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Independent Contractors: IRS Issues Employer-Friendly Rules For Resolving Classification Disputes

An IRS audit claiming you misclassified workers as independent contractors rather than employees can be frustrating and expensive to resolve. But recent changes in IRS procedures for handling independent contractor classification problems may take some of the sting out of dealing with the government.

New Rules For Independent Contractor Disputes

Under the prior rules, if an IRS audit determined you misclassified an employee as an independent contractor, you would be sent an assessment demanding payment of back taxes, penalties and interest. And you would have to pay the assessment in full before you could even contest it. Only then could you request a re-determination from the IRS and, if it came out in your favor, seek a refund of your money. If you lost, you had to challenge the IRS in court.

To make matters worse, if you changed the worker’s classification from independent contractor to employee while the dispute was pending, the IRS would turn around and use this against you to show you had in fact misclassified the person. This put you in a serious bind if you wanted to change your policies for the future without incurring liability for the past.

Recently, however, the IRS implemented more employer-friendly procedures. Now, before the agency can slap you with an assessment, it must first issue an “Employment Tax Determination,” reflecting its conclusion that you improperly classified an employee as an independent contractor. You then have 90 days to file a petition in tax court to contest the determination. And you don’t have to pay the IRS while the case is pending.


The HR Management & Compliance Report: How To Comply with California Wage & Hour Law, explains everything you need to know to stay in compliance with the state’s complex and ever-changing rules, laws, and regulations in this area. Coverage on bonuses, meal and rest breaks, overtime, alternative workweeks, final paychecks, and more.


New Freedom To Correct Errors

You may also fix potential mistakes and reclassify independent contractors as employees without worrying about possible adverse consequences. This is because under the new rules, the tax court can’t use the fact that you changed the classification against you.

Safe Harbor Disputes Also Covered

The new rules also apply if you’re seeking relief under Internal Revenue Code Section 530. This provision provides a “safe harbor” -which means you won’t be penalized-if you mistakenly classify workers as independent contractors and you meet the following three requirements: 1) you filed 1099 and 1096 forms; 2) you consistently treated similarly situated workers as independent contractors; and 3) you had a reasonable basis for not treating the workers as employees. 

Settlement Program Extended

The IRS has also announced that, until further notice, it is extending its trial Classification Settlement Program, which was launched two years ago to facilitate early resolution of independent contractor disputes. Under this program, the IRS can settle independent contractor classification cases for a fraction of the back payroll taxes you owe if you have filed 1099 forms and agree to reclassify the workers.

Program participation is voluntary, and if you disagree with the IRS that you’ve misclassified someone, you don’t have to accept the settlement offer and can appeal instead.

 

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