Tax Administration: Issues in Classifying Workers as Employees or
Independent Contractors (Testimony, 06/20/96, GAO/T-GGD-96-130).

GAO discussed the classification of workers as employees or independent
contractors for federal tax purposes. GAO noted that: (1) the Internal
Revenue Service (IRS) has adopted 20 common law rules to help employers
classify workers; (2) the rules require employers to withhold and
deposit income and social security taxes, and pay the unemployment and
social security taxes for workers determined to be employees; (3)
employers that use independent contractors do not have these
responsibilities because they pay their own social security and income
taxes; (4) classifying a worker as an employee or independent contractor
depends on the employer's circumstances, and the extent to which the
worker accepts the classification; (5) in 1984, IRS estimated that about
756,000 employers misclassified their workers as independent
contractors; (6) this noncompliance resulted in an estimated tax loss of
$1.6 billion; (7) misclassifications occur because it is cheaper to hire
independent contractors, but the rules for doing so are unclear; (8) IRS
completed 12,983 employment tax examination program audits from 1988 to
1995, and recommended $830 million in employment tax assessments and
that 527,000 workers be reclassified as employees; and (9) IRS is
revising its training program to better ensure consistent application of
common law rules, circulating a draft of its training program so that
employers know how to interpret the rules, and testing ways to expedite
disputes over worker misclassifications.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD-96-130
     TITLE:  Tax Administration: Issues in Classifying Workers as 
             Employees or Independent Contractors
      DATE:  06/20/96
   SUBJECT:  Tax administration
             Social security taxes
             Taxpayers
             Personnel classification
             Tax return audits
             Income taxes
             Tax law
             Contractors
             Tax nonpayment
             Noncompliance
IDENTIFIER:  IRS Employment Tax Examination Program
             
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Cover
================================================================ COVER


Before the Subcommittee on Oversight
Committee on Ways and Means

For Release
on Delivery
Expected at
10:30 a.m.  EDT
Thursday,
June 20, 1996

TAX ADMINISTRATION - ISSUES IN
CLASSIFYING WORKERS AS EMPLOYEES
OR INDEPENDENT CONTRACTORS

Statement of Natwar M.  Gandhi
Associate Director, Tax Policy and Administration Issues
General Government Division

GAO/T-GGD-96-130

GAO/GGD-96-130T


(268742)


Abbreviations
=============================================================== ABBREV

  IRS - x
  GAO - x

TAX ADMINISTRATION:  ISSUES IN
CLASSIFYING WORKERS AS EMPLOYEES
OR INDEPENDENT CONTRACTORS
====================================================== Chapter Summary

Employers, to determine their employment tax liability (e.g., social
security and unemployment taxes on employee wages), need to classify
workers as employees or independent contractors.  Many factors affect
this decision.  In making the decision, employers may misclassify
employees as independent contractors.  IRS has estimated that 756,000
of 5.15 million employers (15 percent) misclassified 3.4 million
employees as independent contractors in 1984.  Factors such as costs
and confusion over the classification rules can contribute to
misclassification. 

The common law rules for classifying workers are unclear and subject
to conflicting interpretations.  Employers cannot be certain that
their classification decisions will withstand challenges by IRS.  If
not upheld, they risk large retroactive tax assessments. 

Being responsible for enforcing these rules and concerned about
misclassification, IRS has maintained an audit presence.  From 1988
through 1995, IRS did 12,983 Employment Tax Examination Program
audits, recommending $830 million in taxes and reclassifying 527,000
workers. 

Deliberations over any changes to the classification rules may need
to consider potential impacts on tax compliance.  IRS has found that
independent contractors compared to employees have much lower income
tax compliance and account for a much higher portion of the income
tax gap.  Two approaches that could improve independent contractor
compliance within the existing common law rules are (1) improved
information reporting on payments made to independent contractors,
and (2) withholding income taxes from such payments.  Such approaches
could be implemented regardless of changes to the classification
rules.  Although tax compliance could be improved, these approaches
could increase to some extent the burdens on independent contractors
and employers that use them. 

Aside from tax issues, another important consideration in these
deliberations is the body of laws that create a safety net for
American workers.  Such laws generally apply only to employees.  If
changes to the classification rules lead to more workers being
classified as independent contractors instead of as employees, these
worker protection laws would cover fewer people. 


TAX ADMINISTRATION:  ISSUES IN
CLASSIFYING WORKERS AS EMPLOYEES
OR INDEPENDENT CONTRACTORS
==================================================== Chapter Statement

Madam Chairman and Members of the Subcommittee: 

We are pleased to be here to assist the Subcommittee in its inquiry
into the classification of workers either as employees or independent
contractors for federal tax purposes.  Proper classification of
workers has been the subject of several of our reports and
congressional testimonies.\1 Today, I would like to make 4 points
taken from these reports and testimonies. 

  -- First, in deciding how to classify workers, employers may
     misclassify employees as independent contractors.  In its most
     recent estimate on misclassification, IRS has estimated that
     756,000 of 5.15 million employers (15 percent) misclassified
     workers as independent contractors in 1984.  Many factors can
     cause misclassification, including cost considerations and
     confusion over the classification rules.  For example, not
     incurring the costs of employment taxes (i.e., social security
     tax, unemployment tax, and income tax withholding) and employee
     benefits can give employers cost advantages over competitors who
     use employees.  Further, both we and the Treasury Department
     have found that the common law rules used for classifying
     workers are unclear and subject to conflicting interpretations. 

  -- Second, even with the confusing rules, IRS is responsible as the
     nation's tax administrator to enforce compliance with them. 
     Under its Employment Tax Examination Program (ETEP), IRS has
     completed 12,983 audits, resulting in $830 million in
     recommended tax assessments and 527,000 workers reclassified to
     "employee" status between fiscal years 1988 and 1995. 

  -- Third, deliberations over any changes to the classification
     rules may need to consider potential impacts on income tax
     compliance.  IRS has found that independent contractors compared
     to employees have lower compliance in paying income taxes and
     account for a higher proportion of the income tax gap.  We
     identified two approaches that could boost independent
     contractor compliance within the existing common law rules. 
     They include (1) improved information reporting on payments made
     to independent contractors and (2) withholding income taxes from
     such payments. 

  -- Fourth, aside from tax issues, an important consideration in
     these deliberations is the body of laws that create a safety net
     for American workers.  Such laws generally apply only to
     employees.  If changes to the classification rules lead to more
     workers being classified as independent contractors instead of
     employees, these worker protection laws would cover fewer
     people. 

I would like to discuss each of these points in more detail after
providing an overview on factors that affect the classification
decision. 


--------------------
\1 These reports and testimonies include:  Tax Treatment Of Employees
and Self-employed Persons By the Internal Revenue Service:  Problems
and Solutions (GGD-77-88, Nov.  21, 1977); Tax Administration: 
Information Returns Can Be Used to Identify Employers Who Misclassify
Workers (GAO/GGD-89-107, Sept.  25, 1989); Tax Administration: 
Approaches for Improving Independent Contractor Compliance
(GAO/GGD-92-108, July 23, 1992); Tax Administration:  Improving
Independent Contractor Compliance With Tax Laws (GAO/T-GGD-94-194,
Aug.  4, 1994); Tax Administration:  Estimates of the Tax Gap for
Service Providers (GAO/GGD-95-59, Dec.  28, 1994); and Tax
Administration:  Issues Involving Worker Classification
(GAO/T-GGD-95-224, Aug.  2, 1995). 


   FACTORS IN MAKING THE
   CLASSIFICATION DECISION
-------------------------------------------------- Chapter Statement:1

The rules for classifying a worker as either an employee or an
independent contractor come from the common law.  Under common law,
the degree of control, or right to control, that a business has over
a worker governs the classification.  Thus, if a worker must follow
instructions on when, where, and how to do the work, he or she is
more likely to be an employee.  IRS has adopted 20 common law rules
to help employers classify workers (see appendix I). 

If workers are determined to be employees, employers must withhold
and deposit income and social security taxes from wages paid as well
as pay unemployment taxes and the employers' share of social security
taxes.  In addition, the employers may be subjected to laws that
govern the use of employees and any benefits provided to them. 
Employers do not have these responsibilities if the workers are
independent contractors.  Independent contractors must pay their own
income and social security taxes on payments received.  They have no
unemployment tax responsibility but may purchase benefit packages to
cover this contingency as well as others (e.g., health insurance). 

Ultimately, the decision to classify a worker as an employee or
independent contractor depends on each employer's circumstances. 
And, the extent to which a worker accepts the classification and
understands its consequences plays a role. 


   COSTS AND UNCLEAR RULES CAN
   CAUSE MISCLASSIFICATION
-------------------------------------------------- Chapter Statement:2

Employers sometimes misclassify employees as independent contractors. 
For 1984, the last time IRS made a comprehensive estimate, IRS
estimated that about 756,000 of 5.15 million employers had
misclassified about 3.4 million workers as independent contractors. 
IRS interpreted the classification rules in making this estimate.  As
shown in appendix II, this misclassification involved all industry
groups and up to 20 percent of the employers in some industry groups. 

This noncompliance produced an estimated tax loss for 1984, after
accounting for taxes paid by the misclassified independent
contractors, of $1.6 billion in social security tax, unemployment
tax, and income tax that should have been withheld from wages.  In
another set of estimates, IRS issued an employment tax gap report in
1995 that included the estimated tax gap associated with
misclassification.  This estimated tax gap was $2.3 billion in 1987
and $3.3 billion in 1992 for just social security and unemployment
taxes. 

In doing these estimates, IRS did not identify the reasons for the
misclassification but factors such as costs and unclear
classification rules can play a role.  For example, employers can
lower their costs, such as payments of employment taxes or benefits,
by using independent contractors.  This cost advantage could be
offset if an independent contractor can negotiate higher payments to
purchase their own health, retirement, or other benefits.  Otherwise,
the incentive to misclassify workers as independent contractors
exists. 

Second, many employers struggle in making the classification decision
because of the unclear rules.  Until the classification rules are
clarified, we are not optimistic that the confusion over who is an
independent contractor and who is an employee can be avoided.  The
Treasury Department characterized the situation in 1991 in the same
terms as it used in 1982; namely, that "applying the common law test
in employment tax issues does not yield clear, consistent, or
satisfactory answers, and reasonable persons may differ as to the
correct classification."

In addition to confusion over the common law factors, Section 530 of
the Revenue Act of 1978 has proven to be difficult to administer. 
Given complaints from some employers and independent contractors
about IRS' attempts to reclassify independent contractors as
employees, Congress passed this provision to limit IRS'
reclassification authority.  Section 530 provided qualifying
businesses with safe harbors in determining who is an employee and an
independent contractor.\2 In 1989, we reported that, for the cases
reviewed, section 530 prohibited IRS from assessing $7 million of $17
million in recommended taxes and penalties against employers for
misclassifying employees.\3 The employers usually avoided the
assessments by claiming a prior audit protection, even when the prior
audit did not address employee classification or occurred over 20
years earlier.  Section 530 also has precluded IRS from issuing
clarifying regulations since 1978. 


--------------------
\2 Under section 530, IRS may not assess employment taxes for
misclassified workers against an employer that had a reasonable basis
for its classification, such as a reliance on (1) a judicial or
administrative precedent or technical advice and letter rulings to
the taxpayer, (2) a prior IRS audit that did not challenge the
classification scheme, (3) an industry practice, or (4) any other
reasonable basis.  To qualify for this protection, the business must
have filed all required information returns and have treated similar
workers uniformly. 

\3 GAO/GGD-89-107, Sept.  25, 1989. 


   IRS ENFORCEMENT
-------------------------------------------------- Chapter Statement:3

IRS is responsible as the nation's tax administrator to enforce the
classification rules.  Because of concerns about misclassification
and income tax noncompliance by independent contractors, IRS
centralized a portion of its employment tax compliance efforts into
an Employment Tax Examination Program (ETEP) during 1987.  IRS'
strategy was to identify any misclassification and require employers
to correct it.  Employers whose employees are reclassified are liable
for the portion of the employment taxes that they would have owed if
the worker had been classified as an employee for the audited tax
years. 

From 1988 through 1995, IRS completed 12,983 ETEP audits.  These
audits recommended $830 million in employment tax assessments and
reclassified 527,000 workers as employees.  In addition, the IRS
Examination Division auditors, as part of their regular income tax
audits, also may address classification issues.  However, the
Examination Division does not accumulate data to identify audit
results on these issues. 

Since late 1995, IRS has implemented initiatives to improve its
enforcement of the classification rules and ease the burdens on those
being audited.  For example, IRS is revising its training to better
ensure consistent application of the rules.  IRS has circulated a
draft of its training program so that employers know how IRS intends
to interpret the rules.  Further, IRS is testing ways to expedite and
improve the settlement of disputes with employers over
misclassification.  These initiatives are too new for us to know
whether they are working. 


   CONCERNS OVER INCOME TAX
   COMPLIANCE BY INDEPENDENT
   CONTRACTORS
-------------------------------------------------- Chapter Statement:4

Since 1977, we have supported measures to simplify the classification
rules.\4 However, the development of clearer rules for all types of
working relationships and businesses is neither simple nor easy. 

In an effort to clarify the classification rules, we proposed a
straightforward test in 1977 (see appendix III for details of this
proposal).  In sum, we proposed excluding workers from the common law
definition of employee when they met each of four criteria.\5 If the
worker met three of the criteria, we proposed that the common law
criteria should be applied.  Otherwise, we proposed that the worker
should be considered an employee.  Our proposal was not widely
accepted for various reasons, which we had recognized.  For example,
Treasury and IRS were concerned about lower tax compliance and lost
tax revenue from having more self-employed workers and fewer
employees. 

We have viewed our 1977 proposal as a good starting point for
clarifying the classification rules.  In doing so, the deliberations
also may need to consider the potential impact on income tax
compliance.  IRS studies since the 1970s have documented a much lower
level of income tax compliance by independent contractors compared to
employees.\6 IRS data for 1988 suggest that independent contractors
accounted for most of the income tax gap created by those
self-employed individuals who underreported their business income.\7

IRS' most recent estimates put this part of the income tax gap at
$29.2 billion for 1992.  Among self-employed individuals contributing
to this tax gap, IRS estimated that those who informally supply goods
and services (e.g., street vendors, moonlighting craftsmen or
mechanics, unlicensed child-care providers) reported less than 20
percent of their business income.  The other self-employed
individuals, who operated more formally (e.g., gas station owners),
reported less than 70 percent; these estimates do not distinguish
between independent contractors and other self-employed individuals
such as those who make or sell goods. 

Recognizing these concerns, our 1992 report identified other
approaches to improve independent contractor compliance within the
framework of the existing classification rules.\8 These approaches
would (1) require businesses to withhold taxes from payments to
independent contractors or (2) improve information reporting on
payments made to independent contractors.  While each approach would
increase to some extent the burdens on independent contractors and
businesses that use them, we believe each approach can help improve
income tax compliance. 

For example, withholding is the cornerstone of our tax compliance
system for employees.  It has worked well with over 99 percent of
wages voluntarily reported.  In addition, it provides a gradual and
systematic method to pay taxes and better ensure credit for social
security coverage.  As early as 1979, we concluded that noncompliance
among independent contractors was serious enough to warrant some form
of tax withholding on payments to them.\9

We continue to believe that withholding taxes from payments made to
independent contractors has merit as a way to improve their income
tax compliance.  Several administrative problems would need to be
resolved.  For example, independent contractors with substantial
business expenses, which lower taxable income, may have too much tax
withheld from gross payments made to them.  Appendix IV discusses
such problems and possible solutions. 

A second approach to enhance compliance--improving information
reporting--parallels the withholding approach by shifting emphasis
from unclear classification rules to the relatively clear laws on
filing information returns.\10 Focusing on information returns could
have a significant effect.  IRS data has indicated that when
information returns are filed, misclassified workers reported 77
percent of that income on their tax returns but only 29 percent of
the income not covered by information returns. 

While other options may exist, our 1992 report identified eight
options that could strengthen information reporting and close
potential loopholes: 

(1) Significantly increase the $50 penalty for not filing an
information return. 

(2) Do not penalize businesses for past noncompliance with
information reporting laws if they begin to file information returns
when the penalty is increased. 

(3) Require IRS to administer an education program to make the
business community aware of the filing requirement and of IRS'
intention to vigorously enforce it. 

(4) Lower the $600 reporting threshold for payments to independent
contractors. 

(5) Require information reporting for payments to incorporated
independent contractors. 

(6) Require businesses to separately report on their tax return the
total amount of payments to independent contractors. 

(7) Require businesses to validate the tax identification numbers
(TIN) of independent contractors before making any payments and
withhold a portion of the payments until the TIN is validated. 

(8) Require businesses to provide independent contractors with a
written explanation of their tax obligations and rights. 

Each of these options involves tradeoffs between taxpayer burden and
tax compliance.  Appendix V summarizes the pros and cons of each
option. 


--------------------
\4 GGD-77-88, Nov.  21, 1977. 

\5 The four criteria for independent contractor status included (1)
separate set of books and records, (2) risk of a loss and opportunity
for a profit, (3) principal place of business separate from those
receiving the services, and (4) availability to provide self-employed
services to the general public. 

\6 Over the years, IRS has found that employees report almost 100
percent of their income while independent contractors report about
three-quarters of theirs.  A special IRS study in 1979 estimated that
47 percent of the independent contractors reported none of their
business income. 

\7 GAO/GGD-95-59, Dec.  28, 1994.  Lacking a generally-accepted
definition of "independent contractor", the report developed
estimates on service providers as a surrogate measure since many are
considered by IRS and the business community to be independent
contractors.  Depending on the definition of service provider used,
their portion of the income tax gap created by self-employed
individuals ranged from 56 percent to 81 percent. 

\8 GAO/GGD-92-108, July 23, 1992.  This report also discusses the
tradeoffs of clarifying the section 530 safe harbors (e.g., prior
audit and longstanding industry practice) and codifying section 530
for employment as well as income tax purposes. 

\9 Hearing on Compliance Problems of Independent Contractors, before
the Subcommittee on Select Revenue Measures, House Committee on Ways
and Means, July 17, 1979. 

\10 In general, third parties (e.g., businesses but not individual
homeowners) are required to annually file information returns at IRS
to report $600 or more in payments made to unincorporated individuals
for services rendered in the course of trade or business.  The
information is also reported to these individuals. 


   IMPLICATIONS FOR THE SOCIAL
   SAFETY NET FOR AMERICAN WORKERS
-------------------------------------------------- Chapter Statement:5

Aside from tax issues, another consideration in deliberating changes
to the classification rules is the potential impact on the body of
laws that create a safety net for American workers.  Because many of
these laws apply only to employees, the laws do not protect workers
classified as independent contractors.  Changes to the classification
rules could increase the number of unprotected independent
contractors. 

For example, unemployment insurance is nearly universal, covering
over 90 percent of American workers.  This 60-year old program
provides short-term financial support for covered workers who,
through no fault of their own, become unemployed.  It also helps the
unemployed from having to turn to public assistance programs.  During
economic downturns, payments made to the unemployed may take on added
significance, serving a macro-economic role of helping to stabilize
the economy.  However, federal law does not require coverage of
independent contractors for unemployment insurance, although one
state (California) has provisions that would allow independent
contractors to apply for self-coverage. 

While we have not made an extensive survey to determine all affected
laws, they are quite numerous.  They include basic protections
involving issues such as minimum wage, mandatory overtime pay,
discrimination, occupational safety and health requirements, workers
compensation insurance, and employer-sponsored fringe benefits such
as pensions.  Thus, if clarification of the classification rules
pushes significantly more employees into independent contractor
status, the worker protection laws would cover fewer people. 


------------------------------------------------ Chapter Statement:5.1

Madam Chairman, this concludes my testimony.  I would be pleased to
answer any questions you or other members of the Subcommittee may
have. 


IRS' COMMON LAW RULES
=========================================================== Appendix I

IRS has summarized the common law into 20 rules.  The facts of each
case govern which rules apply, and the weight assigned to them in
classifying a worker.  Even so, workers are generally employees if
they: 

1.  Must comply with employer's instructions about the work.
2.  Receive training from or at the direction of the employer.
3.  Provide services that are integrated into the business.
4.  Provide services that must be rendered personally.
5.  Hire, supervise, and pay assistants for the employer.
6.  Have a continuing working relationship with the employer.
7.  Must follow set hours of work.
8.  Work full-time for an employer.
9.  Must do their work on the employer's premises.
10.  Must do their work in a sequence set by the employer.
11.  Must submit regular reports to the employer.
12.  Receive payments of regular amounts at set intervals.
13.  Receive payments for business and/or travelling expenses.
14.  Rely on the employer to furnish tools and material.
15.  Lack a major investment in facilities used to perform the
service.
16.  Cannot make a profit or suffer a loss from the services.
17.  Work for one employer at a time.
18.  Do not offer their services to the general public.
19.  Can be fired by the employer.
20.  May quit work anytime without incurring liability. 


ESTIMATED PERCENTAGE OF EMPLOYERS
WITH MISCLASSIFIED WORKERS, 1984. 
========================================================== Appendix II

                                                            Percent of
Industry                                                         total
------------------------------------------------------  --------------
Construction                                                      19.8
Finance, Insurance, Real Estate                                   19.3
Mining, Oil and Gas                                               18.6
Agriculture                                                       16.7
Manufacturing                                                     15.8
Services                                                          15.4
Transportation                                                    11.2
Wholesale and Retail Trade                                         9.6
Government                                                         9.6
Not Otherwise Classified                                          12.6
======================================================================
Total                                                             13.4
----------------------------------------------------------------------
Source:  Treasury Department


GAO'S 1977 PROPOSAL FOR CLARIFYING
THE CLASSIFICATION RULES
========================================================= Appendix III

To make the classification decisions more certain, we proposed a
straightforward test in 1977.  As in common law, our test recognized
that a prime determinant of whether a worker is an employee or
independent contractor is the degree of control, or right to control,
the employer has over the worker.  But our test also intended to
recognize that some degree of control to protect the image of the
manufacturer, supplier, or prime contractor should be allowed without
creating an employer/employee relationship.  Our test was also
intended to provide a clear standard to assure better compliance. 
Therefore, we proposed that workers be excluded from the common law
definition of employee when they: 

  -- Have a separate set of books and records which reflect items of
     income and expenses of the trade or business;

  -- Have the risk of suffering a loss and opportunity of making a
     profit;

  -- Have a principal place of business other than that furnished by
     the persons receiving the services; and

  -- Hold themselves out in their own name as self-employed and/or
     make their services generally available to the public. 

We also recognized that a worker may be able to meet some of our
criteria and still have a valid basis for being self-employed.  As a
result, we proposed that the common law criteria should be applied
when a worker met three of the four criteria.  Otherwise, we proposed
that the worker should be considered an employee. 

At the time, our proposed solution was not widely accepted.  Treasury
and IRS were concerned that any change in the law which increases the
number of self-employed would result in lost tax revenue.  This was
because IRS had found that self-employed taxpayers had a low
compliance rate in reporting income earned.  The Departments of
Justice and Labor were concerned that the criteria would permit
taxpayers to be considered self-employed when they have the form but
not the substance of self-employment. 


ADMINISTRATIVE ISSUES CONCERNING
THE POSSIBLE WITHHOLDING OF TAXES
FROM PAYMENTS MADE TO INDEPENDENT
CONTRACTORS
========================================================== Appendix IV

Withholding taxes from payments made to independent contractors has
the potential to significantly improve their compliance with income
tax laws.  For this potential to come to fruition, several
administrative problems would need to be resolved.  The most
important consideration in any withholding system is that the tax
withheld approximates the tax due for the year.  Independent
contractors can have substantial business expenses that reduce annual
net income and taxes owed.  In such cases, withholding could
adversely affect their cash flow.  Because such expenses may vary
among independent contractors, a graduated withholding system to
account for differences in expenses could be used.  A simpler
approach for businesses would be to withhold a flat amount (e.g., 5
percent) of all payments. 

Another problem is that independent contractors may circumvent
withholding by incorporating.  To avoid this problem, withholding
would need to apply to corporations.  Large corporations may view
withholding on payments to them as unjustified since IRS data suggest
that their voluntary compliance exceeds that of self-employed
workers. 

Also, it is likely that any withholding system would exempt some
independent contractors.  For example, the flat 10 percent
withholding proposal developed by the Treasury Department in 1979
would have exempted independent contractors who (1) normally work for
5 or more businesses in a calendar year or (2) expect to owe less tax
than the withheld amount.  Because some independent contractors may
be exempt, it would be important to complement any withholding system
with an effective information reporting system. 


OPTIONS FOR IMPROVING INFORMATION
REPORTING ON PAYMENTS TO
INDEPENDENT CONTRACTORS
=========================================================== Appendix V

In addition to discussing clearer classification rules and withheld
taxes on payments to independent contractors, our 1992 report
analyzed the pros and cons of eight options for improving the
reporting on payments made to independent contractors, as follows. 

Options                 Pros                    Cons
----------------------  ----------------------  ----------------------
(1) Increase $50        Should improve          Would complicate IRS
penalty for failure to  compliance in filing    administration if
file an information     Form 1099-MISC.         other penalties for
return (Form 1099-                              failure to file Form
MISC).                  Should increase income  1099-MISC are $50.
                        reported and taxes
                        paid by independent     Would cause equity
                        contractors.            concerns if one
                                                penalty was higher
                        Would encourage IRS to  than others.
                        check Form 1099-MISC
                        filing during audits.

                        Would discourage
                        agreements to not file
                        Form 1099-MISC in
                        exchange for lower
                        payments.

(2) Do not penalize     Would encourage filing  Would not punish the
businesses for past     compliance.             noncompliance.
Form 1099-MISC.
noncompliance if they   Would ease the          Would result in lost
begin filing.           transition to a higher  penalty revenue.
                        penalty for not filing
                        Form 1099-MISC.         May foster expectation
                                                of future penalty
                                                forgiveness.

(3) Have IRS educate    Should increase         Would add to IRS'
businesses on Form      compliance in filing    costs or use funds
1099-MISC filing        Form 1099-MISC.         that could be used for
requirements and                                other educational
penalties.                                      purposes.


(4) Lower the $600      Would include more      Would increase costs
Form 1099-MISC.         payments in IRS' match  to businesses to file
reporting threshold.    to detect unfiled Form  more Form 1099-MISC.
                        1099-MISC forms and
                        unreported income.      Would increase costs
                                                to IRS to process and
                        Should improve          match more information
                        independent contractor  returns.
                        compliance.
                                                May exceed IRS
                        Would mirror other      computer capacity.
                        lower thresholds
                        (e.g., $10 for
                        royalties).

(5) Require             Would deter attempts    Would increase costs
information reporting   to avoid information    to file more Form
on payments made to     reporting.              1099-MISC.
incorporated
independent             Would not need to       Would increase costs
contractors.            distinguish between     to process and match
                        incorporated and        more Form 1099-MISC.
                        unincorporated
                        workers.                May exceed IRS
                                                computer capacity.

(6) Require businesses  Should increase Form    May not stop some
to report the amount    1099-MISC compliance.   businesses from hiding
of payments to                                  payments to
independent             Could enhance IRS'      independent
contractors on tax      ability to detect       contractors.
returns. IRS would      noncompliance.
match these amounts to                          May increase
amounts reported on     Give tax return         businesses' costs to
information returns.    preparers more          report the
                        incentive to check      information.
                        compliance.

(7) Have businesses     Should improve IRS      Would add burden for
validate Taxpayer       matching and increase   businesses to validate
Identification Numbers  taxes collected.        TINs before paying
(TIN) before making                             contractors.
payments and withhold   Should make backup
taxes until a TIN is    withholding more cost-  Would increase IRS'
validated.              effective by reducing   equipment costs.
                        it or starting it with
                        the first payment.

(8) Have businesses     May improve tax         Would add burden on
notify independent      compliance.             business to make the
contractors of their                            appropriate
rights and obligations  Would encourage         notifications.
to pay taxes as self-   workers who believe
employed workers.       they are misclassified
                        to notify IRS.

                        Would inform workers
                        of their rights and
                        obligations.
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