Summary: Derived from common law, the rules for classifying a worker as an employee or an independent contractor are unclear and subject to conflicting interpretations; businesses often have difficulty distinguishing between the two kinds of workers. Yet proper classification is important because the Internal Revenue Service (IRS) can levy large tax assessments against businesses that misclassify workers as independent contractors. In the 15 years since GAO first reported on this issue, no action has been taken to clarify the common law. While recognizing the existing ambiguity, IRS also feels compelled to enforce tax laws and rules. IRS audits from October 1987 through December 1991 reclassified 338,000 workers as employees, leading to $468 million in assessments. GAO still believes that the classification rules must be clarified. Supporting legislation, however, would enable IRS to require businesses to (1) withhold taxes from payments to independent contractors and (2) improve business compliance with the requirement to file information returns on payments to independent contractors. These two approaches should help collect more of the taxes owed through means other than retroactive tax assessments. Although both approaches would mean a greater burden on independent contractors and the businesses that use them, GAO believes that both approaches have merit. GAO summarized this report in testimony before Congress; see: Tax Administration: Improving Independent Contractor Compliance, by Natwar M. Gandhi, Associate Director for Tax Policy and Administration Issues, before the Subcommittee on Select Revenue Measures, House Committee on Ways and Means. GAO/T-GGD-92-63, July 23, 1992 (14 pages).
