What the IRS Wants to Know

Is your independent contractor really an employee? Time to come clean.

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Consider yourself warned: The U.S. Department of Labor and the Internal Revenue Service are cracking down on companies that misclassify employees as independent contractors to avoid paying employment taxes.

The feds and states that have signed on, nine of them so far, will exchange information about companies breaking the rules. That means you could face sanctions from both state and federal agencies along with back taxes, penalties, interest, and other consequences from the IRS.

The states involved so far: Connecticut, Hawaii, Maryland, Massachusetts, Minnesota, Missouri, Montana, Utah, and Washington. New York is expected to join the effort soon.

Wondering if you accidentally are misclassifying someone? Consider whether the person's services are "an integral part of the organization's activities" and whether the relationship is "permanent or indefinite, rather than for a determinable time," suggests employment lawyer John Thompson on the Wage and Hour Laws.

If you've misclassified, accidental or otherwise, the IRS is offering you a break if you come clean. Under the "Fresh Start" initiative, you can pay one percent of the wages paid to the reclassified employees in the previous year. No interest or penalties will be charged, and the IRS promises not to audit your company for violations in prior years. (Get more information and the form needed to apply.)

Labor Secretary Hilda Solis said the program will "level the playing field for law-abiding employers and ensure that employees receive the protections to which they are entitled under federal and state law."

Inc. contributing editor Courtney Rubin was for five years a London-based staff writer for People magazine. Rubin, a former senior writer for Washingtonian magazine, has written for the New York Times magazine, Time, Marie Claire, and other publications. She is the author of The Weight-Loss Diaries.