Business freedom?

We grow up in this country singing the Star Spangled Banner at the beginning of every sporting event and at many other gatherings. I’m just curious. Does anybody besides me feel hypocritical when you get to the lyrics “the land of the free and the home of the brave”?

Maybe it is because I’ve been a CPA too long. When you have knowledge of the depth and extent of the regulations that businesses are required to comply with, I don’t know many business owners that feel they operate in the land of the free, and believe me, it doesn’t pay to be brave by ignoring many areas of the law administered by the IRS.

When the Star Spangled Banner was written, you could hire a man, pay him his wages, and not worry about withholding and paying employment taxes, unemployment taxes, Federal income taxes, and then preparing all the related payroll tax reports that have to be filed with the government or suffer a battery of penalties if you fail to comply. Today if you were to pay a worker in that manner, i.e., without withholding taxes from his wages and without paying a portion of his Social Security tax and unemployment taxes, you might draw the ire of the IRS.

I’ve discussed this issue in the past.

It’s the question “Is the person you pay for performing a service for your business an independent contractor or an employee?”

For the past few years the IRS has been challenging with increasing intensity businesses that pay workers as independent contractors by reclassifying these workers as employees. Here is why this is significant. If the IRS is successful in their challenge, the penalties can be very large, so large that some businesses might not survive the financial impact.

Here is an example (without the detail of the calculations to avoid being tedious). Joe runs a small janitorial service. In 2010 he paid five workers $20,000 each and treated them as independent contractors. The IRS challenged Joe’s treatment of these workers and successfully reclassified these five workers as employees. The IRS determined that Joe did not intentionally fail to comply with the employment tax rules. As a result Joe had to pay the IRS the employer’s portion of the FICA tax, a portion of the employee’s Federal income tax and FICA tax and the Federal unemployment tax for a total penalty of $10,915.

However, if Joe failed to file the 1099’s for each of these workers, the penalty would be calculated using somewhat higher rates bringing the total penalty up to $13,945. But get this. If the IRS believed Joe intentionally misclassified the workers as independent contractors, the penalty would be assessed at $40,508. And to keep piling it on, they would probably not limit the assessment to 2010. They would most likely assess the penalty on each year not protected by the statute of limitations, generally at least a total of three years. So a worse cast scenario for Joe would be a penalty assessment three times the 2010 penalty, or $121,524. Ouch!

Now ask yourself this question. How brave do you want to be?

If you are a business owner with a history of paying workers as independent contractors, it might be prudent to look closer at the rules governing whether the IRS might consider your workers employees. If you are worried you might be at risk, get a second opinion from a CPA or tax attorney. If you are at risk, here is the good news, kind of. A couple of months ago the IRS introduced a new program called the Voluntary Classification Settlement Program (VCSP). It’s basically a program where you can tell on yourself and get a reduced penalty.

To participate in the VCSP, a business “must have consistently treated the workers as nonemployees, and must have filed all required Forms 1099 for the workers to be reclassified under the VCSP for the previous three years to participate in VCSP.

Additionally, the taxpayer cannot currently be under audit by the IRS and the taxpayer cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.”

If you participate in the VCSP, you will agree to treat workers as employees for future tax periods; you will pay 10% of the employment tax due for the most recent tax year ($1,092 in Joe’s case as discussed above); you will not be liable for any interest and penalties on the amount; and best of all, the IRS will not audit you for prior years.

To participate in the VCSP, the business must apply at least 60 days from the date the taxpayer wants to begin treating its workers as employees.

They say confession is good for your soul. But then again, I’m a cynic. I prefer the proverb “silence is golden.” But I suspect there are many businesses that should seriously consider participating in the IRS’s new VCSP program. If you own a business and pay a significant amount of workers as independent contractors, maybe you should consider applying for the VCSP.

But don’t be too brave, or should I say foolish.

One final piece of advice. If you think it’s in your best interest to participate in the IRS’s Voluntary Classification Settlement Program (VCSP), get professional help. This is a complex area of tax law.

About Potts
David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow more of his thoughts at ThePottsReport.com. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.

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