1099 Risk Blog

Misclassification Epidemic: Part I

Worker misclassification, and the process by which the IRS identifies and handles such misclassifications, was highlighted by the Treasury as a critical issue in a report issued last month. 

The report’s title says it all: “While Actions Have Been Taken to Address Worker Misclassification, and Agency-Wide Employment Tax Program and Better Data Are Needed.”  The last review of the impact of misclassification dates back to 1986, and thus the IRS does not have a grasp on exactly what damage has been done. And while the data on misclassification impact are old, the Treasury did not mince words when describing where the trend was headed: “The limited data available indicates that the worker classification issue is growing significantly.”

Here’s what we do know: The United States tax gap is currently reported to be $345 billion. $54 billion of that is due to the underreporting of employment tax. As for the amount directly attributed to employer misclassification, that number is estimated by the IRS to be markedly higher than the out-dated $1.6 billion number that is most widely cited. 

We know that employers misclassify employees as independent contractors for a number of reasons: There are some employers who can genuinely claim ignorance, some still that have simply received poor advice; some employers have Section 530 Safe Harbor protection and can legally engage workers as independent consultants where other employers could not; and some engage employees as 1099 independent consultants to avoid the steep costs of payroll taxes, overtime, worker’s comp, unemployment, and benefits.  This is incredibly risky for the employer and can lead to expenses that far exceed their initial spend should an audit or a lawsuit find they have misclassified the workers. Misclassifying employees as contractors is financial roulette for the company if their workers are reclassified by the IRS or if there is a lawsuit brought against them.

So what is the IRS going to do about it? We’ll tackle that in part 2.

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