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IRS seeks businesses engaging in payroll tax evasion

The past few years have undoubtedly been difficult on a number of California small businesses. Owners and entrepreneurs have had to tighten their belts to meet the realities of an economy slow to embrace a lasting recovery. One popular strategy has been to hire independent contractors to perform work because a company can reduce the benefits it pays out while incurring lower payroll taxes.

While this move can make smart business sense, it can land a company in tax trouble if done improperly. Internal Revenue Service auditors are on the lookout for businesses that attempt to evade payroll taxes by turning employees into independent contractors. In the IRS's eyes, the label that an employer applies to its workers does not hold much water compared to other facts about the worker's relationship with the employer.

While there is no bright-line distinction that separates an employee from an independent contractor, the IRS will consider a number of factors to discover in which category a worker belongs. These include whether a purported independent contractor recently worked for the company as a regular employee. While not determinative by itself, this could indicate an incorrect classification of the worker.

In addition, if a company has not issued 1099s to its independent contractors, this will go against its classification. IRS agents will also consider a contractor's place within the company's structure. In general, independent contractors have greater freedom to dictate how they work. If a contractor is subject to a great degree of control by supervisors within the company and has responsibilities similar to those of a regular employee, the IRS may be skeptical of the classification.

The IRS actively investigates improper worker designations because of the potential to capture significant revenue. Like ordinary taxpayers, businesses deemed in violation of the Tax Code can face penalties and interest. It is important that companies resolve their payroll tax issues as quickly as possible because the IRS can place a lien on a business's property, potentially affecting its credit.

Source:, "What Auditors Look for: Independent Contractor vs Employee," Bonnie Lee, June 8, 2012.

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