Why Your ICs’ Tax Returns Could Spell Trouble


With the 2015 tax deadline just around the corner, there are a few tax related considerations any well prepared workforce management program must be aware of if they want to avoid trouble regarding the ICs they may have in their workforce. Most already know that the IRS reviews the returns of those filing Schedule C to report business income and expenses more closely than the average return. A schedule C is required for any business that is a sole proprietorship and that is not incorporated. This basically defines the independent contractor. Since independent contractors typically file Schedule C returns, there is an inherently higher probability these returns will be scrutinized; and along with that scrutiny comes additional attention for the engaging organization. Here’s what you need to know to avoid trouble.

Why is it that the IRS examines Schedule C’s more closely? Historically, the IRS has found Schedule C filings tend to contain a higher rate of inconsistency compared to 1040 filings. Therefore it follows that the IRS would focus on auditing these returns up to four times more often than other filings. Typical findings during Schedule C audits show exaggerated business expenses for such deductions as home offices, vehicle mileage, travel and meal expenses. Moreover, it’s easier and quicker for the IRS to audit smaller businesses than their larger, more complex counterparts. With IC workers a rising category with over 33% of the workforce or 50 million workers expected to be among the ranks of the ICs in 2015 we should expect the number of audits to rise accordingly.

In 2014, more than 24 million tax returns of self-employed sole properties were audited, which represents a statistically significant 15% of the total audit population that year. When these audits are conducted, the IRS is almost invariably led to the companies issuing the contractors’ 1099s. This activity has become known colloquially as the “backdoor audit” because it provides the IRS a pretext for examining the tax reporting of companies they might wish to audit, but for which they have no specific reason to examine.

This is yet another reason why strong IC classification protocols are mission critical to workforce management programs. If workers are incorrectly classified as employees, the results of misclassification can be far greater than just a headache for the individual triggering the audit. Things occurring during an audit of one of your ICs can lead back to your organization. For example, when the IRS looks at these workers’ sources of income, they’ll be focusing on such points as whether the contractor had received both a W2 and a 1099 within a single tax year. They may look at if the contractor claims your organization as their only client/source of income.

Yet, there’s not much influence a company can exert over how its contractors file their taxes. So how does one protect the organization from the backdoor audit?  The best thing one can do is to engage an expert, impartial firm such as nextSource to help your organization safely engage independent contractors. If workers are not able to meet the IC classification threshold, companies may still employ their services via arrangement with an employer of record.

Take a few extra precautions when hiring ICs and avoid a host of headaches later. Next to classification compliance issues, tax reporting is the next largest potential mine field for hiring organizations using ICs.

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