You're an employee, and the company decides it needs to cut back. Shazaam! You're suddenly an independent contractor. For the company, it's a win win. It doesn't bother with withholding taxes anymore, plus it's easier to get rid of an independent contractor than it is an employee. The company simply doesn't renew the contract. For the worker, it's often lose lose.
At first, the newly deemed "independent contractor" might like the idea, thinking she gets to be her own boss. Gradually, reality sets in. The company is still telling her what to do, what to wear, how to do the job, when to work, what assignments she can take, and which ones she can't. There isn't really much change in the worker's autonomy, plus the worker gets to pay all of her expenses and all of the employment taxes. Great deal for the company, terrible for the worker.
Some companies think that they can simply call someone an independent contractor, and the IRS will follow along, as if the words "independent contractor" magically transform the worker into cheaper labor. Not so. The IRS looks at the substance of the employer-worker relationship. If it decides that the worker's day to day activity meets certain behavioral, financial, and relational characteristics, then the worker is an employee in the eyes of the IRS. It doesn't matter what the company calls her.
So, how does that translate into tax fraud? The IRS states, "If you classify an employee as an independent contractor, and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker." FedEx got caught in a mis-classification scheme a few years ago. The shipping company ended up paying millions. Of course, knowledgeable whistleblowers can get a piece of a successful mis-classification recovery under the IRS Rewards Program if they qualify.
Why should we care about mis-classification schemes? Unfortunately, the experience of being misclassified is not unique to FedEx workers. Lots of companies are doing it or have already done it. Suren Moodlier, coordinator of the North American Alliance for Fair Employment stated, "It makes [workers] responsible for a whole range of things that normally an employer should provide. In effect, [independent contractors] are responsible for their own exploitation." (Source: The New Standard, July 18, 2006).
Like most things the IRS does, the rules for determining a worker's status are complicated. Interested folks can check out IRS Publication 1976, Section 530 Employment Tax Relief Requirements. Whatever you do, remember that your employment status is not simply a matter of "magic words."
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As an employee who properly classifies their workers in an industry which is rife with tax fraud such as misclassification of workers and also underreporting or flat out non-reporting of tip income it is almost impossible for me to continue my business in an atmosphere which seems to do nothing about this problem. I have worked for ten years with the governing licensing board that overseas this industry to clear up language in existing laws and regulations that allows much of this activity to occur. I also have contacted my State Comptrollers Office concerning this issue. Keep in mind that this issue is not indigenous to my state but is a nationwide problem costing tax collection agencies billions of dollars in uncollected tax revenue each year. Meanwhile honest citizens who pay their fair share of taxes are constantly burdened with the threat of their taxes being raised while these folks stick money in their pocket and never pay. Sounds a little like what our country is seeing happen on Wall Street. CEO's bankrupt companies and walk away with millions while stock holders pay the bill. I would love to see some brave law firm take on this issue and help to level the playing field for the honest law abiding business owners to stay alive.
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