Inconsistent Income Tax Decisions

As you are certainly aware, the U.S. Federal Income Tax code is sometimes quite vague. A number of years ago I read about a little test where the same tax information was taken to a certified public accountant (CPA), and several other tax preparers. When each had completed a sample return for the same information, each return was different. Something is wrong here. Seriously wrong!

Another Case in Point

In a previous posting (Independent Contractors – Know the Rules) the rules used by the Internal Revenue Service (IRS) to determine whether someone was an independent contractor or an employee were discussed. There it was pointed out that the IRS uses several criteria to determine whether someone is a contractor or an employee. Among the things considered are Behavioral Control, Financial Control, and Type of Relationship. Within those general categories are more details that are considered in making the determination. Yet, this is not always consistently applied. For example, some industries have a history of using independent contractors and it appears that the IRS often accepts this tradition. An example would be a carpet company using independent installation contractors while still exercising considerable control over them.

Yet, because these guidelines are not hard and fast and leave considerable room for interpretation, we are left with inconsistent income tax decisions. To say the least, this can leave employers confused and uncertain when attempting to interpret these rules and wondering that by classifying people as independent contractors if are they looking at a ticking time bomb.

ticking -time -bomb

An Update

I recently read an article that said the IRS is stepping up its audits of companies to determine if employees are incorrectly classified as independent contractors. There is considerable potential for companies to find themselves facing large back taxes and penalties. It is certainly conceivable that it could put some companies out of business.

To make matters worse, companies are trying more and more to avoid adding employees in an effort to lower costs. With independent contractors the employer has lower tax expenses for such things as Social Security, Medicare, and Unemployment taxes. Not only that, with the implementation of the Affordable Care Act coming into full force in January 2014, many companies want to stay below the 50 employee threshold where they will be required to furnish health insurance.

However, these reasons alone are not sufficient to classify someone as an independent contractor. It is critical that each company considering hiring someone as an independent contractor carefully evaluate their situation before finalizing a decision.

The Tip of the Iceberg

Of course, the issue above is not the only example. On a personal tax level the deductibility of various items when itemizing is often questionable. For companies there can be confusion as to whether certain purchases should be expensed or capitalized. On top of that there are rules that govern the handling of tax issues for particular industries. These are just a few examples, and as you can see there is considerable potential for inconsistent income tax decisions.

What is the Solution?

Fundamentally there are at least two ways this dilemma can be resolved. One, laws can be passed to clarify existing tax laws. However, more laws often add to the confusion, so I’m not certain that solves anything. The other option is to eliminate the income tax completely and go to a sales tax on retail purchases. This is certainly simpler, but obviously a hot potato from a political perspective. In the meantime, all we can do is work within the existing system and use extreme and conservative caution in making tax decisions.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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