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VCSP CPA explains Worker Reclassification | Employee or Subcontractor?

VCSP CPA explains employees and subcontractor worker reclassification

Gary Bode, CPA: if you're paying employees as subcontractors, look at the IRS VCSP program and assess your risk. (910) 399-2705.

VCSP CPAs are fielding more calls about the Voluntary Classification Settlement Program, even though the IRS has only received 625 applications, according to an article in CPA Insider. Why the IRS interest and how can they ferret out abuse?

  • The increasing number of taxpayers reporting as subcontractors; perhaps as many as 16 Million in 2012.
  • Studies show that mis-classification of subcontractors and employees can be 25%.
  • The business claims subcontractor expenses because they don’t want to lose the tax deduction.
  • The IRS knows that some of these subcontractors are actually employees by comparing the company’s tax return to similar companies.
  • The automated IRS Correspondence Audits now send letters asking for some type of documentation on subcontractors they suspect are employees.
  • The IRS is cooperating with 37 states to cross correlate worker information according to an article in CPA insider.
  • Companies that pay wages and subcontractor fees to the same Social Security number raise red flags.

Company Penalties

VCSP isn’t about retroactive punishment. The fine is 10% of what your last 12 months of employer taxes would have been. The IRS is more interested in your future compliance on the underlying VCSP issue.

“Your company can’t qualify for VCSP if the IRS has already started an audit. Best to check out the program and assess your risk.”
– Gary Bode, VCSP CPA

So what if they do audit you and find employees mis-classified as subcontractors? Well let’s say they go back 5 years and you had $100,000 of mis-classified subcontractors expense per year. The minimum tax due would be $181,250 plus penalties plus interest. If your subcontractors didn’t pay taxes themselves, your company could be on the hook for their taxes; another $181,250 of employment taxes, and, perhaps an additional $100,000 of income tax. Worst case scenario? Perhaps a cool $500,000 in taxes, penalties and interest.

I’m a VCSP CPA with a virtual office to help you wherever your company is located. We offer a free phone consult at (910) 399-2705. You can read numerous worker classification and other payroll issue posts on this website to better gauge how we approach things.

So what’s the VCSP definition of an Employee?

It depends. There are 20 factors the IRS considers, with no clear lines. But the usual rule of thumb is that if you can tell a worker when to show up and tell them what to do, that’s an employee. Here’s a cut and pasted blurb from the IRS website.

Behavioral Control

Behavioral control refers to facts that show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.

The behavioral control factors fall into the categories of:

• Type of instructions given

• Degree of instruction

• Evaluation systems

• Training

Types of Instructions Given

An employee is generally subject to the business’s instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work.

• When and where to do the work.

• What tools or equipment to use.

• What workers to hire or to assist with the work.

• Where to purchase supplies and services.

• What work must be performed by a specified individual.

• What order or sequence to follow when performing the work.

Degree of Instruction

Degree of Instruction means that the more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.

Note: The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.

Evaluation System

If an evaluation system measures the details of how the work is performed, then these factors would point to an employee.

If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.

Training

If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Periodic or on-going training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.

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