Independent contractors have long been a proven path for garden pond
professionals, businesses and other employers to achieve workforce flexibility and save money. Unfortunately, a recent Department of Labor study revealed a whopping 30 percent of businesses “misclassified” employees as independent contractors. Cracking down on employee misclassification has proven such a revenue generator that the
Internal Revenue Service has devoted millions to enforcement efforts.
At its most basic, the employee/independent contractor controversy boils
down to the argument that by labeling a worker as an independent contractor
rather than as an employee, a pond retailer, distributor or installation
business can avoid the voluminous paperwork and payroll tax burden. A
pond professional who is an independent contractor can exclude certain types of compensation from income or deduct work-related expenses.
It is no secret that the self-employed and independent contractors contribute greatly to the ever-increasing “tax gap” — the difference between the taxes owed and the taxes actually paid. The Government Accountability Office estimates that the misclassification of workers costs the federal government $2.7 billion each year.
More recently, under the Affordable Care Act (often referred
to as Obamacare), pond businesses with 50 or more “full-time
equivalent workers” will soon be required to offer health plans to employees, or pay stiff penalties for each uncovered worker beyond 30 employees. Some employers may be tempted to re-classify employees as independent contractors as a way to side-step this mandate — but beware: this is a strategy fraught with problems if the IRS comes knocking and the worker classification rules are not properly followed.
Who Is and Who Ain’t
When disputes reach the courts, many factors contribute to deciding whether a worker is an independent contractor or an employee. Although the courts and the IRS often rely on a 20-factor test when determining just who is and who isn’t an independent contractor, generally the relevant facts fall into three main categories: behavioral control, financial control and relationship of the parties. Is the worker subject to the control of the service recipient, not only as to the nature of the work performed, but
the circumstances under which the work is performed? Individuals who follow an independent trade, business or profession in which they offer services to the public are not employees.
Bottom-line, it is usually up to those pond operations and other businesses that wish to use independent contractors to create a situation in which they do not control how the individual performs a particular task for them. Misclassifying a worker as a non-employee can
result in liability not only for employment taxes, but also for the 100-percent penalty for failure to collect and account for employment taxes.
Relabeled as Employees
From the workers’ standpoint, it is not always a bad deal for people calling themselves independent contractors to be relabeled as employees. After all, a worker may receive employee fringe and pension benefits; may be entitled to reimbursement for business expenses; may be entitled to federal and state minimum wage and hour standards; and may receive coverage under nondiscrimination laws, unemployment insurance and workers’ compensation protection.
Not too surprisingly, the IRS has a special form, Form SS-8, that will
allow either a worker or an employer to quickly obtain an official determination of a worker’s tax status. Although the IRS SS-8 program is helpful, there is some risk involved. According to the IRS, over 72
percent of all Form SS-8 requests received by the IRS resulted in determinations that the workers in question were employees. Only 3 percent resulted in determinations that the workers in question were independent contractors.
Volunteering to Reclassify
Late in 2011, the IRS launched a new Voluntary Classification Settlement
Program, or VCSP, that allows employers to prospectively reclassify — as employees — workers that they have erroneously treated as independent contractors or as other “non-employees.” The new program carried generous settlement terms and provided audit relief for previous years.
Any garden pond professional accepted into the VCSP agrees to prospectively treat the class of workers as employees for
future tax periods and in exchange:
A. Pays 10 percent of the employment
tax liability that may have been due on
compensation paid to the workers for the
most recent tax year, determined under
the reduced rates of Code Sec. 3509;
B. Won’t be liable for any interest and
penalties on the liability;
C. Won’t be subject to an employment
tax audit for the worker classification of
the workers for prior years; and
D. Agrees to extend the period of
limitations on assessment of employment
taxes for three years for the first, second
and third calendar years beginning after
the date on which the taxpayer has agreed
under the VCSP closing agreement to
begin treating the workers as employees.
Even better, the IRS rejection of a VCSP application will not automatically trigger a Federal tax audit. A rejected pond business could, however, be audited for another reason…but not as a result of filing Form 8952 (Application for Voluntary Classification Settlement Program (VCSP)).
Also keep in mind that the VCSP concerns future years only. Thus, the
IRS won’t make any determination about prior years, and any pond professional signing a VCSP agreement isn’t making any representation as to
the workers’ proper federal employment tax status for prior years. In other words, a pond construction business that signs a VCSP closing agreement is not admitting liability or wrongdoing for past periods.
As a reward, employers accepted into the VCSP program will generally
pay an amount equal to slightly over 1 percent of the wages paid to the reclassified workers for the past year.
The New, Expanded Voluntary Changes
Under the expanded VCSP program, employers currently being audited (other than an employment tax audit) can qualify for the VCSP. Also, employers allowed into the program will no longer be subject to a special six-year statute of limitations instead of the usual three-year period that normally applies to payroll taxes.
To be eligible for the VCSP, an employer must currently be treating workers as independent contractors or non-employees and consistently
have treated them as such in the past. In fact, until June 30, 2013, the IRS has waived the eligibility requirement that an employer must file
Forms 1099 for the workers they are seeking to reclassify for the past three years.
As mentioned, employers cannot qualify for VCSP if they are currently being audited by the U.S. Department of Labor or a state agency
concerning worker classification — or be challenging worker classification in court. What’s more, the employer cannot, as mentioned, be
undergoing an employment tax audit.
A Safe Harbor from Morphing Liabilities
Liabilities for violations of the wage and hour laws, discrimination, wrongful termination and similar rules can be easily minimized simply by not having employees or keeping their ranks to a minimum. And, as some pond professionals have discovered, it is possible to have some workers operate as independent contractors, thus sidestepping a panoply of tax and other liabilities — maybe. Or, relief can be obtained with a unique
“safe harbor” in our tax laws.
Created in 1978, Section 530 of the Tax Code provides relief from reclassification liabilities when an employer misclassifies workers. The safe harbor provides protection when an employer has classified a worker as an independent contractor and the worker is reclassified as a result of an audit.
The employer is relieved of liability if the tax returns, including Form 1099, show that all similar workers were consistently treated as independent contractors, and that there was a reasonable basis for that classification. Employers must usually satisfy three requirements: a reasonable basis for treating the workers as independent contractors,
a substantive consistency requirement and a reporting consistency requirement.
The IRS generally relies on the three characteristics to determine the relationship between businesses and workers. Misclassification of a worker as a non-employee can result in liability not only for employment taxes, but also for the 100-percent penalty for failure to collect and account for employment taxes.
The Independent Contractor/Employee Question
In today’s tough economy, employers are looking for every possible way to stay competitive and get the work done. Choosing to classify workers as independent contractors can obviously be a money-saver, but it’s also a huge IRS target and a proven way to wind up making expensive mistakes that can cost employers more than they saved. And, to make things worse, there are often criminal penalties in the worst cases.
Unfortunately, short of treating everyone as an employee, there is no
easy solution to the employee/independent contractor conundrum. It is clear, though, that many pond businesses do not routinely examine their worker relationships before they are confronted with an audit (by the
IRS, Labor Department and more). And workers rarely look beyond the anticipated tax breaks when assuming the independent contractor label.
While the IRS’s recently expanded Voluntary Classification Settlement Program may provide an answer for some pond business owners caught up in the ongoing employee or independent contractor brouhaha, this is one area in which a little thought, a little preparation and some professional
guidance can be better than a cure.