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IRS reclassification as an employee occurs where persons claimed as (or claiming to be) independent contractors are recategorized by the Internal Revenue Service (IRS), or by state tax authorities, as W-2 employees. The reclassification can result in the imposition of fines, penalties, and back-taxes for which the employer is generally liable. These amounts could cost a business large sums of money. The U.S. Government Accountability Office (GAO) (formerly known as the General Accounting Office) reports that the IRS claims to lose millions of dollars in uncollected taxes because of misclassification of independent contractors by taxpayers.[1] According to IRS Commissioner Mark W. Everson in a statement made November 3, 2005, IRS audits of small business organized as corporations increased from 7,294 in 2004 to 17,867 in 2005. [2]

Contents 1 Who is being classified? 2 Employee vs. independent contractor 3 Mitigating IRS reclassification risk 4 External links and resources 4.1 Articles

Employers must report the incomes of employees and independent contractors using the IRS form W-2 and 1099, respectively. Employers pay different taxes (i.e. Social Security and Medicare taxes, unemployment taxes, etc.) on the wages of a worker that is classified as an employee. However, these same taxes are generally not paid by the employer on the compensation of a worker classified as an independent contractor. If an employer mistakenly classifies an employee as an independent contractor, the employer is then at risk for being heavily fined and paying back-taxes.

According to the IRS, an employee is anyone who performs services for an employer if the employer can control what will be done and how it will be done. Independent contractors are defined so if the payer or employer has the right to control or direct only the result of the work done, and not the means and methods of accomplishing the result. There are also other categories such as non-employees, which include direct sellers and licensed real estate agents.[3]

One must determine if an evaluation of a worker’s classification is necessary. Independent contractors on an approved vendor list, or whose services are on an exempt services list, may not require an evaluation. Also, independent contractors immediately willing to become W-2 employees through a PER will not require an evaluation. If the analysis is necessary, a qualified Compliance Officer attempts to produce an accurate judgment of the workers classification, and delivers his or her written recommendation to the employer.

• If the individual is classified as an independent contractor, he or she may begin (or continue) assignments as a Form 1099 payee. (He or she may also join a PER as W-2 employees or as Form 1099 payees if desired.) A Compliance File, including all necessary supporting documentation for the compliant independent contractor, is kept on file in the event of an audit.
• If the individual is not deemed to be qualified as an independent contractor, the Compliance Officer contacts the individual to explain the results. At the employer’s request, the individual may be required to join a PER to begin or continue the assignment. By becoming W-2 employees, contractors become compliant with the IRS and state taxation authorities, as all appropriate taxes are withheld automatically.

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