The U.S. Treasury is losing billions of dollars because employers - including the government itself - fail to withhold taxes from the paychecks of workers who are erroneously designated as "independent contractors," the General Accounting Office said Tuesday.
GAO placed a good share of the blame on Congress, which, in an effort 10 years ago to curtail the Internal Revenue Service, made it more difficult to crack down on employers who violate the withholding provisions.Paul L. Posner, a GAO associate director, said in testimony prepared for a House Government Operations subcommittee that the failure of workers designated as independent contractors to report some or all their income is at the root of the revenue loss.
In turn, GAO found, employers are not complying with requirements that they file reports with the IRS on payments made to individual contractors. Even when auditing business tax returns, the report said, the IRS is not identifying businesses that fail to file such reports.
"The importance of employers filing required information returns on payments made to independent contractors cannot be overemphasized," Posner said. "IRS officials estimate that billions in taxes are lost because independent contractors do not report all income."
Posner told the subcommittee on consumer affairs that in 1984 alone, the IRS estimated it lost $1.6 billion because about one of every seven employers misidentified employees as independent contractors.
Independent contractors are companies or individuals who supply services to a business or government agency but do not have an employee relationship with the business or agency. There are numerous tests to determine whether a worker is an employee or independent contractor, including who controls working hours.
If a supplier is classified as an employee, a business must withhold income and Social Security taxes from his or her paycheck and pay an employer's share of Social Security taxes.
However, if that supplier is said to be an independent contractor, the business withholds no tax and pays no employer's share of Social Security tax. The Treasury loses again when the contractor claims business deductions.
The law requires that payments for services supplied by independent contractors that are partnerships or sole proprietorships be reported to the IRS, but not those supplied by corporations.