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Employee or Independent Contractor?

A look at a new IRS program that makes it less costly if you've made the wrong call.
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TAXES

If you use independent contractors in your business, chances are, you've worried about this nightmare scenario: the IRS swoops down, reclassifies all your independent contractors as employees, and demands hefty penalties, interest, and back taxes. Take heart. Last spring the IRS introduced the classification settlement program (CSP), a two-year experiment "designed to give people an opportunity to get back into the system,' according to IRS spokesperson Anthony Burke. Here's how the program works:

If you are audited, the IRS will first demand proof that you have consistently treated the workers in question as independent contractors in all your tax dealings. If so, your auditor is now required to offer you a CSP deal. Agree to reclassify your independent contractors as employees, and your potential tax liability will be limited to the most recent year for which you're being audited. Better yet, penalties will be waived. (There are circumstances in which, under the CSP, your liability might be even less.) Your auditor is required to inform you of the CSP at the outset and to keep the deal on the table throughout the audit. Because the CSP empowers examiners to negotiate settlement agreements, it should lead to "quicker and easier settlements and fewer time-consuming appeals," according to William R. Rodgers, a lawyer at the Boston firm of Tarlow, Breed, Hart, Murphy & Rodgers.

The disadvantages? Rodgers cautions that reclassifying workers as employees "can alter the complicated calculations used in employee benefits, such as 401(k) plans." And if you agree to reclassify your workers under the program, the IRS will monitor your company for up to five years.

Although the CSP is designed to bring companies into compliance with less trauma, you'll still get nailed if you've completely disregarded the tax code. File 1099 tax forms for all independent contractors. Your chances of receiving some type of relief are vastly improved if you've treated workers consistently and can make a convincing argument for classifying them as independent contractors.

Did you know that...

...at the last White House Conference on Small Business, attendees rated independent-contractor-classification disputes as today's most pressing small-business issue?

...the IRS estimates that in 1992, misclassification of employees as independent contractors cost Uncle Sam as much as $2.6 billion in employment taxes and $1.6 billion in income taxes?

Last updated: Oct 1, 1996

DONNA FENN | Inc.com Contributing Editor

Donna Fenn is the author of Upstarts! How GenY Entrepreneurs Are Rocking the World of Business and 8 Ways You Can Profit From Their Success, an exploration of the ways Gen Y is changing the entrepreneurial landscape.




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