Episode 3: Dealing with IRS Exams (Worker Misclassification)
Legal Thought’s – Episode 3 of Dealing with IRS Exams (Worker Misclassification)
Coleman Jackson, P.C. | Transcript of Legal Thoughts
Published August 14, 2023
Attorney introduction:
Welcome to Legal Thoughts! My name is Coleman Jackson and I am an attorney at Coleman Jackson, P.C., a taxation, litigation, and immigration law firm based in Dallas, Texas.
In addition to myself, we have Leiliane Godeiro – Litigation Legal Assistant, and our administration staff Ernesto Munoz and Michelle Gutierrez.
On today’s “Legal Thoughts” podcast, our Litigation Legal Assistant, Leiliane Godeiro will be interviewing me in our continuing federal tax series entitled, “ Dealing with the IRS”. In todays Legal Thoughts podcast the attorney will be talking about misclassification of a workers as an independent contractor when the worker should be classified as an employee of the employer. This is Episode 3 in our Podcast series entitled Dealing with the IRS. Here its dealing with the IRS examination division
Interviewer Introduction to the Audience:
Hi everyone, my name is Leiliane Godeiro and I am a Litigation Legal Assistant at the tax, litigation and immigration law firm of Coleman Jackson, Professional Corporation. Our law firm is located at 6060 North Central Expressway, Suite 620, right here in Dallas, Texas, 75206.
Good afternoon Attorney; thank you for being here with me to today as I interview you in our continuing podcast series entitled; “Dealing with the IRS”.
In this third episode in our law firm’s Legal Thoughts Podcast Dealing with the IRS series, the focus today will be employer misclassification of workers.
Attorney, let’s get started.
QUESTION 1: Attorney, please explain, why the classification of a worker is of any concern to the IRS to begin with?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 1
Good afternoon Leiliane;
Definitely for sure the Internal Revenue Service is very much interested in how workers are classified for tax purposes for all the reasons I am going to explain in a few minutes. But let me point out at the outset that how a worker is classified is not simply the concern of the IRS, workers themselves should be very concerned how they are classified; the Texas Work Force Commission also cares about how Texas workers are classified for labor law and tax law purposes; and the U.S. Department of Labor and other federal, state and local governmental agencies are also concerned about how workers are classified for all sought of societal reasons.
Now let me turn to the law that imposes this duty to care about worker classification squarely on the shoulders of the Internal Revenue Service which is the federal agency tasked with the responsibility to enforce the nations federal tax laws.
In this particular podcast; we are limiting our discussion of worker classification to federal tax matters. So, let me answer your question from – why should the IRS care about worker classification?
First, United States Code Chapter 26 gives the United States Treasury and the Internal Revenue Service which is the enforcing agency of the Treasury to oversee the application of the United States federal tax statutes. 26 U.S.C. is commonly referred to as the Internal Revenue Code.
Second, the Internal Revenue Service (the IRS) is the agency tasks with enforcing the Internal Revenue Code.
Third, the Internal Revenue Code, courts and the IRS has established rules for determining whether a worker is classified as an employee, a statutory employee, statutory nonemployee or independent contractor.
Fourth, there are significant tax consequences of worker classification for those who hired the worker and for the worker as well.
INTERVIEWER: Leiliane Godeiro, Litigation Legal Assistant
Interviewer Comment: Attorney, this sounds like it could be complicated!
QUESTION 2: Attorney can you explain in clear language what these different classifications of worker mean?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 2
Okay let me try to explain these terms:
First, the term employee is the common law 20 factor test characteristics established by the United States Supreme Court in a case decided around 1954. This is a common law test that contain 20 keep factors devised by the Court basically turns on the degree of control the employer of that particular worker has over the means, method, and results of the workers activities. The Texas Labor Code uses this same type of language when defining the term ‘employee’. Workers performing under this degree of control ( or right of control by the person who hires them) are called “Common Law Employee”. Most people refer to the ‘common law employee’ as simply ‘employee’.
Second, the term Independent Contractor applies to workers in the first category who do not meet the definition of common law employee. Independent Contractors excise control and independents not only over their results, but, their methods and means of carrying out their task. Independent Contractors can experience monetary loss as the results of their work; whereas, employees typically receive their same salary or compensation whether the project or assignment generates a profit or loss.
Third, the term Statutory Employee is created by and defined in 26 USC (IRC Section 31201(d(3)) as workers performing services in four principal occupational areas: (a) certain drivers who distribute certain beverages, food-products and other goods or products, (b) workers from their home who are like fabricators, (c) traveling sales people who distribute merchandise for resale, and (d) life insurance sales persons.
Fourth, Statutory Non-Employees is created by and defined in 26 USC (IRC Sections 3506 and 3508) as certain real estate agents, direct sellers and certain placement service workers.
I left out some of the complexities of these Internal Revenue Code Sections. The most important thing for our audience to know is that statutory workers are “employees”. They are not independent contractors.
INTERVIEWER: Leiliane Godeiro, Litigation Legal Assistant
Interviewer Comment: That sure came through loud and clear. The main thing is whether the worker is properly classified as an independent contractor or whether they should be classified as an employee. That much you have made clear! Now that you have made what these worker classifications mean is clear to us
QUESTION 3: What are the significant tax consequences of all this worker classification stuff?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER– QUESTION 3
The tax consequences to the various worker classifications that we have been discussing are these—
First, those who hire a ‘common law employee’ are required under the Internal Revenue Code to withhold federal income taxes, withhold federal insurance contributions act taxes and pay federal unemployment taxes on wages and compensation paid to an employee. Employers must give employees Form W-2, they must send W-2 to the Social Security Administration. Employers are also required to compete Form I-9 on every employee and maintain I-9 files on each employee hired within days of the new hire. Employers are also required to file quarterly returns to the IRS (Form 941) and annual reports as well (Form 940).
As for reporting requirements and filing requires, there is no distinction between a worker classified as a common law employee and those classified as statutory employee.
Second point I like to make is this one. Those who hire independent contractors are not typically required to make any withholdings from the workers pay check. But there can be instances where federal withholding laws impose a duty on the payor to withhold certain percentages from the payees pay check. But there is never a fica or futa tax withholding or payment requirement on the payor of an independent contractor. Independent Contractor compensation is typically reported on Forms 1099- Miscellaneous and 1099-NEC as appropriate depending upon the reason for the payment. No reports are sent to the Social Security Administration on payments to independent contractors. The only report filed with the IRS by those who employ an independent contractor is the Forms 1099 just mentioned.
Finally, as for those workers who are precluded from being classified as employees under the Internal Revenue Code Sections that I mentioned earlier, the reporting for statutory non-employees must be handled very similar to those of the independent contractor, which I will explain in detail next. No withholding requirements apply under normal situations; but, remember under some circumstances up to 30% mandatory withhold rules apply to payments to certain types of individuals under the United States tax law. Those who hire statutory non-employee workers are required to give them Forms 1099- Miscellaneous and 1099-NEC as appropriate and file appropriate copies with the IRS.
Keep in mind, I have left out all of the requirements imposed by State Law on those who hire workers. I left any discussion of this out because this podcast is limited to federal tax requirements and consequences for misclassification of workers.
INTERVIEWER: Leiliane Godeiro, Litigation Legal Assistant
Interviewee’s Comment: Absolutely attorney; this is only about federal tax law; but, if anyone in our audience want to hear a podcast about Texas tax laws as to how they apply to employers, employees or independent contractors, feel free to write us, call us or email us your request.
QUESTION 4:
Attorney to wrap this up. My fourth question is this: What happens if IRS exam determines that a worker is misclassified? I mean is anyone in big trouble?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 4
Not necessarily. It just depends upon why the worker is misclassified. It will mater whether it is by mistake or whether the workers are misclassified intentionally. There are things the employer can do to correct the situation; and, in fact there are things a worker can do to find out whether they are properly classified. Let me start first with things a worker can do:
The worker can file IRS form SS-8 with the Internal Revenue Service to ask for a determination based on the facts and circumstances of their employment.
Now as for those who hired the worker; the IRS has several voluntary disclosure programs for employers who may have misclassified their workers. These programs can be used even while under audit examination:
1. The Voluntary Classification Settlement Program (VCSP) permits qualifying taxpayers to reclassify workers as employees for employment tax purposes and receive a reduced penalty. The VCSP has strict guidelines as to who can qualify to use this amnesty type program;
2. The second relief valve for employers who misclassified workers as independent contractors when they are not, is referred to as the Section 530 relief program. This program under created under the Revenue Act of 1978 can be relied on by taxpayers even while under IRS examination.
3. The IRS also have other tax position disclosure programs that might work in this misclassification of worker space.
4. Any employer who is not sure how there workers should be classified can ask the IRS by filing an SS-8.
INTERVIEWER WRAP-UP: Leiliane Godeiro, Litigation Legal Assistant
Attorney, thank you for being here today with us, this information about dealing with an IRS when worker classification is a problem. Hopefully our audience finds it informative and helps them to know their rights as taxpayers; know how to protect their rights in the unfortunate event that they or their business has an IRS examination involving misclassification of their work force as independent contractors when they ought to be classified as employees. Likewise workers who are misclassified also suffer from this misclassification whether it was done intentionally or by accident, Attorney.
Our listeners who want to hear more podcasts like this one should subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify or where ever you listen to your podcast. Everybody take care! And come back in about two weeks, for more taxation, contracts, litigation and immigration Legal Thoughts from Coleman Jackson, Professional Corporation, located right here in Dallas, Texas at 6060 North Central Expressway, Suite 620, Dallas, Texas 75206.
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ATTORNEY’S CLOSING REMARKS:
This is the end of “LEGAL THOUGHTS” for now
Thank you for giving us your valuable time this morning and listening to our law firm’s Legal Thoughts Podcast. This has been the first episode in our new podcast series entitled dealing with the IRS. Hope you enjoyed Episode Three: “ Dealing with an IRS Exam regarding misclassification of workers”.
If you want to see or hear more taxation, contracts, litigation, and immigration LEGAL THOUGHTS from Coleman Jackson, Professional Corporation. Subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify, or wherever you listen to your podcast.
Stay tuned! We are here in Dallas, Texas, and want to inform, educate and encourage our communities on topics dealing with taxation, litigation, and immigration. Until next time, take care.
