Avoid Tax Penalties for Independent Contractors

By Perry, Phillip M. | Journal of Property Management, November-December 1995 | Go to article overview

Avoid Tax Penalties for Independent Contractors


Perry, Phillip M., Journal of Property Management


Property management offices that hire independent contractors face new dangers from a tax-hungry government. The Internal Revenue Service has been reclassifying self-employed workers as employees at a faster pace recently.

The result? If you are an employer whose workers are reclassified, you face the risk of huge back taxes and fines. Since the mid-1980s, the IRS has reclassified 439,000 independent contractors. It has collected some $678 million in fines and retroactive payroll, social security, and unemployment taxes.

"These audits are putting many companies out of business," says Patrick Hanes, an employment law partner with Howard & Howard, Lansing, Mich. "It's a huge trap that job providers have to work hard to keep out of."

So why is the IRS on the warpath now? The use of independent contractors has been increasing recently. Employers know that one way to keep the bottom line healthy is to put the payroll on a diet. Independent contractors can be used on a regular basis for tasks that require skills not already found inside the business. And they can be used for temporary periods to ease heavy workloads or accomplish specific tasks without bloating the payroll.

You are at risk if your office uses self-employed workers for keeping books, taking dictation, doing secretarial work, delivering materials, performing research, chauffeuring you back and forth to the airport, cleaning up the office and making coffee, or any other reason.

Why? The IRS is targeting independent contractors even if they work only on a part-time basis for a business. Employers find themselves under fire from several fronts. One audit by the federal or state government usually triggers action by the other. And the wage and price division of the U.S. Department of Labor also gets involved, often determining that an employer failed to pay overtime for those reclassified individuals who worked more than 40 hours a week. That means still more retroactive taxes and fines.

"Many businesses are shocked to learn that people who perform services for them are their employees in the eyes of the IRS and state departments of unemployment insurance, unless business owners can prove that these people are under contract," says Nancy E. Joerg, an employment attorney with the law firm of Wessels & Pautsch, St. Charles, Ill.

Not a pleasant prospect. And the risk of running into a problem is high because the IRS has not provided a clear-cut definition of an independent contractor.

"The IRS is making this a top priority for litigation purposes," warns Allen L. Schwait, a Baltimore attorney who has defended businesses in such cases. "So people need to learn the law."

Take Action Now

For each of your independent contractors, answer the 20 questions below. Attorneys have culled these questions from court cases and IRS decisions over the past few years. The more you answer "yes" to these questions, the more likely the IRS will decide your outside contractors are really employees.

Remember, however, that these questions are only general guides. There is no cut-and-dried method to determine independent contractor status. Consult your attorney for detailed advice about your outside contractors.

* Must the worker follow your instructions as to how work is to be performed? This question is listed first because in some ways it is the most important. It cuts to a fundamental element of IRS reasoning that appears in many of the other questions that follow: The more control you have over the activity of your worker, the more likely it is that you have a full-time employee on your hands.

"The overriding issue has always been control," says Schwait. "Do you tell the person when to come and go? Or do you direct the way the person does the job on a regular basis? If so, the person may be deemed to be an employee." Schwait notes that this guideline can apply if you only have the right to make such directives, even if you do not actually do so. …

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