Many small business owners try to “save money” by paying their workers as Independent Contractors, when they should have been classified as employees. With low state and federal revenue in 2009-2010 the government entities want their money and are aggressively pursuing businesses that are misclassifying workers. This may be some information that will keep you and your business out of trouble.
The IRS has stepped up its enforcement efforts in recent years because of billions of dollars in lost revenue to the government. The IRS has agreements with approximately 37 states to share data from employment tax audits.
The State of Colorado has also stepped up the enforcement efforts also. On June 2, 2009 HB09-1310 became law. This law increases the cost of misclassified employees for the first misclassification with willful disregard to $5000. For the second and subsequent misclassifications with willful disregard an employer can be fined up to $25,000 per misclassified employee.
It can even be worse if upon the second violation the company that misclassified employees and independent contractors can be prohibited from contracting with the State or receiving funds from contracts with the State for up to two years.
OK, let’s go back to the IRS. IRS penalties for unintentionally misclassifying an employee as an independent contractor can be faced with the following penalties.
• For not withholding federal income tax, the penalty assessed is 1.5% of wages. This penalty can double to 3% if you didn’t file a 1099-MISC to the IRS.
• For not withholding the employee’s share of social security and medicate taxes, the penalty assessed is 20% of the employee’s share of the tax. Again this penalty is doubled to 40% if you did not file a 1099-MISC.
If as an employer you intentionally misclassify the worker as an independent contractor even after determining an employer-employee relationship exists, the employer is liable for the full amount of federal income taxes that should have been withheld and for 100% of the employee’s and employer’s share of social security and Medicare taxes. And remember, that as an employer you are also subject to all penalties that can be assessed for failing to file returns and pay taxes.
The IRS has several different methods to determine if companies are misclassifying employees as independent contractors. The IRS uses a 1099 Matching Program that specifically targets individuals who receive only one 1099-MISC in any given year. Generally a person only receiving one 1099-MISC will be an employee rather than an independent contractor of the company that issued the 1099-MISC.
The IRS also looks for individuals who receive both a Form W-2 and a 1099-MISC from the same employer in the same year.
The IRS has an Employment Tax Examination Program (ETE) and has IRS examiners assigned to specifically concentrate on employers suspected of worker misclassification based on information received from other federal and state government agencies. If you have had an unemployment audit for the Colorado Department of Labor and they determined that you had misclassification issues, be on the lookout for the IRS to come knocking on your door.
The question of whether your worker is an Independent Contractor or not usually hinges on how much control you have over that worker. The more control you exercise over the individual, the more likely they are to be classified as an employee. You really have to cross your “T’s” and dot your “I’s”. There are a lot of business owners who have been getting away with this and because of the new attention that the government is placing on this that may change.
If you have questions regarding how you are classifying independent contractors you can find additional information on the Colorado Division of Labor and Employment website www.coworkforce.com or at the IRS website www.irs.gov.
If you would like to receive an “Independent Contractor Checklist” please just give us a call or come by the office. This checklist is a straight forward way to take a look at your business practices and keep you out of trouble. We would be happy to answer any questions that you might have.
Autopaychecks – 245-4244, we are at 441 Colorado Ave. Grand Junction CO 81501