there written contracts or employee-type benefits? Will the relationship continue and is the work performed a key aspect of the business?).
There are special benefit plan issues that could arise from worker misclassification. If the IRS determines an employer/employee relationship exists, then such individuals may acquire benefit plan participant status, requiring the employer to pay an additional expense or employer contributions to its benefit funds. Other issues include benefit plan disqualification and ERISA litigation.
To protect your organization from litigation and/or significant penalties, research the law, evaluate the relationship and degree of right to control, and develop and implement guidelines to prevent worker misclassification. Some examples include not allowing contingent workers to identify themselves as company employees or have company business cards, not permitting contingent workers to supervise company employees, not providing training other than basic orientation to contingent workers, and limiting the duration of contingent worker engagements.
To read more, visit www.IRS.gov and search Employee vs. Independent Contractor. If you have questions or would like us to work with your organization to evaluate worker classification, please let us know.
By Karl F. Gawlas, CPA, Partner, kgawlas@legacycpas.com