The experienced tax attorneys at Nardone Limited, located in Columbus, Ohio, frequently advise taxpayers throughout the Internal Revenue Service (“IRS”) audit and examination process. This includes providing guidance to employers on worker misclassification concerns. Misclassifying a worker can come with significant penalties to a business if audited by the IRS. For more information on penalties for misclassifying a worker, see our prior tax blog article posted on October 10, 2018. If an employer is concerned that an audit may reveal that they have misclassified a worker, it is helpful for the employer to understand how an audit can originate. Worker misclassification typically comes to light in two ways: (i) a worker files a complaint with the IRS seeking determination of their status; or (ii) the IRS conducts an audit of the business.
Background Regarding Worker-Reported Audits
If a worker believes they have been misclassified and reports their suspicion to the IRS, both the worker and the firm are required to fill out Form SS-8. For purposes of Form SS-8, “firm” means any individual, business enterprise, organization, state, or other entity for which a worker has performed services. The purpose of Form SS-8 is to help the IRS determine the status of a worker under common law rules. Generally, under the common law rules, the worker is an employee if the firm “has the right to control what will be done and how it will be done.” IRS Instructions for Form SS-8. The questions on Form SS-8 contemplate behavioral control, financial control, and the relationship between the worker and the firm. Behavioral control considers who decides how the work must be performed; while financial control considers the pay structure for the particular worker. The IRS then reviews the forms to render a decision. The decision may either be a formal determination or an information letter. Formal determinations bind the IRS in all future cases with the same facts, while information letters are only advisory. But, for the worker and the firm, either are binding. IRS Instructions for Form SS-8.
Nardone Limited Comment: Prior to completing Form SS-8 or any other questionnaire sent by the IRS, it is important for the employer to consult with an experienced tax controversy attorney who handles these matters on a routine basis. It is not a good idea to work with an attorney or accountant who is unfamiliar with employment tax audits or worker classification issues. Professionals who do not routinely handle these types of issues, will not have the appropriate perspective and background to know when to respond and how to respond to the IRS. We have seen too many situations where a response from a professional, who does not specifically specialize in tax controversy matters, has hurt the client’s position rather than helped it.
IRS-Initiated Audits and Examinations
If the IRS initiates and performs an audit or examination, the IRS considers several factors, such as: the use of a large number of independent contractors, Form 1099-MISC with large reporting of nonemployee compensation, and mismatches where workers with identical or near-identical jobs are classified differently. The identical jobs issue frequently arises with temp-to-hire workers, who are initially classified as independent contractors. But, upon hire, there is no meaningful change in their job duties or right of control. If the IRS decides to conduct an audit, it will contact the business by mail. An audit can either be done in person—such as at the business location—or by mail. The audit process may involve disclosing company documents such as: contracts, payroll information, and email correspondences to the IRS. Information considered by the IRS will be analyzed to determine whether there should be a change in tax liability. An audit can conclude in three ways: (i) no change; (ii) agreed; or (iii) disagreed. A “no change” determination is made if the business substantiates all of the items being reviewed. An “agreed” or disagreed” conclusion means that either the business agrees with the IRS’ proposed changes or it disagrees with the proposed changes. If a business wishes to challenge the IRS’ decision, the business has 30 days from the date of the determination letter, to appeal to Office of Appeals.
It is important to recognize, as the employer, that the submission of a Form SS-8 may trigger a number of unintended consequences. Thus, recognizing the legal framework of the worker classification issue as it relates to independent contractors versus employees, is really important. It is equally as important to understand the employer’s options as it relates to responding to the Form SS-8 and the potential response from the IRS. With that said, sitting down with someone and investing some time and money to properly understand the overall circumstances regarding the Form SS-8 is prudent under the circumstances. We also have to understand and recognize that there may be some ulterior motives as it relates to the submission of the Form SS-8 by the worker, as well as the impact the submission may have with other federal and state agencies, including the U.S. Department of Labor and the unemployment compensation agency within the particular state.
Contact Nardone Limited
Nardone Limited represents businesses with federal tax issues, including preparing for IRS audits and examinations regarding worker classification issues. If you have workers who may be improperly classified, or think you may need to update your classification procedures, you should contact an experienced tax attorney. Nardone Limited’s tax attorneys and professionals are experienced with representing clients before the IRS. Contact us today for a consultation to discuss your case.