Tax Administration: Issues in Classifying Workers as Employees or Independent Contractors

GAO discussed the classification of workers as employees or independent contractors for federal tax purposes. GAO noted that: (1) the Internal Revenue Service (IRS) has adopted 20 common law rules to help employers classify workers; (2) the rules require employers to withhold and deposit income and social security taxes, and pay the unemployment and social security taxes for workers determined to be employees; (3) employers that use independent contractors do not have these responsibilities because they pay their own social security and income taxes; (4) classifying a worker as an employee or independent contractor depends on the employer's circumstances, and the extent to which the worker accepts the classification; (5) in 1984, IRS estimated that about 756,000 employers misclassified their workers as independent contractors; (6) this noncompliance resulted in an estimated tax loss of $1.6 billion; (7) misclassifications occur because it is cheaper to hire independent contractors, but the rules for doing so are unclear; (8) IRS completed 12,983 employment tax examination program audits from 1988 to 1995, and recommended $830 million in employment tax assessments and that 527,000 workers be reclassified as employees; and (9) IRS is revising its training program to better ensure consistent application of common law rules, circulating a draft of its training program so that employers know how to interpret the rules, and testing ways to expedite disputes over worker misclassifications.