pocketwatch hand dollarThe original title to this article was: “Why having 1099 independent contractors working at your business could get you audited by the IRS and the Labor Department for tax evasion.” I opted for the shorter, if simplistic, title instead.

If you are a business owner who is using (or considering using) independent contractors as labor or services providers for your business, you need to know this information.

  1. You have to report all expenditures to independent contractors that total over $600 in a calendar year on a 1099 form. 1099 forms may trigger audits.
  2. It is difficult to define clearly who should be an independent contractor and who should be an employee. But it is clear that the Department of Labor, the IRS and its cohorts believe that the misclassification of employees as contractors is rampant and should be prosecuted aggressively. Even businesses who have a good faith belief that they are doing it right, run the risk of audit.
  3. If you have independent contractors, the taxing authorities (both the IRS and the state) and the Department of Labor are targeting you for audits.
  4. The reason they are targeting you is that businesses who use independent contractors instead of employees are “evading” employment taxes (never mind that the contractor pays the full amount instead and that economic data clearly shows that wages are adjusted to essentially pass the tax burden onto the employee, anyway, making this a zero sum proposition). That aside, the government can hit you with penalties and more taxes, filling their coffers with your hard-earned money. These economic arguments will not defend you from penalties and prosecution.
  5. Independent contractors are not given the same income in the form of overtime wages, benefits and other earnings, which also may mean a finding of back taxes if the taxing authorities or Department of Labor gets their hands on your business’s books.
  6. Independent contractors are not given the same protections under employment and labor laws for things such as worker’s compensation protection, unemployment insurance and leaves. If they are misclassified, this also carries penalties payable to the government agencies who audit you.

In short, it is possible to use independent contractors properly in your business. But before you do, you should complete a thorough analysis with your legal and financial advisors to determine whether it is legally correct and financially worth the risks.

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