They Might Be Employees, and You May Be in Hot Water with the IRS
Under the Trust Fund Recovery Act, the IRS has targeted businesses which misappropriate funds collected from employees for the purpose of paying payroll taxes. Trust Fund Recovery Act penalties take the back-taxes and interest that are owed on unpaid trust fund taxes, and apply penalties and interest that can increase the amount you owe exponentially over time. To make matters worse, the IRS penalties cannot be discharged in bankruptcy.
Worse still is the fact that failing to pay trust fund taxes can lead to criminal charges and prison time. Recently the IRS is showing an increased willingness to pursue criminal charges against those who willfully violate their payroll tax duties. The IRS is aggressive in assessing the trust fund penalty, and is becoming more aggressive in pursuing criminal cases.
One of the most common ways a business can run afoul of its payroll tax obligations is to classify workers as independent contractors when those workers should really be employees for tax purposes. If a worker is an employee, the employer must withhold and/or pay income taxes, Social Security and Medicare taxes, and unemployment taxes on wages paid to an employee, and pay the proper amounts to the IRS. In contrast, businesses generally do not have these responsibilities towards independent contractors.
One of the most commonly improperly classified type of worker are salespersons. It is very common that business will classify salespersons as independent contractors, especially when that person deals in outside sales. Outside sales is a term that generally describes a representative of the business who goes out into the field to meet with potential customers, rather than dealing with them on-site at the place of business.
If you or your company has received notice of an IRS audit of your payroll taxes, or received any communication from the IRS which you do not understand, it is imperative that you contact an experienced tax attorney as soon as possible. Mistakes made early in the process, could lead to otherwise avoidable consequences such as seizure of assets, financial penalties, and even jail time.
Do You Have Salespersons Classified as Independent Contractors?
If you do, you might have them improperly classified. For payroll tax purposes, salespersons are treated the same as any other workers unless there is a definable reason for classifying them as an independent contractor. Most businesses have to withhold and pay payroll taxes for their salespersons. However if a salesperson can properly be classified as an independent contractor, the business can avoid payroll taxes on their compensation.
The right to direct or control the work being done is the primary consideration in determining the difference. The IRS website, defines independent contractors as someone who “has the right to control or direct not only the result of the work, but also what will be done and how it will be done.” This concept of the worker’s autonomy is the primary consideration, and the IRS website breaks down a 20-factor analysis it recommends that business owners or managers use in making a determination. You can find the 20 factors the IRS uses to distinguish independent contractors from employees here: http://thetaxlawyer.com/payroll-taxes/information/20-factors-distinguish-contractors-from-employees
There are some types of salespersons for whom a business can likely avoid federal and most state payroll taxes by properly classifying and treating them as independent contractors. Examples of such include traveling salespersons, real estate agents, and direct sellers. A primary factor in determining if such relief may exist (along with the “control of work” factors) is whether most or all of the compensation paid to person is directly related to sales or to other output, rather than to the number of hours they work.
"Direct sellers" are persons who sell or solicit the sale of consumer products at a place of business, such as a home, that is not a permanent retail establishment. The sales can be to the ultimate consumer or to a buyer who purchases the products for resale and on a buy-sell basis, deposit-commission basis, or similar basis.
Don’t Trust a Paper Shield
It is an all too common mistake employers make in thinking that they can avoid incurring payroll tax obligations simply by having their workers sign agreements that declare the workers to be independent contractors. Such agreements are viewed by courts as self-serving to employers and carry little, if any, significance under the common-law rules. If your actions show an employer-employee relationship, then your workers are employees regardless of what kind of documentation you might have them sign. The IRS is not stopped by paper shields, only knowledge of the law and effectively executed strategy can protect you.
Consult The Tax Lawyer if You Doubt the Classification of Your Workers
The IRS considers improper classification of an employee as an independent contractor to be an area of significant noncompliance. Small business owners, often lacking the resources to implement internal control systems and safeguards, can be especially vulnerable to prosecution under the Trust Fund Recovery Act. The US Tax Code is one of the most complicated that has ever existed. Even the most honest, competent, and diligent of employers face countless opportunities to run afoul of the IRS. It is crucial to have proper guidance of an experienced tax attorney in making key business decisions.
If you are undergoing an IRS audit involving worker classification issues, or anticipate that an audit may be on the horizon, it is wise to retain experienced legal counsel and take great caution in how you respond to the IRS. William D Hartsock has been successfully helping clients resolve business tax issues and payroll tax matters since the early 1980's. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule your free consultation simply fill out the contact form found on this page, or call (858)481-4844.