March 21, 2013
Cleveland, Ohio

There’s nothing like an IRS audit to rattle the nerves of even the most honest small business owner, and the current employee vs. independent contractor classification tax code greatly increases those chances. The problem stems from what experts call a complicated definition of who should be classified as an independent contractor (self-employed) or an employee. When applied accurately, the independent contractor classification allows a small business owner to avoid withholding or paying any taxes on payments made to the contractor.

The most recent published report from the U.S. Small Business Administration, Office of Advocacy, lists 916,879 small businesses in Ohio, based on 2010 data. Small businesses fall into one of two categories: employers with fewer than 500 employees, and “non-employers”—those with no employees. The latter are generally home-based businesses, and account for 79 percent of the total. So, while it’s tempting to classify workers as independent contractors, it can be a risky decision.

According to Jim Forbes, CPA, principal at Skoda Minotti, “The tax code is confusing, and most small business owners don’t want to contact the IRS for clarification for fear of raising red flags. And, if they do contact the IRS, they’re encouraged to fill out FORM SS-8, which is equally complicated and can put their business into a review process that is lengthy and stressful.”

“On the other hand,” Forbes says, “if the IRS audits a business, they always ask for a listing of all 1099 recipients—it’s standard practice. If they see someone listed repeatedly, over a number of years, who has been receiving larger and steady payments, it could be a problem.”

If a business owner is found liable, he’s then responsible for paying the Social Security and Medicare tax match, worker’s compensation premiums, and federal and state unemployment insurance on every misclassified worker. Also, audited companies are more likely to be audited again.

For owners who want to settle their misclassification issues, the IRS offers the Voluntary Classification Settlement Program (VCSP). The program enables business owners to reclassify workers and receive partial relief from federal employment taxes. There are, however, strict eligibility requirements and guidelines set by both the IRS and Department of Labor.

“It’s always best to work with a firm that specializes in small business accounting and applicable tax codes,” says Forbes. “An audit can disrupt operations anywhere from a few months to more than a year. Add to that professional fees and multiple filings and conversations with the IRS, and you’ve got a miserable situation that could have been avoided by simply partnering with the right tax professional.”

About Skoda Minotti
Skoda Minotti is a business advisory firm with a history of guiding clients’ economic and professional success. Clients include privately held businesses, public companies, individuals, partnerships and corporations. Along with its renowned accounting, financial and tax services, Skoda Minotti offers a unique complement of advisory services including information technology, strategic marketing, professional staffing, wealth management, enterprise risk mitigation, and valuation and litigation advisory specialties to further advance the growth and success of its clients. Skoda Minotti has offices in Cleveland and Akron, Ohio and Tampa, Florida, and is an independent member of the BDO Seidman Alliance.

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