Many companies turn to independent contractors to reduce payroll taxes and cut the high costs of employee benefits. However, this strategy comes with risks, especially as the IRS intensifies its scrutiny of businesses using freelancers. If not structured correctly, the IRS may reclassify independent contractors as employees, leading to hefty penalties, back taxes, and potential audits.
With the rise of gig work, the IRS is cracking down on businesses that improperly classify workers, particularly when employees are laid off and rehired as freelancers to cut labor costs. Even state agencies are known to audit companies when freelancers apply for unemployment benefits, adding further financial risk.
Your pension plan could also be affected. Independent contractors aren’t entitled to retirement benefits, but reclassification by the IRS could lead to penalties and disqualification of your retirement plan. To avoid these complications, follow these guidelines:
Clarify contracts: Ensure freelancers sign contracts that explicitly state they are responsible for their own taxes and are not entitled to employee benefits.
Consistent classification: Treat all workers performing similar tasks the same, either as contractors or employees.
Discretion in duties: Give contractors freedom over how and when they complete their work.
Proper documentation: Issue Form 1099-NEC to contractors paid $600 or more annually.
Limit perks: Avoid offering contractors employee benefits like office space, company equipment, or other perks.
Although rehiring laid-off employees as independent contractors is legal, structuring these relationships correctly is crucial to prevent reclassification by the IRS.
Looking to protect your business from audits and penalties? Reach out to Verity CPAs at info@verity.cpa or 808.546.5026 for expert advice on managing your independent contractor relationships.
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