Did you know many employers pay their workers as “contract labor” rather than “employees”? What’s the difference? Well, simply put, contract labor payments are not subject to payroll taxes (such as FICA and federal/state withholding) whereas employee wages are. For instance, say John Doe works 40 hours for $10 an hour. As contract labor, the cost to the employer is $400 (40 hours x $10). However, as an employee, the cost is at least approximately $435. That extra $35 could multiply into a significant amount of money when factoring in multiple employees and numerous years of payments.
So wouldn’t every employer want to pay their workers as contract labor? Of course! Unfortunately they are not able to arbitrarily classify all workers as contract labor. The IRS has standards on whether or not a worker should be classified as contract labor or an employee. Some considerations are the level of control an employer exhibits over a worker and whether expenses are paid, among other provisions. Needless to say, many employers disregard these standards in order to save money.
But the IRS is cracking down to ensure employers “own up” to their payroll tax obligations. Penalties for misclassification can be very high. For instance, if John Doe is paid $50,000 in a year as contract labor, but he should have been paid as an employee, the resulting penalty is approximately $6,200 for just the one year–NOT including interest. This is the amount the employer would have to pay the IRS. Multiply that by 6 employees over 2 violated years and you’re looking at about $74,000!—again, not including interest.
However, the IRS announced on Wednesday a Voluntary Classification Settlement Program (VCSP). Under this program employers can avoid penalties and interest if they voluntarily reclassify workers as employees going forward and limit the resulting federal payroll taxes for their most recent tax year, plus avoid penalties and interest for prior years. In return, employers will pay 10% of the employment tax liability otherwise due for the most recent tax year, which will not be subject to interest or penalties. In addition, the IRS will not conduct an employment tax audit with respect to the employer’s worker classification for prior years. In the above example, that could turn the $74,000 into less than $4,000.
Do you need help determining if your workers are employees or if they are contract labor? Do you need help determining if you are at risk and what your liability might be? Do you need help deciding if you should take advantage of the Voluntary Classification Settlement Program (VCSP)? If the answer to any of these questions is “yes”, then please email me at dmiller@edanielmillercpa.com.