The Biggest IRS Red Flag of All

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Well, I have to admit it. I messed up on this past Saturday’s teleseminar “25 Stupid Things That Can Cause an IRS Audit”. I actually ended up with over 30 items, but I discovered, after I was reviewing the information before we posted it on the Insider’s Club that I made a big mistake.

I forgot to highlight the #1 Red Flag for all business today!

First let me give you a little background. A few months back the White House had a Conference on Small Business. The IRS was there and said what’s top of their IRS Watch List. They figure there are approximately eight million independent contractors and 85% of whom don’t pay sufficient taxes according to IRS statements. If they instead get reclassified as employees, the employer will have to cough up payroll taxes and the worker will end up losing a bunch of deductions. All of that means more money to the government.

If the IRS determines that your independent contractor is really an employee, they might come after you for back Social Security, Medicare, as well as Unemployment taxes. Plus, you’ll owe for benefits. They could even go so far as claim that you acted criminally by failing to properly call your ICs employees.

So how do you win the independent contractor argument? The fact is that, there isn’t any hard and fast formula to determine if someone is definitely an independent contractor or employee. The IRS looks at the relationship between the business owner and contractor and looks at the amount of financial and behavioral control the owner possesses.

And then the IRS makes a judgment call. A signed ICA isn’t enough to get you out of hot water either, but you better make sure you have one. Failure to provide one is a surefire sign you have an employee, not an Independent Contractor.

Here are some guidelines:

1.Never have an independent contractor fill out an application. The IC should instead submit a proposal or bid. They aren’t applying for a job. They are bidding for one.

2.Always get an authorized project estimate that has specific tasks. For example, an accounting assistant who is an Independent Contractor will ‘file quarterly payroll taxes” or ‘prepare monthly financial statements’ not ‘perform accounting functions as required.’

3. Pay by completed task, not an hourly rate.
4. You can tell your contractor the specifics of the assignment, the standard of work and the completion, but do not tell him HOW to do the job or what hours to work. it. That degree of control will cause the IRS to conclude an employer / employee relationship exists.

5. Do not supply equipment or supplies. An Independent Contractor needs to furnish her own.

6.Indicate a period when the business relationship will end. If the service one that will continue, give the agreement an end anyway and state at that point the agreement can be renewed.
7.Make sure your IC has other clients. If you try to monopolize your IC’s time that’s a surefire way to get the IRS to say you have an employee, not an IC

In his testimony before Congress, the Acting Commissioner of Internal Revenue claimed, “One of the most challenging and controversial concerns in the employment tax area is definition of ‘employee’.”

We can expect a lot of challenges coming this way. Make sure you’re ready with Winning the Independent Contractor Agreement, updated for 2011.

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