Misclassifying employees as subcontractors has always been a hot-button issue for businesses, but it’s getting more airplay recently as the federal government looks to enforcement as a way to narrow the budget gap – generating $7 billion over the next 10 years. President Obama’s 2011 proposed budget would have the Internal Revenue Service adding 100 new enforcement personnel who will be checking businesses. Already, in February, the IRS began an audit of 6,000 randomly selected businesses both large and small. There will be no flying under the radar.

According to Therese Crahan, executive director of National Association of Home Builders Remodelers, a fourth quarter (2009) Remodeling Market Index showed that the average number of specialty trade contractors that remodelers use annually is 18 and that 53% of a remodeler’s work was subcontracted. Subcontracting may mean lower labor costs, but penalties are steep for those who misclassify – i.e., claim that someone is an independent contractor when they really are treated as an employee.

To avoid any problems, remodelers should bone up. Know the rules describing independent contractors. Briefly,

  • A worker misclassification determination is made under a facts and circumstances test. The IRS follows a 20-factor test to determine if a worker is an employee or an independent contractor. The test attempts to establish the level of control that the business owner has over the worker.
  • If the IRS finds that an employer has misclassified a worker as an independent contractor, the IRS will reclassify the worker as an employee. The employer will then be required to pay all back payroll taxes, any interest accumulated on those back taxes, and fines for having erred in worker classification.
  • Section 530 of the Revenue Act of 1978 provides a “safe haven” for employers by allowing an employer to treat a worker not as an employee for employment tax purposes regardless of the determination of the common law test. Under section 530, a reasonable basis exists for treating a worker not as an employee if the taxpayer relied on:
    ==> Past IRS audit practices with respect to the taxpayer;
    ==> Published rulings or judicial precedent;
    ==> Long-standing recognized practices in the industry of which the taxpayer is a member; or
    ==> If the taxpayer has any “other reasonable basis” for treating a worker as an independent contractor.
  • Section 530 also blocked the IRS from drafting any new regulations regarding the classification of workers.

For more information go to the IRS website. --Stacey Freed, senior editor, REMODELING.