Small Business Owners — Are You Classifying Your Employees Correctly?

While cleaning out some old papers I had stacked up, I ran across an article from WAY back in 2013 on the IRS crackdowns on small businesses with payroll audits:

“Payroll Audits Put Small Employers on Edge; Tax Crackdown Intensifies as More Businesses Use Contract Workers to Cut Costs; Firms Protest That Rules Are Unclear”

So, why do employers treat their employees as if they are self-employed? The most common excuse is that the rules are difficult to understand. When clients come to me asking if they can make their employees sub-contractors, I ask these simple questions to help provide an answer:

  • Do you tell them when to arrive, leave, or take lunch?
  • Can they take on other work and not show up?
  • Do they have their own business outside of working for you?
  • Do they send you an invoice stating their rate for the work done, or do you set their hourly wage?
  • Do you provide the tools for them to complete the required work?
  • Do you instruct them on how to complete the work?
  • Is this an ongoing job or does it have a definite period?
  • Is there a contract or engagement between the worker and the business?
  • Can the person bring in others to assist in completing the job?

Generally, most of the answers fall into the “they are your employees” category. The reason employers want the workers to be subcontractors is often that it can help save money. With subcontracting, employers save on paying the matching FICA taxes — they do not pay state and federal unemployment taxes on the payments, they do not pay for worker’s compensation insurance, and they do not pay for any employee benefits.

Fast Forward to July 2022

Guess what one of the big tax crackdowns is once again? The IRS, in conjunction with other Federal and State Agencies, data mine and cross reference all forms of income and banking information (if you have a bank account and a social security number then agencies can get your information). When the Service considers fraud, they can also subpoena third parties for verification. If that doesn’t make you sit up and fly right as an employer, then having your deductions for subcontractors/gig employees denied and penalties for not paying payroll taxes on the employees (which can be as substantial as 25% of the taxes owed) certainly will.

Since 2011, the IRS has used the Voluntary Classification Settlement Program (VCSP) allowing employers to “reclassify” contractors as employees — the employer can’t be under a payroll tax audit and must have provided the “employees” with a 1099 every year they worked. Using this program, the penalties are lower, the taxes due are lower, and the employer gets on track with the IRS. State agencies will have to be dealt with as well, but the penalties state agencies incur are less.

Are you classifying your employees correctly? Get in contact with us.

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