Mistakenly classifying an employee as an Independent Contractor can result in a significant
back tax bill and heavy fines. Over the past few years the IRS has aggressively been pursuing employers who misclassify their workers.
Central to an IRS investigation into the classification of a worker is how much "control" an employer exerts over its workers. The control an employer has over a worker can be broken down into three areas:
Behavioral Control - factors pertaining to job instructions, training, etc.
Financial Control - factors pertaining to investment expenses, profit/loss, etc.
Relationship of the Parties - factors that cover employee benefits, written contracts, etc.
When evaluating these areas, the IRS uses twenty different factors to determine the relationship between the employer and worker and the amount of control that is exerted by the employer over the worker.
In this article we highlight five questions from the list of twenty, the IRS will consider when determining the appropriate classification of a worker. To obtain a complete list of the twenty questions, you may go here to obtain a complimentary copy.
1. Profit or Loss
Can the worker make a profit or suffer a loss as a result of the work , aside from earned from the project? This falls under financial control and for the Independent Contractor there should involve real economic risk-not just the risk of getting paid. The IRS wants to determine whether the contractor is undertaking a financial risk, where they cannot only make money but run the risk of loosing money.
If the contractor is never at risk of loosing capital and is rewarded with set wages or hourly pay, then the IRS will tend to view that as an employee/employer relationship. if on the other hand, the contractor has to purchase material, pay out wages out of his or her own pocket and runs the risk of loosing money, then it favors the Independent Contractor model.
2. Works for More than One Firm
Does the worker work for more than one company at a time? This can indicate Independent Contractor status but not conclusively. Employees often times work multiple jobs, working at multiple companies. In fact today it is not uncommon for a person to work for 2-3 different employers as a W2 employee.
A good example of an independent Contractor is a freelance writer. If a freelance writer is working for multiple companies at a time, and setting his or her own schedule for working on various projects, it is a strong indicator he or she is an Independent Contractor. On the other hand if the freelance writer is only doing work for one company and has set hours, then that indciates an employer/employee relationship.
Instructions
Do you have the right to give the worker instructions about when, where and how to work? Any of these factors demonstrates to the IRS behavioral control over the worker.
Consider a plumbing contractor; a general contrator will let the plumber know when a site is ready for him, but will not instruct him on how to do the work, or what hours the plumber has to work. He will provide him or her with a deadline and it is up to the plumber to meet the agreed upon deadline.
Full Time Work
Must the worker spend all of his or her time on the job? independent Contractors choose when and where they will work. if you are directing an employee that he or she must maintain a full time schedule to be employed, it is a strong indicator to the IRS that it is an employee/employer relationship.
Right to Fire
Can you terminate the worker? n Independent Contractor cannot be fired without subjecting you to the risk of a breach of contract lawsuit. This goes to the relationsship of the party where it is governed by a contract.
Fortunately for may employers that have been using 1099 contractors, the IRS does have a voluntary Classification Settlement program. You can read about the VCSP here.
To further assist you we put together a list of the top twenty questions the IRS will ask to determine whther the worker is atruly a 1099 contractor or employee. If you have been or thinking of using 10999 contractors you will want to download this list.
One hundred years and counting...that is how long the income tax has been in place.
Importance of the 16th Amendment for Collecting Income Tax
The 16th Amendment was ratified in early 1913 and was critical for the federal government to collect income tax. Prior to its passage, collecting income tax was unconstitutional.
At least 36 states were required to approve and sign the 16th Amendment before it became ratified. Delaware was the 36th state to ratify it.
When it was ratified the tax form (the 1040 which we still use today) was only 3 pages long.
Compare that with today's tax return that can be dozens or in some cases hundreds of pages long. The complete federal tax code in total was 400 pages long. Today it is an estimated 73,000 pages plus.
Taxing the "Rich"
Most bills and laws passed today seem to run hundreds and sometimes thousands of pages long. The income tax act passed in 1913 was a total of 14 pages long and was aimed at taxing the "rich." At the time it targeted the top 1 percent of income earners.
The tax rate started at 1% on income greater than $3,000 (approximately $69.5 thousand in today's dollars) and increased to 7% on income greater than $500,000 (approximately $11.6 million in today's dollars). The total tax revenue for the federal government in 1913, in today's dollars, was $16.6 billion compared to $2.7 trillion today.
Prior to the ratification of the 16th Amendment, the federal government relied on tariffs i.e., consumption taxes. At the time of passage the income tax had nothing to do with the federal government requiring more money. The federal government in 1882 was running a surplus of $146 million (the tax revenues were $403 million and the federal expenses were only $257 million).
Originally, under President Grover Cleveland and Democrat majorities in both the House and Senate a 2% income tax on the rich (top 1% of income earners in the US) was passed in 1894. However the income tax was challenged in the Supreme Court (Pollack v. Farmers' Loan & Trust) and the court struck it down by a vote of 5 to 4. The cause for it to be struck down was that the Constitution required that a "direct tax" such as the income tax be apportioned equally among the states according to the population. This could not be the case with an income tax.
John Steele Gordon has a story about the history of the income tax that can be found here.
I included part of the history he writes about and pickup his column following the defeat of the first attempt to pass the income tax in 1894.
"The income tax was dead. But the pressure to tax the incomes of the largely untaxed rich only increased, especially as the Progressive wing of the republican party grew in strength under Theodore Roosevelt. By the time of the administration of President William Howard Taft (1909 -13) the pressure was becoming overwhelming. One representative suggested simply repassing the 1894 tax bill and daring the Supreme Court to overturn it a second time.
That idea horrified Taft, who revered the Supreme Court. He feared that it would weaken its position as the final arbiter of the Constitution. He came up with a brilliant, very lawyerly, alternative: he proposed a constitutional amendment to legalize a personal income tax, while meanwhile imposing a tax on corporate profits. In the early 20th century such a tax was, in effect, a tax on the rich. As the corporate income tax is technically an excise tax, there was no constitutional problem. Taft's solution was implemented and in 1913 the 16th Amendment was declared ratified just as Taft was leaving office.
The new president, Woodrow Wilson, and the strongly Democratic Congress promptly passed a personal income tax."
He goes on to write:
"Unfortunately the corporate income tax, originally intended as a stop gap measure, was left in place unchanged. As a result, for the last 98 years we have had two completely separate and uncoordinated income taxes."
CPAs Thank Congress and the IRS
So here we are, one hundred years later with over 73,000 pages of tax code with Congress continuing to add to it. More confusing and more complex than ever and requiring more knowledge than ever to complete a personal or corporate tax return.
CPA firms are truly blessed to have the IRS, Congress and the Office of the Presidency looking out for them and helping them grow CPA's practices across the country. Just think if we have the same exponential growth (doubled approximately every 11 years) over the next 100 years as the past 100 year our tax code will be about 15 million pages long. Can't wait to attend those continuing education tax update courses...
IRS Files Motion to Force Tax Preparer Compliance Before Appeal Can be Heard.
Update 1 on 1/25/2013
The IRS has filed a motion with the courts in an attempt to force tax preparers into compliance this tax season and before an appeal can be heard. David Fazio has published a good update that can be found by following this link: IRS Files Motion to Force Preparers back Into Compliance, Cites Guess Who?
After suffering it's defeat last week, the IRS filed a Motion to Suspend Injunction Pending an Appeal. David explains this in his article:
"Procedurally, appeals take awhile. And the IRS really, really wants the Court to set aside the injunction before tax season opens - in six days. So this motion is intended to void that injunction "temporarily" while the IRS works something else up. To win this kind of motion, the IRS has to prove a few things (taken from the Motion): (1) they have a reasonable likelihood of prevailing on appeal; (2) they will suffer irreparable harm if the injunction is not suspended; (3) the plaintiffs will not be harmed by the request; and (4) suspending the injunction will serve the public interest.
So basically, they have to say that they're pretty sure that they can win the appeal AND that in the meantime, neither the plaintiffs nor the public will be harmed."
Stay tuned for the outcome on the ruling of this Motion...In the meantime let us know if you think the IRS has the power to regulate an industry without authorization from Congress.
Original Article Posted on 1/24/2013
Last week, the IRS was dealt a big blow in their attempt to regulate tax preparers. Judge
James E. Boasberg, a US District Court Judge, ruled against the IRS and its program to force an estimated 600,000 to 700,000 tax preparers to pass a standardized test and demonstrate a minimum level of competency.
Exempted from the new IRS regulations were CPAs, Tax Attorneys and Enrolled Agents. These preparers are already regulated by Circular 230 (Regulations Governing Practice before the Internal Revenue Services).
The IRS attempted to use a law dating back to 1884. The 1884 law allows the IRS to regulate people presenting cases before the Department of Treasury (the IRS is part of the Department of Treasury).
The decision for Loving v. Internal Revenue Service came down to whether preparing taxes constituted "presenting a case" on behalf of the taxpayer before the Department of Treasury (IRS) IRS.
The Judge in his rulings noted: "Filing a tax return would never, in normal usage, be prescribed as 'presenting a case' he wrote "At the time of filing, a taxpayer has no dispute with the IRS; there is no case to present."
The program was launched by former IRS commissioner Douglas Shulman in his attempt to impose further regulations on the industry and to combat fraud. Rather than seeking change through proper congressional proceedings and passage of new legislation, he and the IRS attempted to circumvent the process. The court, in its ruling, disallowed them to use the existing law for a purpose it was never intended for.
The lead attorney for the plaintiffs, Dan Alban, after the ruling said "This was an unlawful power grab by one of the most powerful federal agencies and thankfully the court stopped the IRS dead in its tracks. The court ruled today that Congress never gave the IRS authority to licenses tax preparers, and the IRS can't give itself that power."
For obvious reason, one of the more disappointed parties was Turbo Tax. The spokesperson, Dan Maurer, a senior vice president and general manager of the consumer tax group said Intuit which makes Turbo tax was "disappointed" in the ruling.
Tax Software and do it yourself tax preparers were not part of the new regulations. Imposing additional regulation on tax preparers would most likely have decreased the number of tax preparers, weeding out additional competitors to Turbo Tax. The additional requirements could have also resulted in an increase in tax preparation fees, thus causing more individuals to consider preparing their own return.
Because of the court ruling, the IRS has temporarily suspended its plan to move forward with regulating tax preparers. At this time, the IRS has not stated how they will move forward or whether they will appeal this ruling.
With this ruling taxpayers, have very distinct and very different choices on how to complete their tax return, they can:
- Use a DIY software program and attempt to learn all the applicable taxes, tax codes and deductions that apply to their circumstances.
- Choose a low cost tax preparer that may have very little training or knowledge of the tax code and are not required to pass a standardized test or meet minimum requirements.
- Engage the services of a professional preparer such as a CPA.
CPAs must demonstrate a base line of knowledge through a Board Certified test, are governed by a set of regulations (circular 230) and participate in continuing education courses throughout the year. With about 70,000 plus pages of tax code, the tax code this year is more complex and more confusing than ever before in the history of the US. In a previous blog post we discuss he benefits of using the services a CPA verses other alternatives.
Comment below and let us know what you think. Should the IRS have circumvented Congress to impose additional regulatory requirements and standards on tax preparers?
To assist you this year we have put together the top 21 Tax changes for 2013 that you can download here.
Each year, the IRS comes out with a list of the top twelve tax scams. Although taxpayers can be taken advantage of by tax scams throughout the year, the IRS warns that the scammers are in full gear during tax season.
This is the time of year when tax payers are most aware of how much they pay in taxes and are looking to reduce their tax burden or trying to maximize a refund. Don't take the scammers bait and get yourself trapped.
Taxpayers should be wary of promises of free money, lost or unclaimed refunds that are available to be claimed by anybody or programs that promise to eliminate your tax burden. If it sounds too good, seek a second opinion and do additional research. Often times these scammers will try and apply pressure for you to act immediately, i.e. you have to act now, otherwise you will miss out on the opportunity, tax credit, etc.
Here are the top twelve tax scams that the IRS has highlighted his year.
1. Identity Theft
Tax scammers may steal your identity for the purpose of filing a false tax return, so that a refund will be sent to them. Recently the IRS has stepped up its efforts to crack down on refund fraud and identity theft. Contact the IRS at www.IRS.gov/identitytheft if you believe your identity was stolen and used for tax purposes.
2. Phishing
The IRS does not communicate via email, text or social media. If you receive an email, text or phone call requesting personal information that appears to be from the IRS, you may report it by sending an email to phishing@irs.gov.
3. Return Preparer Fraud
As with any profession, there are always a small percentage of preparers that are looking to prey on individuals. The tax preparation profession is no different. Some preparers try and take advantage, by promising a larger than normal refund, demanding a percentage of the refund for the preparation fee, encouraging falsification of information for the purpose of obtaining a larger refund and using or promoting other unethical behavior. Do your homework and check out the reputation of the tax preparer you intend to use.
4. Hiding Income Offshore
It has been common knowledge that a number of individuals have hidden income offshore in an effort to evade paying taxes on income. In recent years the IRS has gone after individuals with offshore accounts. They implemented the Offshore voluntary Disclosure Program, allowing individuals to disclose their offshore accounts and come into compliance with US tax laws. Since they rolled out the program, 30,000 individuals have come forward. The IRS has let it be known, that those who do not come forward will be subject to severe penalties and possibly criminal prosecution. With the new reporting requirements for foreign accounts it will become increasingly difficult to continue to hide money in offshore accounts.
5. Free Money from the IRS & Tax Scams Involving Social Security
Beware of promises in fliers and advertisements of getting "free money" from the IRS or refunds or rebates from Social Security.
6. False/Inflated Income and Expenses
The IRS has found tax returns with over inflated income or expenses for the sole purposes of getting large refundable credits. Any taxpayer found over inflating their income or expenses, for this purpose, will not only be liable for paying the money back with interest and penalties but may also be subject to prosecution.
7. False Form 1099 Refund Claims
Individuals that file a false informational tax return, such as a 1099, for the purpose of filing a refund claim on a corresponding tax return may be subject to financial and criminal penalties.
8. Frivolous Arguments
Not the ones you have with your teenage children. These are unreasonable and outlandish arguments one makes to justify not paying taxes.
9. Falsely Claiming Zero Wages
Taxpayers may try and submit form 4852 (a substitute W2) or a "corrected" 1099 showing no wages. A $5,000 penalty can be assessed if it is found that a taxpayer filed one of these incorrect forms.
10. Abuse of Charitable Organizations and Deductions
IRS examiners are watching closely how donations to 501(c)(3) organizations, manage the donations, making sure that donors are not maintaining control over donated assets or the organization is not improperly shielding assets or income from taxation to benefit the donor.
11. Disguised Corporate Ownership
Third parties that are used to try and mask the true owners of a corporation. Often times disguised Corporations are used for underreporting income, claiming fictitious deductions, facilitating money laundering and committing financial crimes.
12. Misuse of Trust
There has been an increase in the abuse of trusts for the purpose of avoiding income tax liability and hiding assets from creditors. Taxpayers should always work with reputable professionals to understand the purpose of setting up the trust and how it will fit into their estate and tax planning.
Business owners, sales people and employees who have to use their automobiles for business, received good news last week when the IRS announced that the mileage rates for the second six months of 2011 (July 1- December 31, 2011) will increase from 51 cents per mile to 55.5 cents per gallon. A 4.5 cent per mile increase.
Typically, gas mileage rates are increased once per year (usually at the beginning of the year), but as a result of increased gas prices at the pump, the IRS made this adjustment mid-year. "This year's increased gas prices are having a major impact on individual Americans. The IRS is adjusting the standard mileage rates to better reflect the recent increase in gas prices," said IRS Commissioner Doug Shulman. "We are taking this step so the reimbursement rate will be fair to taxpayers."
The table below list the mileage rates for the first six months of 2011 and the new mileage rates.
| Purpose |
Rates 1/1/2011 - 6/30/2011 |
Rates 7/1/2011 - 12/31/2011 |
| Business |
51 |
55.5 |
| Medical/Moving |
19 |
23.5 |
| Charitable |
14 |
14 |
For those that use their vehicle for business purposes, the individual has a choice of deducting actual costs of using the vehicle for business purposes or deducting business mileage.
To use the actual cost for the vehicle, you will have to maintain all receipts and records related to business use for the vehicle and then total up the cost.
Keeping track of mileage is much simpler, you only have to keep a mileage log and record the business mileage usage of the vehicle. The mileage log for the vehicle becomes your business usage record and should be kept with your tax return and all other related financial receipts and records. A mileage log can just be an inexpensive notebook recording the date, where you are going, the purpose of the trip and the mileage.
All employees should have received a copy of their W2s by the beginning of February. If you have not received yours yet, then you should call your employer and request a copy immediately. By law, employers have until the end of January to mail out copies of W2s to employees. Failure to comply with the W2 filing requirements and deadline can lead to hefty fines and penalties for employers.
Follow the steps below if you have not received your W2 or if you have received an incorrect W2.
- Contact the employer to find out, if and when, it was mailed. If you changed your address, or an incorrect address was listed on the W2, then the W2 may have been returned to the employer as undeliverable. Make arrangements to have it picked up or mailed to the correct address.
- If after a few days, you still have not received it, contact the IRS at 800-829-1040. The IRS will ask for your name, SS number, address and phone number. You will also need to provide them with your employer's name, phone number address, dates of employment and an estimate of your wages for the year. Usually, you can find this information on the last pay stub you received.
- You are still required to file a tax return and report this income before the tax filing deadline (April 18, this year) regardless of whether you received a W2 or have an incorrect W2. The IRS has form 4852, than can be used as a substitute for the W2, but only after you have contacted your employer and the IRS. Fill out form 4852, estimating your income and withholding taxes. You can use your last pay stub for the basis for your wage and income tax withholding estimates.
- After your tax returns has been filed, it is possible you will receive the missing W2 or a corrected W2. If this information is different than the amount listed on form 4852, that was filed with your taxes, you will have to do an amended return to reflect the correct amount listed on the W2.
As a taxpayer, you are responsible for reporting all income to the IRS. Not receiving a W2 is not an valid reason to not report the income. Employers are forced to pay hefty fines and penalties for not sending out W2 information and reporting its employees' wages to the IRS. Eventually, they will report your income. If the IRS cannot match the income you reported on your tax return to what your employer reported to the IRS, you will receive a an IRS notice detailing the additional taxes you owe plus penalties and interest.
Visit our services page to see how we can asssit you with your tax preparation this year.
Businesses scored a big win yesterday as the Senate voted to repeal the 1099 reporting requirements that was part of the Healthcare bill. This requirement had been the topic of several blog articles that can be found here, here, here and here. In these blog articles, we highlighted the devastating impact and high costs that this requirement would have had on businesses. Fortunately, both parties realized this was a burdensome reporting requirements.
This provision was slipped into the Healthcare bill and required that businesses would have had to report all business transactions with any single person or business that totaled more than $600 in a calendar year. According to Kenneth Schortgen, JR in his article that appeared on examiner.com today, he highlights the cost to businesses: "The sheer cost of doing this, coupled with the cost many people would have incurred by hiring accounting help just to deal with this provision, could have burdened small businesses to the point that up to 40% would have had to close their doors, or layoff workers."
The bill must still pass the House and be signed into law. Few problems are anticpated with it passing the House and President Obama during the State of the Union address indicted hew was willing to compromise on the 1099 reporting requirement.
Because of the Job Creation Act Passed in late December, 2010, your employees' take home pay will change beginning in January, 2011.
There are two reasons for this occuring:
- The Social Security rate has changed for your employees in 2011. The SS tax rate for employees' has decreased from 6.2% to 4.2% as highlighted in our previous post, The Top 8 Highlights of the 2010 Tax Compromise That Will Save You Money. For example; In 2010, if your employee received a gross amount for his payroll check of $1,000, 6.2% or $62 would have been deducted for Social Security taxes. In 2011, the amount taken out of an employees check for Social Security taxes will only be 4.2%. For a $1,000 gross paycheck, he will see $42 of Social Security taxes taken out rather than the $62 per check taken out in 2010.
This change is not permanent and will expire on December 31, 2011, so beginning January 1, 2012, the social security tax fro employees will increase back to 6.2%.
This change was not extended to employers. Employers will still have to pay the 6.2% rate. The Medicare tax rates remain unchanged for both the employees and employers.
- The Making Work Pay Credit has not been extended. While most employees have heard about the Social Security tax reductions, not so widely publicized, is the end of the making Work Pay Tax Credit.
This tax credit was provided to employees through a reduction in their payroll federal withholding, Becuase of this credit, less federal taxes were take out of their paychecks, resulting in a higher take home paycheck.
Since this tax credit was not extended, your employees federal withholdings will increase beginning in January, 2011.
The net impact of both of these changes will be based on each indviduals circumstances. Some employees may see a slight bump in their paychecks while others may see a slight decrease in their paycheck.
For many taxpayers who are hoping to get a fast refund this year, that may not be possible. Congress, in December, passed the Unemployment Insurance Reauthorization and Job Creation Act of 2010. As a result of the bill that was passed and signed into law, the IRS needs to reprogram its processing system to accommodate three provisions contained in the law.
Becuase of this, taxpayers that itemize their deductions will not be able to file their taxes until mid to late February. Taxpayers, where the total amount of itemized deductions exceeds the standard deductions ($11,400 for married couples and $5,700 for single filers), are the ones that will be affected. This applies to you, if you own a home and write off the mortgage interest on your taxes.
The impact to you, is it will delay how quickly you can get your refund. If you cannot file until late February, most likely you will not see a refund check until sometime in March.
The law affects three categories:
- Taxpayers itemizing deductions on the Schedule A. This includes taxpayers who use the mortgage interest deduction, charitable contribution deduction, medical and dental deduction or real estate tax deduction.
- Taxpayers claiming the Higher Education Tuition and Fees Deduction. This deduction is for parents and students and covers up to $4,000 of tuition and fees to post-secondary institutions. There will be no delays for parents and students who claim other educational tax credits such as the American Opportunity Tax Credit and Lifetime Learning Credit.
- Taxpayers claiming the Educator Expense Deduction. This deduction is for K-12 grade educators with out-of-pocket expenses of up to $250.
If you are a taxpayer that falls into any of these three categories, and want to claim these deductions, you will have to delay your tax filing until the IRS updates its processing system. As soon as they make that date available we will update this post.
This should not stop you from visiting your CPA and having them prepare your taxes. You will want to make sure that they are prepared ahead of time and only need to be transmitted. Delaying the preparation of your taxes will only further delay, how quickly you can get your refund.
On Friday, December 17, 2010, President Obama signed into law, the much talked about, tax compromise and extension of the President Bush tax cuts. Included in the bill were some additional benefits to taxpayers and employees. Here are eight highlights from the recently passed tax bill:
- The tax rates for all individuals and all income groups, including the top 2% of earners has been extended for an additional two years.
- The capital gains and dividends tax rate remains unchanged at a top rate of 15%.
- A $2,500 college tax credit has been extended for two years.
- A $1,000 child tax credit has been extended for two years.
- The estate tax will be set at 35%, with a $5 million dollar individual exemption.
- Long-term unemployment insurance benefits will be extended for 13 months. Individuals can receive the unemployment benefits for up to 99 weeks.
- Employees will see a 2% reduction of Social Security withholdings. For employees the Social Security withholding amount will decrease from 6.2% to 4.2%. Employers do not receive a corresponding reduction in SS withholding amounts.
- The Alternative Minimum tax, which was originally set up to make sure the wealthy pay some income taxes, will be indexed to inflation. This had not been done previously and on a year to year basis, temporary adjustments had to be made. Indexing this to inflation, will prevent some 20 million middle-class taxpayers from having to pay the AMT. A group that the tax was never intended to target.