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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.
  • Independent Contractor designation and the problems it can cause for your small business

    Footba12Employment tax law requires the employer to withhold the employees’ fica tax, unemployment tax and income tax from the paycheck, throw it in a pot, mix some more money into the pot equal to the employee’s fica tax and shoot the whole thing over to the IRS each quarter.

    This process requires a lot of work and a lot of money, especially when the business has a lot of employees.

    So, the employer has a natural incentive or really a “dis-incentive” to do this work and pay this tax. The investment comes with no reward, reduces profits and reduces the number of employees the business can hire and products it can sell.

    This incentive leads the small business to find ways in which it can avoid the burden by treating workers as independent contractors instead of as employees.  By doing this, the business avoids the tax reporting, the bookkeeping and the withholding tax and save’s itself a lot of money and headache.

    The problem?

    If the business treats workers as Independent Contractors when it should be treating them as employees, the headache can be much larger.

    If the IRS gets involved and determines that an independent contractor should have been treated as an employee, the business can get stuck with penalties/costs up to 35% of the payments made to the wrongly classified worker…plus interest.

    This misclassification is a priority problem in the IRS’ world. It targets businesses it suspects, like building contractors, doctors, sales organizations and beauty shops among others.  Often the IRS will make the determination without fully analyzing the status of the business’ work situation and leave it to the owner to prove that the workers deserve the independent contractor determination.

    So – how to follow the IRS’s rules and classify/treat the worker appropriately in order to avoid a mess is the question and the topic of future posts.