IRS: Small Businesses Must Accurately Classify Their Employees and Independent Contractors

The Internal Revenue Service (IRS) is using National Small Business Week to remind business owners that they must accurately classify their employees and independent contractors. With the IRS Small Business/Self Employed Division’s new Fraud Enforcement Office now fully operational, this is likely to be a key enforcement area for the remainder of 2021 and heading into 2022. Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, explains:

Understanding Proper Classification of Employees and Independent Contractors

The proper classification of employees and independent contractors is important for federal tax compliance purposes. While employers must withhold and pay employment taxes for their employees, this obligation does not apply with respect to independent contractors. Thus, misclassifying an employee as an independent contractor can result in failure to withhold and pay employment-related taxes (i.e. Social Security, Medicare and unemployment taxes), and this, in turn, can lead to trouble with the IRS.

When does a worker qualify as an “employee” (and when is a small business required to withhold and pay employment taxes)? The IRS provides the following explanation:

“An employee is generally considered to be anyone who performs services if the business can control what will be done and how it will be done. What matters is that the business has the right to control the details of how the worker's services are performed.”

In contrast, the IRS defines independent contractors as individuals who, “are normally . . . in an independent trade, business or profession in which they offer their services to the public.” As examples, it notes that “lawyers, accountants, [and] contractors,” typically qualify as independent contractors when engaged by small businesses to provide discrete business-related services. Freelancers also generally qualify as independent contractors, and the IRS provides specific guidance regarding gig economy workers.

Understanding the Risks of Improper Classification

Improper classification of employees as independent contractors can lead to IRS audits and investigations for small businesses. Not only can these inquiries lead to liability for back taxes, but they can lead to the imposition of interest and penalties as well. In cases involving allegations of intentional misclassification, small business owners can also face criminal prosecution for tax evasion and tax fraud.

With this in mind, proper classification is extremely important, and it is not an issue that small business owners can ignore. If a small business has misclassified its employees in the past, there are options available (including the IRS’ Voluntary Classification Settlement Program (VCSP)), and it is strongly in business owners’ best interests to correct their mistakes before they hear from the IRS. If you have questions or concerns, you can contact Thorn Law Group for a confidential consultation.

Request a Confidential Consultation with Boston Tax Attorney Kevin E. Thorn

Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, represents all types of businesses in federal tax compliance and enforcement matters. If you would like to schedule an appointment with Mr. Thorn, please call 617-692-2989, email ket@thornlawgroup.com or contact us online today.