Tax Problem in the Making: Employee vs. Independent Contractor

If you have people who work in an organization on a permanent or semi-permanent basis, you will be faced with the issue of classifying them as either independent contractors or employees.  We are not exaggerating when we say that this issue alone can close a thriving million dollar business down by the IRS. The tax debt that may result from the wrong classification can be huge.

 

How do we know that the help you hire should be contract labor or be treated as an employee? There are several criteria that we can look at. 

 

1) If the hired help has to clock in and out everyday according to your rules, he is probably an employee. If he comes whenever he likes, he may be classified as contract labor.

 

2) If you tell him how he should paint the wall starting from the left upper corner with a larger brush, he is most likely your employee. If he were an independent contractor you would have told them you wanted this room to be painted period without any details.

 

3) If they have to furnish their own tools, that is another parameter that indicates they are an independent contractor.

 

4) If they work for you and for other customers that they serve, as opposed to being exclusively working for you, then they are contract labor.

 

What can happen if you decided to classify all your hired help as contract labor? You may need tax help soon as well. 

 

About 25 years ago I acquired a client who had about 150 persons working for him. He treated all his help as contract labor instead of employees. He had been doing this for years. I calculated that he may owe a tax liability of $1 million if he were subject to an IRS audit for the years on which the statute of limitation is open. 

 

I advised him that he should immediately convert all his help into employees instead of contract labor which he did. Sure enough he received an audited notice three years after he became clean. All his payroll taxes were in order. He would have to shut his business down for the back taxes had he had an IRS audit three years earlier. So before you make the decision, take the time and think about the future IRS debt that you may be accumulating without knowing. Also think that the tax relief may not be as readily available. If you need tax help with regards to contract labor issues consult Publication 1779 or just talk to your CPA or tax attorney.

Payroll Taxes and Tax Settlement

Payroll taxes is the worst tax debt you can owe to the IRS. Your tax problem is magnified by the fact that payroll taxes are not personal taxes or even corporate taxes that you or the corporation pay out of pocket to finance public policies. They are taxes taken from others and given to you to deliver to the IRS. I guess that is why they call them “trust fund.” For some reason those payroll taxes were not delivered. At the end of the year, your employees will file their personal income tax and send the W-2’s along with them and they will request the refund. The IRS will have to pay them their refund even if they never received the money from you. You get the picture. That will make them mad, of course.  Did you intend to willfully choose to ignore the tax law and to incur tax debts to IRS? Most likely not. You just got caught in a cash flow problem threat which became an IRS tax problem. Does the IRS care that you did not mean to use the trust fund? Probably not.

The IRS will deal, most likely, harshly with you if that tax debt ever became excessive. They will hold you personally liable for the tax debt. Your company tax problem is not only a proprietorship or a corporate tax problem but also became an individual tax problem. The tax problem has mushroomed into tax problems.

The IRS will issue a bank levy your account as they will the corporate account. They will garnish your wages if you become an employee of someone else and still owe those back taxes. The bank levy and the wage garnishment are not the only manifestation of IRS anger. They may attach among other tax penalties hefty civil penalties. Is their a tax resolution to this tax problem?  The answer is like anything in life, there is always a solution hanging out there; tax problem or no tax problem.

The proposed IRS settlement will be one of the traditional tax resolutions we have enumerated previously such as Installment agreement (IA), Offer in Compromise (OIC) or to be declared Currently Not collectible (CNC) by the IRS.  After you obtain tax representation the question will be: which flavor would a CPA, a tax attorney or an enrolled agent propose as a tax relief? The tax relief will depend on your financial situation. The worse it is the better the tax resolution to your tax problem it will be.

The best tax settlement to your IRS debt probably will be a minimum amount of an Offer in Compromise, if you qualify.  This will be an ideal tax help or tax relief for your IRS debt. The worst tax resolution is payment of the full amount of IRS debt which will include the penalty and interest. This solution is an Installment Agreement. Obviously, your CPA or your tax attorney will prefer to provide a better tax relief but they may have no choice because of your financial situation. You may have to accept this tax solution as the best tax help available at that time. Certainly such an IRS settlement can be renegotiated if your situation changes in the future.