Classifying a worker as independent contractors provides many small businesses with needed flexibility. Unfortunately not all workers can be classified in such a way and according to IRS payroll laws, they need to be reclassified as a W-2 employee, not a 1099 subcontractor. Yet even as the economy grows more reliant on temporary or flexible 1099 labor, regulators are becoming increasingly vigilant about getting employers to classify these mislabeled workers.
I was working with a payroll services client in Raleigh last week and learned that six months ago their business triggered an IRS audit because of a misclassified carpenter subcontractor. The penalties were significant.
When these reclassifications are enforced, small businesses have to start withholding federal income, Social Security, Medicare, and unemployment taxes. Adding to the cash flow strain is the possible payment of fees and penalties for previous misclassifications. Additionally, such firms would have to start paying for the same employee benefits and workers’ compensation that they currently do for full-time employees.
As I’ve said before, federal and state governments are facing budget deficits, and tax regulators see a huge pool of potential back taxes, fees, and penalties to be gleaned from the detection of employee-classification errors. The IRS estimates that 15% of all employers have misclassified a total of 3.4 million employees as independent contractors, resulting in an estimated annual revenue loss of $3.4 billion dollars.
If you’re unsure of the specific rules that regulate 1099 subcontractor or independent contractor classifications, seek help with a payroll service such as Ashgrove Payroll. As the state departments of revenue continue to share more and more information with the IRS, the odds of being detected continue to increase.