Tax Problem in the Making: Employee vs. Independent Contractor
Posted by Dean Alexander on Mon, Aug 23, 2010
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.