In an effort to reduce labor costs in a depressed economy, many employers have reclassified full-time employees as independent contractors. However, using independent contractors reduces the amount of federal and state income tax, social security and unemployment tax employers have to pay. Over the past two years, the IRS has been leading the effort to crack down on employers, and this year is no different. Companies will be identified for audit through a collaborative effort between the Department of Labor, the IRS and state agencies. How can you protect your company from a time-consuming audit and avoid penalties and possible criminal implications? Consider the following five tips.
- Don’t try to beat the system. Classify people as independent contractors only when that is truly the correct relationship.
- Have legal documentation. You should have independent contractors sign a legal agreement that clearly outlines their status and the fact that they waive all employee benefits. All company procedures should be in writing and a clear distinction should be made between protocols for employees and independent contractors.
- Outline job descriptions. There should be a clear difference between the job descriptions of employees and those of independent contractors. If a person changes their status to an independent contractor, their job description should change, and that should be in writing.
- Avoid “red flags.” Stay clear of behavior that is suspicious. For example, filing a w-2 and a 1099 for the same employee in the same year, could raise a red flag. Laying someone off one week and hiring them as an independent contractor the next could make the IRS take a second look at you. Other red flags might be if your contractor files for unemployment or worker’s compensation, or if they submit multiple SS-8 forms from the same company in the same year.
- Do your own audit. If the IRS audits you, they’ll look at your records for the last three years. It’s a good idea to hire a third-party to audit the company at least that often.
Contact us with any of your IRS or tax questions.