The Hidden Risk Among Your Workforce

In these tough economic times, is it any wonder that the IRS and other taxing authorities would look for ways to raise revenues?  Recently, one area of increased scrutiny has been the misclassification of employees as independent contractors.  This is an especially important consideration for not-for-profit organizations, and a consideration that boards and executives would be well advised to carefully evaluate.

It’s an easy perspective to understand – a small not-for-profit serving its community wants to put every dollar possible toward providing services.  The classification of workers as employees or independent contractors is somewhat subjective, so a not-for-profit may choose to take their chances or rely on “we’ve always done it this way.”  What they don’t know, however, is if the wrong decision is made and workers are misclassified, the organization can be held liable for a variety of hidden costs, such as the taxes that would be due along with interest and penalties, as well as the cost of employee benefits.

Not-for-Profits Beware
First and foremost, there could be a real cost to the organization of misclassifying employees as independent contractors.  Just think of how quickly the dollars would add up when payroll taxes, interest and penalties are compounded over multiple years of making the same mistake!  Many organizations would further face costs at the state and local levels, as those jurisdictions look for amounts to which they would be entitled.  Any organization doing business in the City of Philadelphia, for example, could be liable if those they classify as independent contractors do not maintain the appropriate business licenses.  As such, the City would consider them employees subject to the city wage tax, and could hold the organization liable for the cost rather than the individual.

Beyond just the dollars and cents, though, disclosure could be required in the organization’s annual audited financial statement and federal form 990.  Under the provisions of Accounting Standards Codification 740-10-55: Accounting for Income Taxes, the organization would be required to disclose in its financial statements the amounts that would be due should the organization’s classifications not stand up to a test of “more likely than not.” Likewise, that disclosure would need to be included on Schedule D of the organization’s federal form 990.  Not only does this disclosure become public information along with the rest of the 990, but the potential for a public relations issue becomes a factor.

It’s Not Just the CFO’s Problem
This issue of proper classification is not just the problem of the chief financial officer, the controller or the business officer.  First, program people within the organization will need to be enlisted to help make the proper determination.  The IRS publishes guidelines to help with this.  As the financial and program people go through this thought process, it would be wise that the considerations are documented in support of the ultimate conclusion.

Second, executive level management and the board of directors should be on the lookout for this issue, and raise these questions if the financial team has not yet done so.  No executive director or board member will want to have to answer questions down the road as to why such a problem could be allowed to exist year after year.   Furthermore, someone that is more properly classified as an employee is due all the benefits of any other employee, creating an additional level of human resource costs and considerations.

Now what?

Now that the misclassification of employees as independent contractors has become a hot topic, it is the perfect time for organizations to take a close look at their policies and procedures and make adjustments as necessary.   The IRS has begun offering a Voluntary Classification Settlement Program (“VCSP”).  Under this program, organizations have an opportunity to correct prior misclassifications in exchange for partial relief from prior federal employment taxes that would have been due.  To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.  It’s better to correct the situation before it becomes a problem than to try and handle the costs and public relations fallout down the road!

Resource Links:

IRS: Independent Contractor (Self-Employed) or Employee? - click here

IRS: Voluntary Classification Settlement Program - click here


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