Are you paying your boss's taxes?

The IRS, to coordinate enforcement, has entered partnerships with the Department of Labor, the National Association of State Workforce Agencies, the Federation of Tax Advisers and the agencies that administer state employment and unemployment taxes.

For employers who are caught misclassifying, monetary pain is just the beginning. They can be criminally charged with evasion of payments, filing of false tax returns and conspiracy. Another tax code section, Section 7202, makes it a felony to willfully fail to collect or pay tax to the government.

And it should be. In such cases, the employers are stealing from the employees. If workers are treated as independent contractors, they are responsible for 100% of their payroll taxes. They're paying twice what they truly owe for Social Security and Medicare. The difference goes into the employers' pockets.

What's an employee?

There is a big problem, however. That is determining if a worker really is an employee. The National Labor Relations Act, Civil Rights Act, Fair Labor Standards Act and Employee Retirement Income Security Act each use a different definition for the word "employee." Even more confusing, each has different criteria for distinguishing independent contractors.

In May 2007 testimony before the House Ways and Means Subcommittee on Income Security and Family Support, Sigurd Nilsen of the Government Accountability Office complained that "no definitive test exists to distinguish whether a worker is an employee or independent contractor."

The Internal Revenue Code has never been a model for clarity. Worker classification is both complex and subjective.

In the Revenue Act of 1978, Congress created a safe harbor for employers (referred to as Section 530) by prohibiting the IRS from collecting employment taxes when workers were "reasonably" misclassified as independent contractors. That provision includes only a $50 penalty for employers who file the wrong forms. Compare that to the thousands of dollars of potential payroll-tax savings, and you have a legislative incentive to push the envelope.

That's lawyer talk for "cheat the government."

IRS guidelines

The IRS has a 20-factor test for determining whether you're really an employee. These tests, contained in Form SS–8, Determination of Worker Status (.pdf download), boil down to three main categories:

• Behavioral control.

• Financial control.

• Relationship of the parties.

Does the employer control not only the nature of the work performed but the circumstances under which it is performed? If the employer contracting for services has the right to control not only the result of the services but also the means by which that result is accomplished, you're an employee. If your boss tells you not only what to do but how to do it, the game is over. You're an employee.

Do you have a stake in the action? Do you have a personal risk of loss? If not, you're probably an employee.

Most importantly, if you don't make your services available to more than one person or company, you're likely an employee.

What can you do about it?

If you think you're being misclassified, file Form SS-8 and have the IRS make a determination of your status. Remember, it's a 20-factor test, so the final resolution will be subjective.

If you have been misclassified, Form 8919, Uncollected Social Security and Medicare Tax on Wages (.pdf download) should be filed to ensure that the proper Social Security and Medicare taxes are credited to your account. Don't use the older form, No. 4137.

In September, Sen. Barack Obama, D-Ill., and three other senators filed legislation aimed at closing what was termed the safe-harbor Section 530 "loophole." The Independent Contractor Proper Classification Act is pending.

Updated Feb. 24, 2009

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