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Employers Can Avoid IRS Assessments for Misclassified Employees Under Safe Harbor Rule

S.J. Steinhardt
Published Date:
Oct 23, 2023


An employer that improperly misclassifies an employee as an independent contractor could be assessed a sizeable tax bill by the IRS for unpaid payroll taxes, plus interest and penalties, but there is are ways to avoid such assessments, CPA Practice Advisor reported.

The definition of the relationship is crucial: If a worker is an employee, the employer must pay its share of payroll taxes, withhold the employee’s share of payroll taxes and required income taxes and report those amounts to the IRS. It does not have to take these actions if the worker qualifies as an independent contractor.

To distinguish independent contractors from employees, employers should examine the relationship between the worker and the business, factoring in the degree of control and independence in the relationship.

The evidence fall into three basic categories: behavioral control, financial control and relationships of the parties. Behavioral control covers facts that show whether the employer has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means; financial control covers facts that show whether the employer has a right to direct or control the financial and business aspects of the worker’s job; and relationship of the parties covers facts that show the type of relationship the parties had.

There is, however, a special safe harbor rule for employers that may be assessed back taxes for certain workers. Such employers may avoid liability if they qualify for relief under Section 530 of the Revenue Act of 1978. Under this provision, the employer must have consistently treated the worker as an independent contractor, filed all the requisite forms and returns for this worker, and have a reasonable basis for treating the worker as an independent contractor.

To learn more about employment and payroll tax planning, including issues pertaining to statutory employees, independent contractors, and possible changes to Section 530 relief, attend the Foundation for Accounting Education’s Guide to Payroll Taxes and 1099 Issues Webinar on Nov. 3.

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