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December 02, 2010
The IRS Focuses on Independent Contractor Status

“The current environment could be looked at as a perfect storm of [worker] misclassification issues,” said William E. Bonano, Esq., partner with Pillsbury Winthrop Shaw Pittman, LLP, during an October 2010 webinar hosted by Business & Legal Resources, Inc. (BLR).

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“You have the federal and state governments’ need for increased tax revenues due to the economic downturn. You have many employers that have decided to use independent contractors, rather than keep on or hire employees. Finally, you have more employees filing overtime and/or unemployment claims, which trigger scrutiny of classifications.”

He explained further. “One federal study has concluded that employers misclassify 3.4 million employees as independent contractors. DOL [U.S. Department of Labor] estimates that up to 30 percent of companies misclassify employees. The Federal Government Accountability Office (GAO) estimates misclassification resulted in underpayment of an estimated $2.72 billion in taxes. Other studies suggest a tax gap of $15 billion.”

On the state level, Bonano commented that states are experiencing decreased tax revenue and budget concerns, so they’re also taking more aggressive enforcement actions. He provided an example from 2009 in California when the attorney general won a $13 million judgment against two companies that had misclassified 300 janitors.

In addition, Bonano noted that there is pending federal legislation, the “Employee Misclassification Prevention Act,” which amends the Fair Labor Standards Act (FLSA) to require companies to keep records of nonemployees who work as independent contractors, adding penalties for misclassification. It also requires states to conduct audits and tasks DOL to oversee states’ efforts to crack down on violations, as well as perform its own audits, he said.

Bonano explains that the Internal Revenue Service’s (IRS) National Research Program (NRP) stated goals are: “To secure statistically valid information for computing the employment tax gap and to determine compliance characteristics so IRS can focus on the most noncompliant employment tax areas.” He added two unstated goals as well: “To help close the employment tax gap and thereby increase tax collections, and also to support legislation aimed at closing the gap.” He noted that state tax agencies are focusing on similar goals.

The only published document regarding this NRP accessible on the Internet is the “Headliner Volume 280,” produced in November 2009, stating that the IRS would begin the program in February 2010, said Bonano. The Headliner stated that the examinations would be comprehensive in scope, he added.

The randomly selected audits cover 2008, 2009, and 2010. By May 2010, the 2008 Form 941 returns had already been selected for audit with about one-third of those employers having been contacted already and currently under audit, he explained.

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