The IRS Focuses in on Small Businesses

The IRS has been conscious for years of the benefits freelancers offer small businesses and the inevitability of some of those freelancers becoming permalancers (a freelancer or independent contractor that functions as a full time employee for months or years.) Scrutiny of businesses that use freelancers on a regular basis is expected to grow.

Many businesses, particularly small ones, are using independent contractors because they offer more flexibility and are less expensive than hiring full-time employees. By hiring an independent contractor over a full-time employee, an employer will usually save about 30% on wages because with independent contractors employers can avoid paying payroll taxes, unemployment insurance, and worker's compensation coverage.

In February the IRS announced the launch of a program implemented to uncover permanent employees that are classified as freelancers, a violation of tax code. The program will last three years and study 6,000 companies. The General Accountability Office reports that over the past few years the average small business size has decreased and the IRS sees that as indication that small businesses are using more freelancers. In the current economy, it makes more sense for small businesses to hire more independent contractors than full-time employees.

Researchers say that this program is part of overall closer scrutiny of smaller businesses by the IRS. According to the Transactional Records Access Clearinghouse, in the past five years, the IRS has increased its time spent auditing companies with less than $10 million in assets and decreased the time they spent auditing larger companies.

The current push on small businesses could result in federal agencies standardizing the classification system of employees for small businesses in order to clarify the difference between independent contactors and full-time employees. A bill has already been introduced by Representative Jim McDermott to help define independent contractors and make harsher penalties for companies that choose to misclassify these employees. Representative McDermott said, "Far too many workers aren't receiving the benefits and protections they deserve. This will level the field for companies playing by the rules."