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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?

 


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Murray Singerman, JD, LLM

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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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