A hint of Kafka: IRS payroll audits and worker classification

In order for the law to be fair, the rules must be clear enough so that people can use them as a guide. Unfortunately, that is not really the case, many people believe, with IRS payroll audits of small businesses regarding suspected misclassification of employees.

In Texas and across the country, the IRS has been increasing such audits, looking for evidence that employers may have classified independent contractors as employees. The agency is concerned that employers might do this in order to avoid payroll taxes, specifically Social Security and Medicare tax payments.

Small employers may have many legitimate reasons other than tax avoidance to classify certain workers as contractors rather than employees. The overriding reason for using more contractors may simply be to keep labor costs down – not to avoid taxes.

Labor costs have gone up, in large part, because health insurance costs have continued to go up. And, under the American system for delivering health insurance, employers carry a considerable burden in providing health coverage.

It’s also true that the legal test for distinguishing contractors from employees can be pretty confusing. There are many factors involved and the IRS has not spelled out a way to make the analysis simpler. The IRS and Congress should probably clarify the rules first before it emphasizes increased enforcement.

After all, it’s hard to follow rules that aren’t clear. In fact, there’s something Kafkaesque about this whole payroll audit scenario.

In Kafka’s classic story The Trial, a man faces a bewildering legal proceeding even though the charges against him are never spelled out. Many small businesses may well feel that way about IRS payroll tax audits.

Source: “The IRS’s Worker-Classification Rules Aren’t Working,” Bloomberg Businessweek, Scott Shane, 3-15-13