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The Rise in Employment-Tax Penalties

By Jerry Kalish

Last month, Marc Tracy, my leader (editorially speaking), touched on the issue of worker classification, and efforts to make it less complicated for business owners to hire someone as an independent contractor rather than an employee. I wanted to discuss this because several signs indicate that misclassification enforcement is on the rise. (My guess why? Blame the economy. Governments need revenue, and so they're cracking down on everything from jaywalking to, well, employee misclassification.)

It’s a cost issue, of course, for the business owner, and a payroll tax issue for the IRS. I’ve written about this matter before for this blog in November of last year ("What’s In A Name? Sometimes A Lot") and for my own Retirement Plan Blog this past January ("Independent Contractor Or Employee? Employee Classification Still A High Priority Enforcement Matter").

And so here I am again revisiting the same topic. Why? Because tax advisors have been reporting that in addition to the IRS, several states are stepping up their audit and enforcement activities of small businesses to determine if workers are being properly classified. And it’s not just a payroll tax matter for the states, by the way: it’s also about getting employers to pay employment tax on workers the state considers employees.

Here are some recent sightings:

This past January, Attorney Rush Nigot told us that the state of Iowa is planning to increase anti-contractor misclassification efforts.

And this past April, Attorney Joseph Dang in his San Diego Small Business Law Blog wrote about both the feds and the state of California’s enforcement activities.

(Both attorneys do an excellent job of translating legal issues affecting small business into practical information, and should be part of your regular reads.)

And now in my own state of Illinois, CPAs, Sikich LLP, report that they have noticed a significant increase in the number of random small business audits being conducted by the Illinois Department of Employment Security, the state agency that regulates unemployment benefits.

So it’s no large leap in logic to assume that because of the economy, the various states are taking stricter positions to beef up employment taxes, in order to pay for increased unemployment benefits. And it’s also known that these state agencies often share information with the IRS, which could lead to additional taxes and penalties if a worker is misclassified.

What to do? This is another one of those "kids, don't try this at home" matters. Consult a qualified tax advisor, because a mistake can be very expensive. In the meantime, check out the IRS’s updated online resource page, Independent Contractor (Self-Employed) or Employee? The page includes links to how to get a determination from the IRS on a worker’s status, and how to get tax relief.

Jerry Kalish is founder and President of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm that serves private-held companies, publicly traded companies, and public sector employers. He blogs at The Retirement Plan Blog and can be reached at jerry@nationalbenefit.com.

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