Help with New York State and IRS Tax Audits

Both the IRS and New York State are trying to reclassify independent contractors as employees in order to collect additional taxes. We anticipate these type of tax audits by both the IRS and New York State to increase.

One of the steps our NYC tax experts recommend to clients that use independent contractors (and therefore face a heightened risk of a costly IRS payroll tax or benefits audit), is a quick review of some of the key things the IRS tells its agents to look at in determining whether a worker is an independent contractor or an employee.

The primary inquiries fall into three categories. Who has financial control of the job? Who can exercise control over how the worker performs the specific task? And, how do the parties themselves view the relationship? When reviewing the checklist, keep in mind that the IRS will make its decision based on the whole picture, not just a single factor.

Workers are more likely to be classified as independent contractors if they:

  • Make a significant investment in business property, such as tools
  • Pay their own business expenses
  • Receive a flat fee that is not based on an hourly or similar rate
  • Are not prohibited from doing work for other companies
  • Can pay subcontractors to get the job done
  • Are not performing services as an integral part of your regular business
  • Have a contract with an enforceable liquidated damages provision
  • Can make a profit
  • Can suffer a loss

Workers are more likely to be classified as employees if they:

  • Are given specific instructions and on-going training in how to get the work done
  • Cannot work for others
  • Have expenses paid by your company
  • Are paid with a salary or hourly wage
  • Do not have a significant investment in their trade or business
  • Are an integral part of your regular business
  • Receive direct reimbursement for all, or almost all, expenses

Other factors are:

  • Whether or not the work is performed on the business’s premises
  • Whether the worker has flexibility in setting hours
  • Whether the relationship is temporary or short-term
  • Whether the work is full- or part-time
  • Whether the worker performs services for one or more businesses

Relief Programs for Misclassified Workers

Claiming you’ve always handled business matters in a certain way usually isn’t an effective defense against IRS challenge. However, consistency can be an important defensive tool if you have always treated workers as independent contractors, and you fear that the IRS may now want to treat them as your employees for employment tax purposes. A special safe haven rule may prevent the IRS from reclassifying your workers as employees if you meet the following requirements:

  • Your business has never treated the workers in question as employees.
  • Your business has treated the workers in question as independent contractors on all of its federal tax returns, this includes filing Form 1099 information returns for these workers.
  • Your business has never treated anyone holding a substantially similar position to the workers in question as an employee for employment tax purposes after 1977.
  • Your business has a “reasonable basis” for not treating the workers in question as employees. A “reasonable basis” for not treating workers as employees automatically exists if:
  1. The IRS has audited your business and has never charged you with an employment-tax bill based on your treatment of anyone holding a substantially similar position to the workers in question;
  2. A court decision or an IRS ruling specifically has said that similarly situated individuals were independent contractors rather than employees; or
  3. A significant segment of the industry your business is in has historically treated similarly situated workers as independent contractors.

Even if your business does not pass any of these three tests, you may still be able to prove some other reasonable basis for not treating the affected individuals as employees. Also, businesses that have filed returns, but that do not clearly meet the other safe haven requirements, may be able to take advantage of a test program that allows the IRS to make a settlement offer. The exact amount that the IRS will ask for depends on the degree to which the safe haven requirements are met. A business that meets the reporting requirements and has a “colorable” argument that it meets the consistent treatment and reasonable basis tests, can expect to pay approximately 25 percent of its liability for one year. One trade-off of this arrangement is that the business must agree to properly classify its workers in the future.

Let us help you determine whether your business would qualify for relief, or find out if there are other ways to effectively insulate you from an expensive payroll audit in NYC, contact us today.