Independent Contractor Or Employee

A long-standing struggle between the IRS and business taxpayers could get a bit dicier next year with the new increased Democratic majority in Congress and the Obama administration possibly set to change the law related to proper worker classification.

Last year, President-elect Obama introduced a bill in the Senate (S.2044: Independent Contractor Proper Classification Act of 2007) that would eliminate the safe harbor defense of “industry practice” as a justification for classifying workers as independent contractors. Under current law, a business may be able to treat a worker as an independent contractor if it can demonstrate that it is a long standing industry practice to treat the worker’s position as an independent contractor and the business did not treat any worker in the same position or a substantially similar job position as an employee and the business filed all federal tax returns and information returns (including Forms 1099) for the year consistent with its treatment of the worker as an independent contractor.

The bill would also require the Secretary of the Treasury to establish a procedure for workers to petition for a determination of their status as employees or independent contractors and prohibit employers from retaliating against workers filing a petition. Additionally, the bill would require a workplace notice informing workers of their right to seek a status determination and would require employers to notify their independent contractors of their federal tax obligations.

House members Jim McDermott (D-WA) and Richard Neal (D-MA) introduced similar legislation this year stating they would try to push the measure early next year as one of the first orders of business after a stimulus package. This bill would go even further than Obama’s Senate bill by levying an additional $10,000 fine per misclassified worker.

Since 1988, the IRS has engaged in an aggressive payroll tax collection program for determining a worker’s classification. Estimates of federal revenue loss attributed to worker misclassification have been as high as $4.7 billion a year.

Business owners should pay close attention to the developments in this issue as the tax bill for misclassified workers could be substantial. The total additional tax costs incurred (including penalties and interest) are commonly double the amounts potentially saved by claiming independent contractor status.