An IRS representative talks about the agency's focus on IC classification
For the March issue, CWS 30 talks with a representative of the Internal Revenue Service. John Tuzynski, chief employment tax operations in the Small Business Self Employed (SBSE) group, discusses what misclassification means. The misclassification of employees costs the U.S. government money that it can ill-afford to lose when those ICs don't pay their taxes. Meanwhile, companies are estimated to spend up to four times more money on independent contractors as on agency-provided temporary employees. Seeing a significant source of additional revenue, the government is cracking down on the issue as a whole. To that end, the IRS has hired hundreds of additional auditors and will conduct nearly 6,000 random audits of businesses as part of its National Research Program (NRP). Tuzynski talks about why misclassification is a top priority and reasons companies run into trouble.
Q: What does misclassification mean for companies who engage independent contractors in 2011?
A: I would say that misclassification of workers has been a concern for the IRS and in particular where companies classify workers improperly. (We look at instances) where companies treat them as independent contractors, when in fact they should be considered employees. Misclassification is where we really have employees that aren't treated as employees and they're not on payroll.
Q: Why is the IRS so focused on this area?
A: As chief employment tax operations, I'm concerned with fair tax administration, which means that there are no unfair advantages for certain businesses because of the way they may treat some of their workers. So, some businesses may see economic incentives in misclassifying their employees as independent contractors, and so they may not have a level playing field. My interest is to level the playing field, so that every taxpayer is treated the same.
Q: So what would you say the IRS priorities for the year are in terms of this misclassification?
A: Well every year in our various audit plans, we do audits in the worker classification area -- that's across the whole IRS, whether it's SBSE, our large business operation, or our tax exempt, government entity operation. We're out there doing audits each and every day in this area.
Q: So what are the red flags for an audit?
A: One would be a large business that has no wages reported on its return. That would be a red flag for us. We also have programs (where) we work with the states. Say a contractor gets hurt on the job and applies for workers' comp benefits. Then, the state does an audit and determines that this person actually was an employee. The state would refer the case to us, so that would be an indicator and could trigger a federal tax audit.
Q: So do you have a lot of communication between the state and federal governments?
A: Yes, we have a lot. We have a program that's called the questionable employment tax program, QETP. And that works with the various state workforce agencies. We share information with the states under these agreements.
Q: And what is the advantage or disadvantage of doing that?
A: Well, when we get referrals from the states, they've usually contacted the taxpayer and have already done some of the fact finding, so we don't have to waste time in developing some of the facts. We can actually take what the state has done and use some of that in [audit process].
Q: What are the common mistakes a company makes around this classification problem?
A: I think it's not making that determination up front. A small business starts out and just starts paying somebody, and they don't sit down and really think about what kind of relationship they have, whether in fact they are an employer or not. Early on, the small business is just focused on its business -- they may not have a tax background and so they're just trying to conduct their business. So it's not until a little bit down the road that they really start thinking about the proper classification.
Q: What about larger companies? They're running a lot into these issues. Why do you think that is?
A: I think sometimes, again, the smaller company starts to grow and then they become a larger company and then they just don't re-examine the issue as they start to get bigger.
Q: So you think it's lack of knowledge?
A: I think that's part of it. And some of it is the company's business model is based on independent contractor relationships. But, when that business model is more based on trying to get to the end result of an independent contractor and not looking at some of the various factors that would lead to that conclusion.
Q: What advice would you give to companies (big and small) that are trying to do the right thing?
A: I think they just need to objectively look at the information that's out there, who has the right to directing control of the worker. Is there a contract that's provided that stipulates the agreement? Does that worker work for that particular business and that's it? [A worker who] has only worked for that business in the last three years versus somebody that works for all kinds of other companies [could be misclassified]. It is multifaceted and takes a number of different factors to reach the conclusion.
Q: Some larger companies have complained that the IRS focused on the large companies because it's easier to get money from them than it is from small businesses. Would you agree with that assessment?
A: I think we look at a range of businesses in this area; there's no design to go after the larger companies. It's about fairness, so no, I don't think [we do that]. The audits of the larger companies have more publicity around them and you just don't hear about the smaller ones that we do.