IRS Intends to Increase Scrutiny of Worker Classification Cases
It has always been essential that governmental entities correctly classify its workers as employees or independent contractors. Recent developments at the Internal Revenue Service remind such entities the importance of proper worker classification.
The head of IRS employment tax policy, John Tuzynksi, recently told the American Bar Association about IRS plans to increase enforcement of worker classification regulations. This means that all employers, including governmental entities, should anticipate increased scrutiny over their classification of workers as independent contractors instead of as employees. Our May 22 E-Alert
explained how employers in general were impacted. This E-Alert discusses how this latest news impacts governmental employers specifically.
Generally, when workers are classified as employees, the governmental entity that employs them must pay federal employment taxes (including federal income tax withholding, Social Security (unless the employees are not covered by Social Security), and Medicare taxes) and file employment tax returns. In most cases, public officials, elected and appointed officials, and volunteers who meet the common-law test are employees and should be classified as such. When workers are classified as independent contractors, the governmental entity is not required to withhold and pay employment taxes on behalf of those workers, although it may be responsible for backup withholding and filing Form 1099-MISC for independent contractors who were paid $600 or more during a calendar year.
The ramp-up of worker classification enforcement comes on the heels of state and federal efforts to streamline the enforcement process. In September 2011, the Department of Labor and the IRS signed a Memorandum of Understanding to ensure agency cooperation on misclassification enforcement. This agreement allows the DOL and the IRS to “work together and share information to reduce the incidence of misclassification of employees, to reduce the tax gap, and to improve compliance with federal labor laws.” Twenty-nine states have also signed the exchange agreement with the IRS, meaning that a foundation for vigorous enforcement exists at both the federal and state level.
Governmental employers who misclassify employees face a broad array of potential financial penalties. For example, the IRS often seeks to recoup unpaid employment taxes from employers who classify an employee as an independent contractor without reasonable justification. Employers also face potential overtime compensation, FICA, workers’ compensation, and other tax liabilities at both the federal and state levels.
So what can employers do to prevent against existing misclassification risks? Perhaps the most effective tool is the “self audit.” Employers who self-identify potential risks are able to initiate appropriate corrective measures. The ability to self-correct carries with it tangible and real economic benefits – the costs associated with a self-audit and self-correction plan are far less than the fines and fees that can result from a single IRS audit or a lawsuit.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.