Renewed Focus on Worker Classification

Whether a worker is an employee or independent contractor is a longstanding question. The answer results in vastly different tax consequences for both the worker and employer. For example, a contractor reports his/her earnings on Schedule C and gets full, above-the-line deduction for expenses incurred in generating that income. In contrast, an employee's unreimbursed work expenses are miscellaneous itemized deductions subject to the 2% of AGI floor. For a contractor, the employer owes no payroll taxes (no FICA or FUTA) and the worker pays self-employment tax (and has not unemployment insurance unless purchased on his/her own).

Congress has mostly ignored getting better guidance out on how to classify workers. President Obama has a proposal in his FY 2011 tax plan. Also, his middle-class task force has noted the issue and how misclassification of a worker as a contractor poses problems for the worker.

I've got a short article on the topic in the 8/26/10 AICPA Corporate Taxation Insider - here.

I believe there is a possible remedy. After all, the key end result from a tax perspective is that the government wants to be sure that all payroll and income taxes are properly paid by the employer and worker. Part of the solution would be to allow employees a better deduction for their work-related expenses that are not reimbursed by the employer. Also, better systems for tracking independent contractors to improve their tax compliance would help. I've been working on a paper on this which I put on the shelf for a while, but think I'll dust off and take another look at it.

Worker classification will become a bigger deal as some of the health care legislative changes come into effect because employers need to provide certain coverage to employees, but not to contractors. Also, if we ever do have a VAT added to our Federal tax system, the determination is more relevant because wages are taxable while payments to contractors are not.

What do you think would be a remedy to the classification question?