Small businesses are sometimes faced with the problem of succeeding too quickly. It’s a problem most small businesses would be happy to have, but it can still be a serious problem for businesses when orders are coming in faster than they can be filled, and the owner has to take various shortcuts to meet demand. One of the common problems employers face in this situation is caused by quickly hiring employees, but calling these workers “independent contractors” in order to avoid the more complex paperwork and filing requirements that come with hiring employees. In the category of serious mistakes that can really bite you later, this one probably ranks pretty high.
The problem is that just calling somebody an “independent contractor” doesn’t necessarily make it so. If an employer is telling a person when to come and go, how to do their job, what tools to use, etc., then that person is probably an employee–even if paid in cash. And when the IRS discovers that employers haven’t been paying the proper payroll taxes on these misclassified employees, employers are often on the hook for significant penalties. After enough time has passed, it’s not uncommon for the back taxes and penalties to amount to more than what the employees were actually paid in the first first place…sometimes much more!
Complicating the situation is the fact once employers have gotten into this situation, it’s hard to get out of. Just coming clean and paying all back taxes has typically meant simply paying a very large bill, often large enough to put the employer out of business. But switching reporting methods now without also fixing prior years tends to be a big red flag to the IRS. So employers sometimes just punt on the whole thing, and continue misclassifying workers even after they could fix the situation, because they’re afraid of the consequences of correctly classifying the workers.
Fortunately, the IRS is offering something close to an amnesty program right now. (Funny how “amnesty” isn’t such a hot-button issue for businesses, only for immigrants…but I digress.) If you find yourself in the scenario described above with possibly misclassified workers, or know somebody who might be, then you really need to look into the Voluntary Worker Classification Settlement Program. There’s also an FAQ that answers many common questions.
I won’t go into a lot of detail here, but here are some of the basics. The VWCSP allows employers to come clean and reclassify workers in a way that will eliminate the possibility of the IRS opening up prior year’s returns for audits and assessing more penalties. The business owner does have to make a payment, but it’s only a very small fraction of the actual taxes and penalties that would have been paid without this relief option. In fact, the amount of the payment is only a little over 1% of the wages paid to misclassified employees in the most recent year…prior years are simply forgiven!
One other important note is that you can’t be under audit currently by the IRS or any other state or federal agency in relation to misclassified employees. Plus you must have filed 1099s for your misclassified employees. So if you want to come clean, you may have to file past 1099s.
This is just a quick overview, so please don’t make a decision based only on this information. Talk to a qualified professional about your situation. Make sure to consider the consequences at the state level because this is only a Federal program. But this is certainly a huge boon for many businesses that have found themselves with thorny employment issues.