6000 Audit Disasters 05/19/2011
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Faced with a recession that won’t seem to go away, small companies are employing a strategy that reaps huge benefits, clearing $50,000 to $100,000 of net profit without having to develop a new product or win new customers. To a small business owner, that can mean the difference between more years of sweat equity or the start of a profitable business.
These small companies have embraced the aggressive strategy of laying-off workers and then hiring them back as independent contractors. Engaging an independent contractor instead of an employee brings huge savings. Companies save on FICA and FUTA taxes, Maryland unemployment taxes, Maryland worker’s compensation insurance, benefits, and overtime pay. In addition, companies have more protection from negligence or damages caused by independent contractors.
The risks, however, are huge.
Over the next two years, the Internal Revenue Service will steam roll over 6,000 randomly selected businesses, auditing them to determine whether they have misclassified employees as independent contractors. As Maryland tax attorneys, we solve tax problems for companies throughout the Baltimore and metropolitan DC area. We’ve learned there’s nothing more shocking for a client than being hit with a bill for taxes, interest, and penalties that result from misclassifying employees. Because the audits often include several years, it’s not unusual to see a tax bill for hundreds of thousands of dollars – often the death toll for a small business.
Before rolling the dice and taking the risk, small business owners should consult with a tax lawyer to provide guidance through the morass of applicable law. In Maryland, companies are subject to federal tax law – the 20-Factor classification test and the section 530 Safe Harbor rules – the Maryland Code and COMAR, and federal and state common law.
For those unlucky enough to be among the 6,000 businesses selected by the IRS, solid legal representation during and after the audit can lead to a victory. Even if the IRS finds that misclassification occurred, the IRS Classification Settlement Program offers a cost-efficient resolution, often for 10-cents on the dollar and a pledge to be bound by the proper classification moving forward.
Don't Kill Builder Bob! 12/26/2010
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At the rate the government is spending its way out of this nagging, resilient recession, the Administration and Congress have been forced to find inventive ways to fill the Treasury’s coffers. One of those quick fund raising initiatives involves clamping down on the classification of workers as employees and not subcontractors.
One legislative proposal involves HR 5107 and S. 3254, the Employee Misclassification Prevention Act. In plain English, what used to be an expensive mistake now becomes a crime. If this bill is passed, misclassifying workers could lead to fines of up to $5,000 per employee. In addition to facing a huge fine, employers will shoulder the burden of increased record keeping and more bookkeeping costs.
When it comes to classifying employees, we’ve been through the 1978 Safe Harbor Section 530 rules, the 20-Factor test of Revenue Ruling 87-41, and most recently, the three category common-law rules determining control and independence that appear on the IRS website.
Each decade, it seems, the government promulgates more regulations and promises clarification. Our clients, however, end up flummoxed and we withhold a litany of verbal abuse as a stone-faced IRS auditor waves the magic “20-Factor” wand or recites “the control and independence” incantation and turns our 1099s into W2s, even though we know the audited workers are subcontractors and not employees.
No matter what clarification the IRS offers, employers are stuck with risky decisions. As the IRS admits on its webpage:
"There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another." (http://www.irs.gov/businesses/small/article/0,,id=99921,00.html)
Because there is no “magic” or “set number of factors” to determine proper classification, this latest legislation, which aims to stem abuse of misclassification, will end up penalizing honest entrepreneurs trying to stay in business and make a living.
When these issues surface, I’m reminded of my client, Builder Bob (not his real identity). When the IRS reclassified all of his subcontractors as employers, Builder Bob was ready to close his doors. The FICA and unemployment taxes on his annual $1 million subcontractor fees would come to roughly $85,000, his take home salary. Fortunately, in Appeals, thorough lawyering prevailed and the IRS auditor was forced to eat crow. Builder Bob lived to see another day. But how many honest firms will go under because of aggressive IRS auditors? How many businesses will be undercut when they’re not fortunate enough to prevail in Appeals? How many dollars will be spent in litigation which would be better spent growing our economy?