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

Madam Chairman and Members of the Subcommittee: We are pleased to be here to assist the Subcommittee in its inquiry into the classification of workers either as employees or independent contractors for federal tax purposes. Under its Employment Tax Examination Program (ETEP), IRS has completed 12,983 audits, resulting in $830 million in recommended tax assessments and 527,000 workers reclassified to “employee” status between fiscal years 1988 and 1995. IRS has adopted 20 common law rules to help employers classify workers (see appendix I). If workers are determined to be employees, employers must withhold and deposit income and social security taxes from wages paid as well as pay unemployment taxes and the employers’ share of social security taxes. Employers do not have these responsibilities if the workers are independent contractors. Ultimately, the decision to classify a worker as an employee or independent contractor depends on each employer’s circumstances. And, the extent to which a worker accepts the classification and understands its consequences plays a role. This noncompliance produced an estimated tax loss for 1984, after accounting for taxes paid by the misclassified independent contractors, of $1.6 billion in social security tax, unemployment tax, and income tax that should have been withheld from wages. For example, IRS is revising its training to better ensure consistent application of the rules. IRS has circulated a draft of its training program so that employers know how IRS intends to interpret the rules. Further, IRS is testing ways to expedite and improve the settlement of disputes with employers over misclassification.
Why GAO Did This Study

GAO discussed the classification of workers as employees or independent contractors for federal tax purposes.

What GAO Found

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.