IRS Worker Re-Classification
The Liability Issue behind Worker Re-Classification
Worker classification issues arise when the business owner reports an employee as an independent contractor and thereby fails to pay the required social security and medicare taxes for that employee. The employee later gets reclassified by the government and the business owner "responsible party" is hit with a huge tax liability which he/she later finds out is personally liable. The business owner cannot hide behind the corporate veil and is held personally liable for the "trust fund" portion of the tax.They also find out that the tax liability has doubled and they now owe twice as much in tax due to the severe IRC 6672 penalty for wilful failure to collect, account for and pay the taxes. The responsible person does not necessarily have to be the owner of the business, it can be any individual that has the status, duty and authority to pay the taxes. Moreover, the authority attaches when the individual has the control and authority to decide which creditors will be paid and when they will be paid. The legal elements are a "Responsible" party and acting "Willfully."Consequently, a person who assumes control over a business that has been delinquent in paying payroll related taxes could, unknowingly, become a responsible person under the law for not paying the taxes with available funds from the business. The title of the individual is not a controlling factor, the situation is based on the facts and circumstances. However, an owner may have a difficult burden proving that they were not liable, do to the duty to perform the act in which the violation occurs. Owners are usually held liable do to this duty.
Remedies for The Business Owner
A business owner facing a reclassification problem with the IRS has several issues to think about concerning the case. First, are these really employees under the law and am I as an employer entitled to Section 530 relief. Secondly, am I a responsible party under the law, whereby I may be assessed the tax liability for the reclassification and did I act wilfully.
Section 530 Relief
To qualify for relief under Section 530 of the revenue act of 1978, the business owner must have filed all information returns with the government, treating the individuals as independent contractors (10-99), must have some type of industry related consistency where all workers have been treated in this manner in this business and other businesses in that industry, and have a reasonable basis for treating the workers as independent contractors. If granted 530 relief, the business may continue treating the workers as independent contractors and no assessments will be made. Section 530 sets some ground rules for the IRS to follow in making the determination of a worker classification. If Section 530 is not met, then the IRS must apply the common law standard to the case in making a determination of whether to reclassify the workers as employees. The common law test can be involved because the IRS must consider all the facts and circumstances to make a determination.
IRS Classification Settlement Program
Requesting a hearing under the Classification Settlement Program (CSP) can be a smart move for an employer that is in a bad position, because the CSP hearing may offer some relief from the penalties by utilizing graduated settlement offers, and give the business owner a chance to pay the liability over time with an installment agreement.
Officers of Corporations and Their Classification
So, your an officer in your corporation that performs services, are you an employee or an independent contractor? The answer is, it depends. It is interesting that if you read Rev Rul 58-505 and several Chief Counsel Memorandums in 2000 & 2001, you would conclude the Service held that officers can work in two distinct capacities, employees and independent contractors. The opinion states that, if the two services are "interrelated," the officers do not act in two separate capacities. If, however, the services in the two capacities are separate and distinct, with no interrelation either as to duties or remuneration in the two capacities, then the status of each type of service must be considered separately. Both a W-2 and a 1099 would apply to the same individual in the same year. However, if you read WESTERN MANAGEMENT, INC. v. UNITED STATES 45 Fed. Cl. 543, you come to a strict interpretation of IRC 3121 and the “officer” gets reclassified if he performed more than “minor services” for the corporation. The safe harbor relief provisions under “section 530” do not apply if a 1099 was not issued (as in this case) and the IRS re-classifies the officer as an employee. Ouch. Maybe that’s why there are so many PLR’s under this subject.
Employees Unfairly Treated as Subcontractors
In this modern day business environment, where most businesses are being choked to death with taxes, there is a trend to misclassify employees as independent contractors. Businesses that do this suddenly see more money in their cash accounts because the employees will be paying the social security taxes themselves, in the form of self employment tax at the end of the year. For a true employee, this is an exploitation of your situation and you will get hit with an enormous tax bill at the end of the year that you may not have anticipated. The reason, is that you will have to pay a 15.3% tax on your net self employment income that you will be responsible for at the end of the year. This is in addition to your income tax that you will have to pay. Often, in these situations, there are other workers in your office that are being paid as employees, that are performing the same work duties, in the same work environments that you are, but getting paid as employees.
If you believe that you have been misclassifed, there is something that you can do about it. File a Form SS8 with the IRS and report your employer as a violator. They most likely will be sheduled for an employee classification audit by the IRS.