Are you paying your boss's taxes?

By Jeff Schnepper

Just before Christmas, package-delivery company FedEx was slammed with a $319 million tax bill. The Internal Revenue Service ruled the company had misclassified about 13,000 drivers as independent contractors when, the IRS said, they really were employees.

For FedEx, this could get a lot more expensive. The penalties and back taxes are just for 2002. The IRS is still auditing FedEx for 2004 through 2006 (the status of 2003 is unclear). The Teamsters union, which has been pushing this fight, thinks it could ultimately cost FedEx $1 billion.

Perhaps. But FedEx plans to fight this ruling for as long as it takes.

What got the IRS and FedEx into a tussle was the package company's assertion that drivers were contractors who operate their delivery routes as independent businesses, even though the drivers use FedEx equipment, wear FedEx uniforms and work under explicit FedEx rules.

This fight bears watching by employers and workers alike. Big money is at stake.

The government will argue that misclassification of workers deprives it of billions of dollars of tax revenue annually. The Government Accountability Office has estimated the amount at $4.7 billion a year.

The bosses will argue that the ruling upsets precedents in place since the 1990s.

Workers will argue that employers have gone too far in pushing taxes and payroll costs onto them, effectively forcing workers to subsidize their bosses. If the IRS wins, you can bet many more workers classified as independent contractors will try to change their classifications.

Companies save big on taxes

Why do companies like independents? Simple. It saves them a bundle of money.

If you're an independent contractor, the company doesn't pay state workers compensation or federal unemployment and disability taxes. It is released from matching your 7.65% Social Security and Medicare taxes; an independent contractor pays the full 15.3% load.

In addition, the employer is saved the burden and cost of income-tax withholding. The worker has to remit the appropriate payments.

Independent contractors don't qualify under minimum-wage laws and have no government rights to a safe work environment. And they can't qualify for employee benefits.

Microsoft (the publisher of MSN Money) suffered a stinging judicial slap several years ago when it misclassified employees as independent contractors and denied them benefits granted to other employees. It proved to be a $97 million lesson.

Before I could start writing tax columns for MSN Money, I had to sign a mountain of documents proving I was an independent contractor. I even had to get a Washington state business license as a contractor, even though I have never physically worked there.

Say you have one worker making $102,000. Just in Social Security and Medicare taxes, the company saves $7,803 (7.65% of $102,000). Multiply that by the number of real "employees," add other payroll-tax savings plus a little interest, toss in a few penalties, and it becomes a $319 million kick in the wallet.

Why misclassifications are an IRS priority

Money is the reason that John Tuzynski, the IRS' chief of employment-tax operations, made worker classification "a major focus" for fiscal 2008, which ends Sept. 30.

Migrant workers and many illegal immigrants are misclassified as independent contractors, never have any withholdings taken out and don't file or pay income taxes. That magnifies the tax gap -- the difference between what the government is due and what it collects in taxes.

Continued: Criminal charges possible

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