THEY AREN’T REALLY EMPLOYEES, ARE THEY? CORRECTLY CLASSIFYING INDEPENDENT CONTRACTORSBondBeebe
A recent tax court decision, Kureck v. Commissioner, T.C. Memo 2013-64 (Feb. 28,2013), highlights the danger faced by many taxpayers utilizing independent contractors in their businesses. The taxpayer in this case (Kurek) was a sole proprietor contractor specializing in home renovation. He hired approximately 30 part-time workers on a project by project basis. None of the workers were engaged full-time by Kureck. Each worker was paid weekly based on the percentage of work completed on a particular job. The workers set their own work schedules and provided their own small tools. The taxpayer purchased the materials and provided any large equipment needed for the jobs.
Kurek did not provide any benefits, nor did he pay any payroll taxes, unemployment insurance, or workers’ compensation insurance for any of independent contractors. He did not issue any 1099s to any of the workers. The IRS conducted an employment tax audit and determined that the workers were in fact the taxpayer’s employees and assessed the taxpayer for unsatisfied FICA, FUTA, and income tax withholding obligations.
The Tax Court upheld the IRS’s determination concluding that the taxpayer failed to prove that he did not have control over the workers. While the workers did work part-time, set their own hours, and provide their own small tools, the taxpayer closely supervised their work and set deadlines for the projects. The court cited the following facts in support of the employee classification:
- The taxpayer had the ultimate authority in instructing the workers as to their job responsibilities.
- The taxpayer had the right to approve the quality of their work.
- The taxpayer paid the workers weekly rather than at the end of the projects.
- The taxpayer communicated with the homeowners and was responsible for the success or failure of the projects.
Section 530 Safe Harbor and Voluntary Worker Classification Settlement Program
This case serves as an excellent example of how to do just about everything wrong in establishing an independent contractor relationship. One of the principal mistakes the taxpayer made in this case was failing to issue 1099s to the workers. If Kureck had issued the correct 1099 forms to his independent contractors, he would likely have been eligible for relief from IRS assessments, penalty, and interest under the provisions of Section 530.
Section 530 is a safe harbor program that prevents the IRS from retroactively reclassifying “independent contractors” as employees. In order to qualify an employer must have:
- Consistently treated the workers (and similarly situated workers) as independent contractors;
- Complied with 1099 reporting requirements; and
- Had a reasonable basis for treating the workers as independent contractors.
The IRS is also currently offering an opportunity for taxpayers who wish to rectify worker classification issues and treat workers as employees for future tax periods. By applying to the Voluntary Worker Classification Settlement Program (VWCSP), an employer can classify employees for future periods without fear of being audited or having interest or penalties due for prior years. This assurance is gained in exchange for completing Form 8952 Application for Voluntary Classification Settlement Program and paying a fee of approximately one percent of the wages paid to misclassified workers for the most recent year.
Typically in order to qualify for the VWCSP, an employer must have consistently treated workers as independent contractors in the past, including filing Forms 1099, and must not be currently under audit on payroll tax issues by the IRS, the Department of Labor or any other state agency. However, the IRS has waived the 1099 requirement for taxpayers coming forward before June 30, 2013. Also, taxpayers under IRS audit for issues not related to employment tax can participate in the VWCSP. It is important to remember that relief under the VWCSP only applies to federal tax obligation.
Worker classification and correct 1099 filing are issues that the IRS has highlighted as priorities for enforcement. Worker classification can also involve obligations for many other jurisdictions including state unemployment, state withholding, and workers’ compensation. Taxpayers using independent contractors should take the time to ensure proper classification and comply with all the related reporting requirements. The cost of failing to comply could be extremely high.
If you have questions regarding worker classification or would like to consider applying to the VWCSP, the tax professionals here at Bond Beebe would be happy to assist you.