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Small businesses are often lauded by politicians of all types for their role in role in driving the economy and creating jobs. But small employers face many practical challenges in trying to make their businesses work. Some of those are tax challenges.

This week, the Wall Street Journal reported that the IRS has been tightening up its scrutiny of employers on the issue of employee classification. The IRS is concerned about what it perceives to be a tendency for employers to classify their workers as independent contractors rather than employees.

In California and across the country, there are of course many factors that go into employers’ decisions on whether certain workers should be treated as employees or as contractors. In the eyes of the IRS, however, one reason for choosing contractor status may be to avoid payroll taxes.

What is it like for employers who face IRS audits on this issue? As with any audit, the process can be stressful. Even if you end up in the clear, the audit can be a serious stressor for a significant amount of time. And that stress can easily distract a business operator from focusing on many other aspects of running the business.

Even veteran human resources professionals struggle to articulate the distinction between full-time employees and contractors who are brought in to work full time. The question is as timely as ever, however, in part because of the federal Affordable Care Act (ACA).

Under the ACA, businesses that employ 50 or more people will face new responsibilities next year. Businesses over that threshold will be obligated to pay for health insurance for their employees. If they do not pay, they will face a penalty.

Clearly, then, tax considerations are not the only factor involved in questions of employee classification. But when the IRS comes calling, alleging employee misclassification, it certainly gets employers’ full attention.

Source: “Payroll Audits Put Small Employers on Edge,” The Wall Street Journal, Angus Loten and Emily Maltby, 3-13-13

To learn more about our practice, please visit our page on tax audits.