IRS ‘contractor’ study raising big concerns

The Internal Revenue Service has launched a hard look at how companies count contractors and full-time employees, prompting business advisers to urge companies to take a look before the revenue service does.

“I’m guessing the use of independent contractors and contingent workers has expanded a lot in the last 25 years,” said Mike Abcarian, an employment law attorney at Fisher & Phillips in Dallas. “For the IRS this is an issue of a lot of money not finding its way to the federal government.”

The study, which began in March, will involve three years of intensive audits of businesses and workers, and will be used to help the IRS determine the difference between how much tax it collects and how much goes unpaid, said Clay Sanford, an IRS spokesman.

The study will also be used to look for tax cheats on both sides of work arrangements, Sanford said.

An IRS program manager told industry publication Tax Notes Today that 20 Texas companies are part of the first wave of companies being studied, despite the companies being randomly selected. The IRS manager was not immediately available for additional comment.

Speed bump for growth

The study comes at a hard time for businesses looking to grow and be flexible during a stop-and-start recovery.

“A lot of employers are looking for ways to be more efficient,” Abcarian said. “If you use independent contractors, you can price your product lower because you have less administrative costs.”

Add in the prospect of additional health care costs tied to regulatory reform, and government changes are giving companies even more reason to avoid new hires, said J.R. Gonzales, former president and CEO of the U.S. Hispanic Chamber of Commerce.

“The economy’s not making it any easier (to hire), and more restrictions will make it more difficult,” he said.

Independent contractors are concerned, too.

“When you’re looking for a flexible work force this is an ideal situation,” said David Dunnigan, executive director of the Dallas-based Coalition for Independent Contractor Freedom. “In many cases, you can make more money as an independent contractor because there’s not a ceiling there.”

If the IRS redefines how contractors are classified, that flexibility and upside for entrepreneurial contractors could be challenged, he said.

A more aggressive IRS

Fundamentally, it’s easier for the IRS to collect employment taxes from companies and their full-time employees, Abcarian said.

That creates a bias in the IRS toward counting workers as employees rather than contractors, said Jim Smith, an accountant with Smith Jackson Boyer & Bovard PLLC in Dallas.

“They are increasingly auditing (small and mid-sized businesses) that are reporting a large number of contractors,” he said. “It’s not a program, it’s a pogrom,” Smith said.

If a company has accidentally misclassified full-timers as contractors, it should simply correct that mistake, said the IRS’ Sanford. But if a business has “no reasonable basis” for misclassifying a worker, it can be held liable for all the workers’ employment taxes, not just the portion typically paid by the company.

Companies could also face penalties and interest. In extreme situations, a company could face class action lawsuits on behalf of misclassified workers claiming they haven’t been properly paid for the hours they’ve worked, Abcarian said.

He said he expects to see a more aggressive IRS even before the study is done, and businesses should get ready.

“This is a very appropriate time for employers to do their homework in terms of classification of employees to be sure they’re doing it right,” he said.