Independent Contractor Compliance Blog - by Collabrus™

WASHINGTON - IRS National Taxpayer Advocate Nina E. Olson released her annual report last week, urging Congress to greatly simplify the tax code.  The report recognizes that IC compliance is a difficult and complex area, stating that “the complexity and ambiguities in the existing worker classification rules create uncertainty and lead to noncompliance.”

Tax Laws are too Complex

The report cites the following facts to show how complex the laws have become and how difficult it is for business and private taxpayers to comply with them.

• U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with tax-filing requirements…the equivalent of 3.8 million full-time workers.
• U.S. taxpayers spend $193 billion a year complying with income tax requirements. (That’s not tax but administrative costs of complying).
• One count shows the number of words in the tax code has reached 3.7 million.
• Changes to the tax code have been made at a rate of more than one a day, including more than 500 changes in 2008 alone.
• More than 80 percent of taxpayers pay transaction fees to help them file their returns.
• About 60 percent pay a preparer to do the job.
• Another 22 percent purchase tax software.

The report includes a series of recommendations including bills her office supports.

For example, the Taxpayer Advocate supports H.R. 5719, the Taxpayer Assistance and Simplification Act of 2008, which passed the House and was referred to the Senate Committee on Finance. The bill includes several provisions, but Section 5 of the bill “clarifies” that home-based workers are employees rather than independent contractors.

The IRS Taxpayer Advocate Reports on Worker Classification.

The report states that, “The complexity and ambiguities in the existing worker classification rules create uncertainty and lead to noncompliance. In general, businesses are only required to pay employment tax, withhold income tax, and provide benefits with respect to employees. As a consequence, businesses often classify workers as independent contractors to reduce their costs. Some employees seeking to avoid their tax obligations may also prefer to be classified as independent contractors if the employer does withhold taxes or report the payments to the IRS…”

(Read here another reference to the Tax Gap).

The IRS Taxpayer Advocate recommended in the report that Congress

1. Replace Section 530 of the Revenue Act of 1978 (Safe Harbor) with a provision applicable to both employment and income taxes and require the Secretary of the Treasury to issue associated guidance (for IC classification), including guidance with specific industry focus,
2. Direct the IRS to develop an electronic tool to determinate worker classifications that employers would be entitled to use and rely upon,
3. Allow both employers and employees to request classification determinations and seek recourse in the United States Tax Court.
4. Direct the IRS to conduct public outreach and education campaigns to increase awareness of the rules as well as the consequences associated with worker classification.

Allow Health Plan Deductions for ICs

The report also recommends that Congress repeal IRC § 162(l)(4) to place self-employed taxpayers on an equal footing with their wage-earning counterparts in regards to Health Insurance Deductions. The report cites that many wage-earners (employees) participate in benefit plans that allow them to exclude the cost of their health insurance premiums from gross income…However, unlike their wage-earning counterparts, self-employed individuals (IC’s who receive a 1099) cannot deduct health insurance costs when determining net earnings for self-employment tax purposes (Social Security and Medicare taxes).  This law change would allow IC’s the same deductions as employees.

What does this report mean?

The IRS Taxpayer Rights Advocate reports each year to Congress with recommendations.  Most recommendations are not passed into law.  However, oftentimes the information is used as support for other bills that do get passed.  What is significant is that even the IRS recognizes the law they enforce is complex and replete with ambiguities in all areas, including:

• Income taxes,
• Employment taxes, and
• IC compliance.