Earlier this year, I reported how Governor Patrick created an “Executive Order on the Underground Economy and Employee Misclassification”. This order created a joint task force who was charged with seeking business owners who fail to pay taxes, maintain workers compensation insurance and/or fail to pay bona-fide employees as independent contractors (among other misdeeds).

 

As a result, the Massachusetts Department of Revenue (MDOR) has created a new Wage Enforcement Unit within its Audit Division. The auditors will work to identify and audit noncompliant businesses, assess taxes and then enforce collection of the tax.

 

I have written many times about the dangers of misclassifying employees and not reporting business income. However the MDOR has just raised the stakes with this newly formed audit unit.

 

Small business owners in Massachusetts are reminded that for state purposes an independent contractor is:

·        A worker who is free from the control and direction in performing the service (both under a contract and in fact) of the employing party and

·        Providing a service that is outside the employing party’s usual course of business and

·        Customarily engaged in an independent trade, occupation, profession or business

 

Example: a contractor hires a helper to assist him with painting, carpentry, etc. The helper works 30-35 hours per week for the contractor and will occasionally pick up a “side job” doing home repairs. The contractor tells the helper when and where to work and provides the brushes, saws, hammers and other tools necessary to complete the job. They also have an agreement that the contractor will “1099” the helper and not withhold taxes. This is clearly an example of an employer-employee relationship and the contractor will be subject to all state payroll taxes and penalties if audited. A Mass. audit will result in a Federal audit and vice-versa due to extensive file sharing between the two agencies.

 

Example: a contractor hires a painter to assist him on all remodeling jobs.  The painter has his own business cards and advertises through word of mouth and ads in the newspaper. Painting is his main source of income. The painter is called when the drywall is set and arrives with his own brushes, tarps, tape and solvents. The contractor directs the painter which walls are to be painted and what color is to be used. The contractor completes the job and is then ready to accept another job from any contractor. In this case, the painter is an independent contractor and should be issued a 1099 form accordingly.

 

Let’s go back to the contractor and helper example. Let’s say they get into an argument and the helper is fired. He then tries to collect unemployment and files a claim with the Department of Unemployment Assistance. The DUA will find no record of him being an employee of the contractor (employee wages are reported by employers every quarter to the MDOR/DUA). The DUA will most likely reject his claim but the helper can then appeal. What will happen next? The employer will be in for a very rude awakening when the auditors step in. DUA and MDOR will move quickly to assess taxes, penalties and interest and move on to enforcing tax collections. The contractor will pay thousands of dollars in fees for tax representation and/or attorney’s fees to keep the government from attaching bank accounts, equipment and real estate. After the state mess is settled and the contractor thinks the worst is over the IRS will come knocking and the process starts all over again!

 

I am once again reminding all small business owners about the perils of employment misclassification. It’s important to note that the Massachusetts laws are more stringent than the IRS’s rules for employee vs. independent contractor treatment. Furthermore, the IRS’s guidelines are revenue rulings, not laws, therefore state law trumps federal rulings so if Massachusetts audits and determines independent contractors are truly employees, the IRS will too.

 

If you are a small business owner or considering starting a small business and have questions about employee vs. independent contractor treatment, please feel free to call or email me.