The Trust Fund Recovery Penalty–Employee Classification
One of the many tax risks faced by owners of businesses is the trust fund tax penalty. With the IRS’s current focus on payment and collections of employment taxes, owners may wind up with a notice from the service inquiring about their Social Security, Medicare, and income tax withholding from employees wages. IRC 6672 provides the Service with the authority to collect 100% of the employee’s portion of the unpaid or uncollected taxes from the responsible person(s) personally. This has been defined very broadly by the courts and can encompass multiple managing officers or employees. There are many reasons why a business owner might run afoul of IRC 6672, and I will cover them in a series of posts for this blog, including an explanation of how these penalties work as well as certain IRS programs that may benefit owners facing employment audits. In this entry, I intend to discuss the basic but critical distinction between independent contractors and employees. Business owners who improperly classify their workers and do not withhold the appropriate payroll taxes are at risk of being penalized.
Some readers of this blog may have noticed that wrestlers formerly employed by World Wrestling Entertainment recently sued that company. One of the arguments made in this lawsuit is that the decades-long distinction between independent contractors and regular employees, in which wrestlers were characterized as independent contractors, is legally incorrect. The owners of the WWE, like the owners of other businesses, classified their workers as independent contractors because it meant they did not have to pay employment taxes on behalf of these workers or offer them various other benefits.
The Affordable Care Act, which was the signature piece of legislation passed during the Obama administration, has raised costs for some business owners by requiring them to offer health insurance benefits to their employees. As such, owners concerned about these added costs may go out of their way to classify or reclassify the workers they employ as independent contractors. This can save them time and money, since it places many administrative burdens back on the workers, but the IRS carefully polices these classifications and may penalize employers who improperly label their workers as independent contractors.
The IRS offers guidelines for employers seeking to determine whether their workforce consists of independent contractors or employees. There is no bright-line test, but factors such as control of workplace performance, the presence of a pension plan or a vacation time schedule, and the provision of employer-owned tools may lead to a determination that an owner’s workforce is made up of employees. Employers who are concerned about this issue can complete Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” which will allow the IRS to make the decision for them, but it may be several months before a decision is rendered.
Several “best practices” can help employers avoid complications involving the IRS. If a workforce does consist primarily of independent contractors, the employer should be diligent and thorough about filing the necessary Form 1099-MISC paperwork and getting contractors to complete their Form W-9s. Relationships with these workers should be documented thoroughly in each employee’s HR file–noting, for example, that a construction contractor is “required to provide his own tools and vehicles.” Employers and their HR employees should also stay abreast of recent developments in the law involving important companies such as Uber (e.g., Berwick v. Uber, a California Labor Commission decision, classifying an Uber driver as an employee rather than an independent contractor). By staying on top of paperwork and keeping up with recent trends in employment law, employers can potentially avoid a determination that they have intentionally tried to misclassify their employees to avoid paying employment taxes. Such an intentional misclassification will trigger the trust fund recovery penalty, which will be discussed in my next blog.
To schedule an initial consultation regarding the trust fund recovery penalty, payroll taxes, or other tax matters, please contact the Law Office of Aaron P Richter, PLLC, a Reno-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Probate.