by Brian Mahany
Warning. Unless you have a business that employs independent contractors or suffer from insomnia, this post is not for you. Earlier this year the IRS started an amnesty program of sorts for businesses that have misclassified workers as independent contractors. Predictably, that program has generated many, many questions.
Social security, unemployment and the IRS all use different classification rules. That sounds crazy, but its true.
For income tax purposes, the IRS uses a 20 factor test developed in 1987. These factors are used to determine how much control the employer has over the worker. While a full discussion of the factors could be the subject of 20 individual blog posts, the factors include: instructions, training, integration, services rendered personally, hiring and supervision of assistants, continuing relationship, set schedule, full time required, work on employer’s premises, sequence test, oral or written reports, payment by hour or week, payment of business expenses, furnishing tools, significant investment by worker, realization of profit or loss, ability to work for more than one firm, making services available to general public, right to discharge and right to terminate.
Still reading? No one test is dispositive and the IRS must look at least situation on its own merits. It’s more of an art instead of a science. Carefully worded agreements are often the deciding factor.
If you are using independent contractors at your workplace, spend a few bucks before you are audited. This is one area where a little prevention can save thousands of dollars.
The 20 factor test is for income taxes. The test for employment tax purposes is not as complex but it is equally unclear. Businesses can treat workers as contractors if the business has a reasonable basis for doing so, if it is consistent in its treatment of other similar workers and all returns are properly filed. That sounds reasonable. But what exactly does “reasonable” mean?
Good question. Don’t expect any answers from the government. The law says that the IRS can’t publish any regulations or rules. Apparently that law was well intended. Congress wanted to make sure that small businesses did not have to deal with hundreds of pages of complex rules. Instead, it has tied the hands of the IRS and prevented them from providing any clear guidance.
Earlier this year, the Treasury Department and Department of Labor developed the Voluntary Classification Settlement Program. Essentially, the program allows employers to classify contractors as employees with little risk of penalties and years of back taxes. Many states are also participating in the program.
Of course, some workers really are independent contractors. Traditionally, however, many workers are misclassified as contractors meaning the government loses millions in tax revenues. (It is also easier to collect from those workers who have regular withholding than those who are left to voluntarily make quarterly estimated payments.)
Like all IRS programs, this one has special rules and its own form. To participate in the VCSP, one must submit a form 8952.
Because there is such little clear guidance, businesses are still left wondering what they should do. The Voluntary Classification Settlement Program is ideal for employers who have obvious misclassification problems. Many businesses do. For the rest, see a tax lawyer or CPA well versed in classification issues.
For more information, contact attorney Brian Mahany at (414) 704-6731 (direct) or by email at All calls are completely confidential. Our experienced tax attorneys have helped taxpayers across the United States.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine and San Francisco, California. Tax services available nationwide.