IRS Lets Employers Come Clean on Contractor Payroll Taxes

The Internal Revenue Service is giving companies that have been misclassifying employees as independent contractors a chance to pay a fraction of back taxes to avoid interest, penalties and audits for previous years.

Under the program announced today by IRS Commissioner Douglas Shulman, U.S. companies would have to agree to treat the workers as employees going forward and pay 10 percent of the previous year’s payroll taxes. The program is open to employers of all sizes, though Shulman said he is trying to encourage smaller businesses to participate.

“A lot of our job is to make sure that we provide clarity for the vast majority of people that are trying to get it right,” Shulman said on a conference call with reporters today.

Worker misclassification is a complex area of the tax code without clear rules to guide businesses, Shulman said. Since 1978, Congress has prohibited the IRS from issuing general clarifying regulations.

Employers are responsible for paying part of the payroll tax as well as paying federal unemployment taxes for their workers. Independent contractors pay the employee and employer shares of the payroll tax.

‘Gradually Change It’

Representative Jim McDermott, a Washington Democrat who has pushed for crackdowns on worker misclassification and has sponsored legislation on the issue, said in a brief interview today that the IRS action isn’t exactly what he wanted, and called it a step in the right direction.

“They’ve been getting away with murder for years,” he said of employers. “You gradually change it and so people begin to see you can’t make everyone a contract worker.”

Brian Turmail, a spokesman for the Arlington, Virginia-based Associated General Contractors of America, a trade group, said in a phone interview today that the IRS program is an acknowledgment of how complex it is to comply with employment classification requirements.

Within the construction industry, home building is particularly challenging because it can involve multiple trades and small jobs, Turmail said.

“From our perspective, there are only a few bad eggs,” he said. “A lot of folks are trying to do the right thing, but it’s awfully complex.”

Reclassifying Contractors

President Barack Obama in his most recent budget plan proposed allowing the IRS to issue guidance and to require companies to reclassify some contractors as employees. That proposal was projected by the Treasury Department to raise $8.7 billion over the next decade.

Shulman said he didn’t have estimates of how many employers would join the voluntary compliance program or how much money it would generate. The program has no deadline.

The IRS just completed a voluntary compliance program for Americans with offshore bank accounts. Shulman said part of his approach as commissioner is to encourage long-term tax compliance even as the agency continues auditing taxpayers for past actions.

“The real win for American taxpayers is if we set up the right incentives for all taxpayers to pay the right amount of taxes this year, five years from now, 20 years from now,” he said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE