Both the Wall Street Journal and Entrpreneur.com are reporting that the IRS is cracking down on small businesses, suspicious that they are underreporting revenue, and misclassifying freelancers. The Wall Street Journal investigated numerous letters that had been sent to small businesses, inquiring after what the IRS considers a “widespread problem: failure by businesses, including mom-and-pops, to report all-cash sales in order to minimize tax bills.” Their key interest was in cash receipts which are more difficult to track than credit-card sales.
In addition to underreporting data, the IRS is also concerned that small businesses may be misclassifying employees as freelancers in order to avoid additional taxes. Jeff Weld examines this particular issue in a recent article posted to Entrepreneur.com entitled “The IRS Wants to Know If Your Freelancer Should Be Getting a W2.” He explains, “With a W2 employee, the government gets timely payments through withholding, there is no danger of non-reporting, the worker doesn’t write off expenses… and payment is made to unemployment insurance, workers comp, and disability. Even though independent contractors are supposed to cover their own unemployment, works comp, and disability that still leaves a tax gap that is driving the IRS crackdown.”
It’s important that you appreciate this crackdown in order to help your small-business clients avoid undue attention from the IRS. To eliminate the question of misclassified freelancers, help your clients answer the following four questions, as posed by Jeff Weld:
1. Is this person really a freelancer? This can be determined by having your client answer the following questions:
- Did she incorporate?
- Does she have business insurance, a business bank account, an actual office?
- Does she have a website, a logo, marketing materials?
- For how many other customers does she provide service?
If your client answers “no” or “0” to any of the above questions, chances are he/she should add the individual to their payroll and have them complete a W2.
2. Do you have financial control over the person doing work? Your client is not responsible for any equipment or tools the freelancer uses to complete his/her assignments. The client should also pay a fixed amount for either hourly or per/project work.
3. How much influence can you have over this person’s day? If your client can contact the freelancer and demand them to complete an emergency project by day’s end, chances are that individual sees him/herself as your client’s employee.
4. How does this person’s work get performed? As Weld explains, “In some ways, this is the most important test. The core of the IRS focus is determining whether the work should have or could have, been done by a full-time employee. If you are engaging freelancers simply to not hire more full-time employees for something core to your business, you are taking on a risk. You should not have employees sitting next to freelancers doing the same work.”
Help your clients ensure that those they see as freelancers can really be categorized as “freelancers” by IRS standards. Not doing so could put them at risk for an audit in the future.
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Allen Bostrom, President, and CEO of Universal Accounting Center have a lot of experience helping small businesses become more lucrative, and he’s written a book about it called In the Black: Nine Principles to Make Your Business Profitable. Practical and easy-to-apply, you can finish this book in one day and begin implementing those principles the next. To learn more about this book and some of the principles he shares, visit his website today!
Hennessey, Ray. “5 Reasons the IRS’s New Focus on Small Businesses Is Ridiculously Egregious.” 12 August 2013 Entrepreneur.com
Weld, Jeff. “The IRS Wants to Know If Your Freelancer Should Be Getting a W2.” 14 August 2013 Entrepreneur.com