IRS and Department of Labor Take Steps to Address Worker Misclassification

 Posted on January 11, 2023 in Small Business Taxes

Small business owners need to address a variety of small business tax issues, and it is important to comply with all requirements put in place by the IRS and California's Employment Development Department (EDD). Worker misclassification is one issue that has received increasing scrutiny in recent years, and businesses that improperly classify workers as independent contractors instead of employees may face a variety of tax penalties. Recently, the IRS and the federal Department of Labor (DOL) announced that they will be working together to identify tax compliance issues related to worker misclassification This may result in tax audits and penalties for businesses that have failed to follow the proper procedures.

Understanding the Joint Worker Misclassification Initiative

On December 14, 2022, the IRS and the DOL issued a Memorandum of Understanding for Employment Tax Referrals, and this document stated that the agencies will be working together to improve compliance with laws related to worker classification. The Department of Labor's Wage and Hour Division regularly investigates complaints related to the misclassification of workers. Under this initiative, the WHD may refer information related to investigations about alleged worker misclassification to the IRS's Small Business/Self-Employed Specialty Employment Tax unit. The IRS will then evaluate these referrals to determine whether to conduct audits and assess penalties against noncompliant employers.

The Memorandum of Understanding detailed certain requirements that must be met before cases can be referred to the IRS. A business must still be in operation at the time of the referral, and the IRS will typically only investigate businesses that did not have a good-faith basis for misclassifying workers. Referrals will only be made in cases where a business had an annual dollar volume of at least $500,000. That is, the business's gross earnings over a period of 12 months must be $500,000 or more.

In addition, the IRS will not accept referrals in cases where a business may qualify for safe harbor under Section 530. Section 530 allows businesses to receive relief from employment tax liability if they meet all of the following requirements:

• Reporting consistency - The employer must have filed all required tax returns showing that they did not treat a worker as an employee. These include 1099 forms filed for independent contractors.

• Substantive consistency - The employer must have treated workers consistently. If the employer treated some workers holding similar positions as employees and others as independent contractors, they will not qualify for relief.

• Reasonable basis - An employer may receive relief if they relied on previous tax audits, standard industry practices, judicial precedents, or other valid reasons when classifying workers as independent contractors.

Contact Our San Jose, CA Tax and Employment Tax Lawyer

Employers are facing increasing scrutiny related to how they classify workers, and they may be subject to a variety of penalties if they are accused of incorrectly classifying workers as independent contractors. If your business is facing an IRS audit, an investigation by the Department of Labor, or queries from the California Franchise Tax Board, you will need to understand how to respond correctly. At John D. Teter Law Offices, we can advise you on the best ways to address these issues, and we can provide representation in tax audits and help you determine how to avoid or minimize potential penalties. Contact our San Jose tax and employment attorney at 408-866-1810 to set up a consultation and get the legal help you need.

Sources:

https://www.dol.gov/sites/dolgov/files/WHD/MOU/MOU-WHD-IRS-22-signed.pdf

https://www.irs.gov/government-entities/worker-reclassification-section-530-relief