To hear an audio recording of the blog, click on the Play button (>) below.  Transcript follows.
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. 
To listen, click on the Play button below.  Blog transcript follows.
Almost daily the media reminds us that small business drives the American economy.  The IRS is listening and with increasing zeal has hitched a ride on the small business engine.

Latest statistics show that the IRS Examination Division – the army of feared auditors – focuses on small business owners with positive incomes between $100,000 and $200,000.  Many of our neighbors fall into this category.  Even with a limited number of revenue agents to conduct audits, in 2009 the IRS targeted almost 40,000 small business owners.  Of those, 88% ended up with increased tax assessments between $23,000 and $32,000.  For someone living on $150,000, for example, that’s a big chunk to come up with.  Add penalties and interest and the number often rises to as much as $50,000.  Could you come up with a third of your annual income for quick payment to the IRS?

If you’ve ever faced off against an enthusiastic revenue agent, you know it’s wise to bring a pair of sunglasses to shield against the glint in the eye of the hunter.  Focused on the trapped taxpayer sitting in the cross-hairs, IRS auditors love to blast away using the feared indirect methods of assessment to raise the small business person’s taxes.

The Internal Revenue Manual defines indirect methods as “…the use of circumstantial evidence to determine the tax liability based on omitted income, overstated expenses, or both.” IRM 

Circumstantial evidence.  Just think about it.  As the fictional but wise Sherlock Holmes taught:

“Circumstantial evidence is a very tricky thing…It may seem to point very straight to one thing, but if you shift your own point of view a little, you may find it pointing in an equally uncompromising manner to something entirely different."

Here’s an example of one indirect method used when the taxpayer doesn’t deposit a lot of cash and doesn’t volunteer cash outlays.

The indirect Markup Method invents an estimated income based on the use of percentages or ratios considered typical for the business under examination.  The revenue agent analyzes sales and/or cost of sales and the application of an appropriate percentage of mark up to arrive at the taxpayer’s Gross Receipts.  The revenue agent determines sales, cost of sales, gross profit or even net profit.

We all know that there is no such thing as the “typical” business.  Statistics may give an idea but cannot deliver the truth.  With a bit of imagination, the over-zealous revenue agent can get a joy ride on the back of the small business owner. 

Small business owners:  your mother was right when she told you to never pick up hitchhikers – especially when they’re wearing an IRS badge.
Murray Singerman, JD, LLM


Self-dubbed "Tax Knight," Murray Singerman writes in defense of the "humble citizen," often beaten down by the IRS and state taxing authorities.  Enjoy his short ruminations about the ever-changing area of tax controversy law.  Written with accountants in mind, Murray offers useful info and a chuckle to make your day a bit more enjoyable.


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