Looming IRS Problems for Small Business
Many small businesses have big problems classifying their employees correctly. Why? Because some business owners go out of their way to save a few bucks on the taxes paid for employees. They think they can pull a fast one and pay their employees cash under the table. Even worse, some business owners will tell their workers that they are “independent contractors” and just cut them a check each week. Either way, both methods are illegal. This behavior is the reason there are so many looming IRS problems for small businesses in this country. The IRS has targeted many of the industries that abuse this practice.
Shady Independent Contractor Classification
Let’s elaborate more on the larger issue of paying employees by check as an independent contractor. Whether you pay your employees by cash or check with no taxes taken out, it’s essentially the same issue as far as the IRS and state tax collectors are concerned. Some shady business owners think they are getting away with avoiding taxes by paying workers this way. They pay them by cash or check and then give them a Form 1099 at the end of the year.
This is what I call the shady independent contractor classification.
So why bother issuing a 1099 at all? Because the small business owner wants to get the best of both worlds. They want to avoid paying the payroll taxes on the employee income, but they still want to deduct the payments they make off their own income taxes.
The business owner who behaves like this doesn’t care what happens to their employees. So, they will pay them straight time for hours worked or a per diem rate. Then they cut them a check for the full amount.
The shop owner then sells it to the employee by pointing out that they are making more money because there are no taxes deducted from their “paycheck”. Obviously this is a lie since somebody has to pay the taxes due on this income. This scenario is played out thousands of times a day and is a major contributor to these looming IRS problems for small businesses that I’m talking about here.
Targets for Audits and Investigations
Over the past decade the IRS has identified a growing number of industries as targets for audits and investigations to catch these shady business owners. These are mainly small businesses that have a bad habit of paying their workers under the table or as “contractors”. Businesses like landscapers, detail shops and construction contractors are big targets.
When the business owner issues a 1099 to the employee, they are attempting to transfer the employment tax obligations from their business to the employee. And the IRS knows you are doing this because you announce it when you deduct the payments made to these “contractors” on your own taxes. 1099’s that are sent to these contractor/employees are also submitted to the IRS to deduct those payments from the business income and overall tax liability.
Screwing Your Employees
As a business owner, you are essentially screwing your employees in multiple ways by doing this. The employee doesn’t have a record of earnings so nothing is paid into either the social security or unemployment compensation system. These employees/contractors also aren’t covered by workers comp that is legally required by the state where the business is operating.
- If the business owner fires the employee/contractor, they get no unemployment because they haven’t paid anything into it.
- If the employee/contractor gets hurt or injured on the job, they aren’t eligible for workers comp benefits to help them get back on their feet while they are unable to work.
- If the employee/contractor works for the shop for many years, literally none of their earnings are recorded with social security. The shop owner is basically creating an awful future possible retirement fiasco for the employee.
- The employee might save a few bucks on taxes in the short term, but in the long run they are getting screwed. The clear winner in this situation is the business owner who saves all the employment taxes, the employer contribution for unemployment insurance with the state and the workers comp coverage.
This is underhanded and sleazy behavior. Most business owners I know are much better than this. I get that it’s expensive to have employees, but if you can’t afford it then you shouldn’t have employees. It’s simple math. Figure out how to do the work without employees or do it yourself. You can attempt to justify what you are doing all you want, but that doesn’t make it right.
Take Care of Your People
If my opinions on this sound harsh, it’s meant that way. I think business owners who do this are low-life sleazebags. Over the past 25 years I’ve built multi-million dollar businesses and gave my employees great pay and benefits. I also made a nice profit doing so. When you take care of your people, they take care of you.
Exposing Your Business to Unnecessary Liability and Risk
You are also exposing your business to unnecessary liability and risk with both civil and criminal penalties for trying to pass-off your “contractor” as an employee. If the employee/contractor creates a situation where you need to file an insurance claim, you run the risk of opening yourself up to potential insurance fraud. Your commercial insurance coverage won’t cover non-employees or contractors. Mainly because they are supposed to have their own liability and workers comp coverage. So, the only way the business can get the claim paid by the insurance carrier is to lie about the employee/contractor’s status. And if you don’t have W2 and payroll records to prove it, you will get caught.
And if you try to pass off your employee/contractor as an actual W2 employee, the IRS can ask the insurance carrier for those records to use against you later.
This is a lose lose proposition. But small business owners still try to get away with it.
Looming IRS Problems for Small Business
As business owners, we’ve got enough hassles to deal with to have the IRS and state tax collectors start piling on with more issues. I wrote “Looming IRS Problems for Small Businesses” to highlight this problem. It’s a big deal.
With so many sources of information everywhere, it’s hard sometimes to figure out what is accurate and not. I have seen “How To Guide’s” explaining the ways to get away with paying employees under the table, “off the books” and as 1099 contractors. There is something wrong with your business model if this is the only way you can make a profit. Nobody goes into business to screw people. It’s something that happens slowly. I get it. You have a bad year or even a few bad months and suddenly your expenses become your entire focus. No matter how bad it gets, reclassifying your employees as contractors is not the place to cut expenses.
Ended in Jail Time
I’ve known business owners that got themselves into jams with the government by paying people this way. One situation ended in jail time. That guy lost everything including his family after his wife divorced him while he was in jail.
You have an obligation as a business owner to fully understand the rules and regulations that apply to your business. Claiming that you didn’t know something isn’t a defense in court. The government doesn’t accept that argument. And rightly so.
You should not be in business if you don’t understand the rules. It makes the rest of us look bad.
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