Worker Classification: Getting It Right The 1 st Time

Worker Classification: Getting It Right The 1st Time

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Worker Classification

Getting It Right The 1st TimePart 2

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Lesson Outline

Properly classifying workers 3 Categories of classification What are the various classes of workers Penalties for misclassification Case studies Form SS-8 and it’s importance Federal vs. state law Industries with classification issues Voluntary Classification Settlement Program (VCSP) Section 530 Safe Haven Protection

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Independent Contractor or Employee

Which one should it be?

How do you determine proper classification?

What affect does improper classification have on employer and worker?

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So How Do You Get It Right? Do you know how to properly classify workers?

How do you determine if your workers are employees, or independent contractors?

What factors should you use to make the proper classification?

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3 Categories For Classification

Worker classification facts are based on three main categories

1)Behavioral Control

2)Financial Control

3)Relationship of the Parties

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3 Categories For Classification

Must consider all facts in the case

Each case has different facts and circumstances

No single fact provides the answer

Misclassification can have major ramifications on employer and worker if you get it wrong

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Behavioral Control

These facts show if there is a right to direct or control how the worker performs the work

A worker is an employee when the business has the right to direct and control the worker

Business doesn’t have to control the way work is done – can direct and control the work

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Financial Control These facts show whether there is a right to direct and

control the business segment of the work

Does the business or the worker control financial elements such as expenses?

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Relationship of The Parties

These facts show how the business and the worker perceive their relationship

Does the business perceive the worker as an independent contractor?

Does the worker think he/she is an employee?

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So Where Do We Go From Here?

The worker perceives employee status,

The business perceives independent contractor status

Who is right and who is wrong?

How do you proceed now?

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Employees Under Common Law

A worker is usually an employee if the business can control what will be done and how it will be done

If business has ability to control the details of how the services are performed it indicates an employee-employer relationship

Workers in business for themselves are not employees

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Who Are Independent Contractors?

Accountants

Doctors

Lawyers

Veterinarians

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Who Are Employees?

Food servers

Bartenders

Receptionists

Office managers

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Statutory Employees

A Statutory Employee is a worker who cannot be classified as an employee under the Common Law rules

But is an employee for payroll tax purposes due to specific statutory requirements (Social Security and Medicare)

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Who Are Statutory Employees?

An Agent or Commission Driver (Food and beverage delivery driver – “No Milk”)

Full-Time Life Insurance Salesperson (Sells primarily for one company)

Homeworker (Works from home using materials furnished by business)

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Who Are Statutory Employees?

Traveling or City Salesperson (Full-Time – Works for One company taking customer orders)

Corporate Officers (One who provides No services or Minor services and is not entitled to receive payment)

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Who Are Statutory Employees?

Statutory Employees must have Social Security and Medicare taxes withheld if the Three Tests are met

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3 Test For Statutory Employees

1) Service contract states or implies that almost all services will be performed personally by employee

2) The employee has little or no investment in the equipment and property used to perform the services

3) Services are performed on a continuing basis for the same company

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Statutory Non-Employees

Two Categories of Statutory Non-Employees

If worker falls into either category they can be classified as Independent Contractors

Statutory Non-Employees are responsible for federal income taxes, and self-employment taxes

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Who Are Statutory Non-Employees?

Direct Sellers - (Must meet Three Factors to qualify)

Real Estate Agents – (No property managers)

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Direct Sellers 3 Factors

1) Salesperson sells consumer goods in the home, or at a place of business other than a permanent retail establishment

2) Sells consumer products to any buyer on a buy-sell basis, deposit commission basis, or any similar prescribed by the regulations

3) Substantially all of payment made to direct seller must be directly related to sales output, or performance or service output (Can’t Be Paid For Hours Worked)

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Direct Seller Requirements

To obtain direct seller’s exemption there must be a

Written contract between direct seller and company

Stating that direct seller will not be treated as an employee for federal tax purposes

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So Who Are Direct Sellers? Door-to-door salespersons

Home demonstration persons

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Statutory Non-Employees

Real Estate Agents

Need to be a qualified and licensed agent

Output should be based on sales and not on hours worked

Written contract stating they are not an employee for federal tax purposes

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Real Estate Agents

Provide services such as

Advertising

Showing real estate property

Acquisition of a lease to real property

Recruitment, training, and supervision of other real estate persons

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Real Estate Agents Property Management services are NOT included

Property Managers are not classified in the real estate agent category

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Statutory Non-Employees Statutory Non-Employees are not employees for

federal tax purposes, but

Can be an employee for other purposes such as state worker’s compensation, and tort liability

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Penalties of Misclassification

Employers are required to collect withholding taxes

Can ask for abatement of liability for employee portion of taxes if employee has paid the taxes

Use Form 4670 to request relief of tax liability

Employee’s statement submitted using Form 4669

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Failure to File Return Penalty

5% of balance due for each delinquent month

Maximum penalty – 25%

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Failure To Collect Tax Penalty

Business that “Willfully” fails to collect and pay trust fund taxes will be assessed

100% penalty of tax due

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What Are Trust Fund Taxes?

Federal income taxes and FICA taxes required to be withheld from employee’s wages

Trust fund taxes do not include employer’s FICA portion

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Trust Fund Penalty100% Penalty if Two Requirements are Met

1)Must be responsible person

2)Responsible person must have “Willfully” failed to collect or pay the trust fund taxes

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What Is Willful?Willful is defined as

Intentional

Deliberate

Voluntary

Reckless

Knowing

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Case Study 1

Business misclassifies employees as independent contractors and does not withhold federal and FICA taxes

Should responsible be assessed the 100% penalty for failure to collect and pay trust fund taxes?

Is there reasonable basis for not collecting and paying?

Crowd Management Services, Inc. DC Ore, 95-1 USTC

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How Far Back Can IRS Go?

Statute of limitations is based on filing date of Form 941 and 940

3 Years from filing date

If forms are never filed, statute never expires

If fraud is involved, there is NO statute of limitations for reclassifying workers

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Form SS-8

Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding)

Can be submitted to IRS by worker

Can be submitted to IRS by employer

Can be requested by IRS examiner

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Form SS-8

SS-8 is a restatement of 20 Common Law questions

It’s an excellent self-audit tool

Business should use it when drafting independent contractor agreement

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Federal vs. State Law

Every state has different laws for determining independent contractor status

Most states base it on “Employment”. Do worker’s services constitute employment?

Employment for state unemployment purposes is defined as “any services performed for remuneration or under contract for hire, written or oral, express or implied”

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Federal vs. State Law

Services for remuneration are considered “employment” unless the ABC Test is met

If ABC Test is met worker is not an employee for state unemployment purposes

Burden of Proof falls on the business

Some states require that only One or Two of the conditions are satisfied

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ABC Test

A. The worker is free from control of direction of the performance of the work

B. The service is either outside the usual course of business for which the service is performed, or it is performed outside of all the places of business of the enterprise for which the service is performed

C. The worker is customarily engaged in an independently established trade, occupation, profession, or business

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ABC Test Some states use ABC Test

Other states use the Common Law IRS 20 Factor Test

Other states use a variation of tests

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States With ABC Test

Alaska Louisiana New Jersey

Arkansas Maine New Mexico

Connecticut Maryland Rhode Island

Delaware Massachusetts Tennessee

Georgia Nebraska Vermont

Hawaii Nevada Washington

Illinois New Hampshire West Virginia

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States Using Common Law 20 Factor Test

Alabama Kentucky North Dakota

Arizona Minnesota South Carolina

California Mississippi Texas

District of Columbia Missouri Utah

Florida New York

Iowa North Carolina

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Variations of State Unemployment Insurance Tests

State Test Colorado ACIdaho ACIndiana A – Part of B – CKansas ABMichigan Economic Reality TestMontana ACOhio A – Part of B – C

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Variations of State Unemployment Insurance Tests

State Test

Oregon AC

Pennsylvania AC

South Dakota AC

Virginia AB or AC

Wisconsin Unique 8 Factor Test

Wyoming AC

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Possible Industries With Worker Classification Issues Building and construction industry

Trucking industry

Computer industry

Automobile industry

Legal industry

Taxicab industry

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Construction Industry Case Study 2

Facts Jared Jones – Experience tile setter

Oral agreement with corporation to perform full-time services at construction sites

Uses his own tools and performs services in order designated by the corporation

Corporation supplies all materials, makes frequent inspections of work

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Construction Industry Case Study 2 (Cont)

Facts

Jared gets paid on a piecework basis

Company carries workers compensation on him

He doesn’t have a place of business

Performs similar services for other customers

Either party can terminate the services at any time

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Construction Industry Case Study 2 (Cont)

What is Jared Jones?

Employee or

Independent Contractor

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Construction Industry Case Study 3

Facts

Freddy Thomas is an electrician who submitted a job estimate to apartment complex for electrical services

$16 per hour @ 400 hours

He will receive $1,280 every 2 weeks for 10 weeks

Not considered payment by the hour

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Construction Industry Case Study 3 (Cont)

Facts Freddy can work more or less than 400 hours to get job done.

He will receive $6,400 for the job

He performs electrical services for other companies obtained by advertising

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Construction Industry Case Study 3 (Cont)

What is Freddy Thomas?

Employee or

Independent Contractor

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Auto Industry Case Study 4

Facts

Susan Bachman performs auto repair services for auto sales agency using their space

She uses her own tools, equipment, and supplies

She seeks out business from insurance adjusters and other individuals and does all of the work that comes to the sales agency

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Auto Industry Case Study 4 (Cont)Facts Susan hires and discharges her own helpers

Determines her own and her helpers working hours

Quotes prices for repair work, makes all necessary adjustments

Assumes all losses

Receives as compensation for her services, a large percentage of the gross collections from the auto repair shop

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Auto Industry Case Study 4 (Cont)

What is Susan Bachman?

Employee or

Independent Contractor

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Auto Industry Case Study 4 (Cont) What are Susan’s workers?

Employees or

Independent Contractors

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Taxicab Driving Industry Case Study 5

Facts

Dexter Manning rents a cab from Speedy Cab Co for $150 per day

He pays all costs of maintaining and operating the cab

Dexter keeps all fares that he receives from customers

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Taxicab Driving Industry Case Study 5(Cont)

Facts

Dexter uses Speedy Cab’s two-way radio communication equipment

Speedy Cab’s dispatching services

Speedy Cab’s advertising

These items benefit both Speed Cab Co. and Dexter Manning

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Taxicab Driving Industry Case Study 5 (Cont)

What is Dexter Manning?

Employee or

Independent Contractor

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What Triggers An IRS Worker Classification Examination?

The employee (worker) files Form SS-8 requesting a ruling

The business issues an “extraordinarily high number” of 1099-MISC forms

The business issues 1099-MISC forms with “high dollar” amounts

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What Triggers An IRS Worker Classification Examination?

The state unemployment agency conducts an audit and shares information with IRS

IRS performs “project audits” on a certain industry

Informant tips off IRS or DOL and provides audit lead (Be cautious of disgruntled former employees or vengeful competitors)

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2 Types of Worker Classification Audits

Employment tax exams

Income tax exams

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Examination Location

IRS wants to conduct audit at taxpayer’s place of business

Taxpayer’s representative wants it off the business premises

Never allow examiner to conduct exam on business premises! Easy to “misinterpret” events observed/overheard

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Voluntary Worker Classification Settlement Program

VCSP allows employers to voluntarily reclassify workers as employees for future tax periods

Provides partial relief from federal employment taxes

Nearly 1,000 employers have applied as of February 2013

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Who May Qualify for VCSP?

Businesses, tax-exempt organizations, and government entities may qualify

Must currently be treating workers (or a class or group of workers) as independent contractors or other nonemployees

Must have consistently treated workers as independent contractors or other nonemployees

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Who May Qualify for VCSP? Must have filed all required Forms 1099 for workers

the previous three years (temporarily waived thru 6/30/13 – See Announcement 2012-46)

May not currently be under employment tax audit by IRS, or under classification audit by DOL or State agency

Taxpayer previously audited for classification must be in compliance with audit results

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Who May Qualify for VCSP? May not currently be contesting the classification of

workers in court

If you qualify apply using Form 8952, Application for Voluntary Classification Settlement Program (at least 60 days before you want to begin treating workers as employees)

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What Does It Cost for VCSP?

Accepted employers will pay an amount equaling to just over 1% of wages paid to reclassified workers for the past year

No interest or penalties will be due

Employer will not be audited on payroll taxes related to these workers for prior years

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What Does It Cost for VCSP? Employers applying for VCSP under the temporary

relief program (Announcement 2012-45) may qualify even if Forms 1099 were not filed

Will pay a slightly higher amount than 1%, plus some penalties, and must file any unfiled Forms 1099 for workers that will be reclassified

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Section 530 Safe Haven Protection

Section 530 of the Internal Revenue Act of 1978 provides a “safe haven” for companies who use independent contractors

Passed in 1978 – To provide relief for businesses that used independent contractors in good faith

Intended to last only one year until Congress evaluated and passed legislation defining independent contractors. 35 years later Congress is still evaluating the matter!

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Section 530 Safe Haven Protection

Section 530 provides the new IRS Classification Settlement Program (CSP)

CSP establishes procedures for early and timely resolution of cases, reducing taxpayer burden

It is “Mandatory” that examiner offer a CSP to taxpayer if they qualify for Section 530 relief

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3 Qualification Requirements For Section 530 Relief

1) Reporting Consistency

2) Substantive Consistency

3) Reasonable Basis

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Reporting Consistency

All federal tax returns and information returns must be filed by the business on a basis consistent with the business’ treatment of the individual worker not being an employee.

Test must be applied to each worker separately since Form 1099-MISC may be filed for one worker in a class, but not another worker in same class. Treat these workers as separate classes.

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Substantive Consistency

Business must have consistently treated similarly situated workers as independent contractors.

If business or predecessor treated a similarly situated worker as an employee, Section 530 relief is not available.

Test must be applied to each class of workers.

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Reasonable Basis Business must have some reasonable basis for not

treating workers as employees

Reasonable basis can consist of reasonable reliance on several items

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Reasonable Basis

Judicial Precedent Published Ruling Private Letter Ruling Technical Advice Memorandum Results of past audits Long standing recognized practice of a significant

segment of the industry

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Are Section 530 Requirements Met?

If business clearly meets the reporting, substantive consistency requirements, and satisfies the reasonable basis test

Section 530 requirements are fully met and business is eligible for “Safe Haven” relief

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Are Section 530 Requirements Met?

If the business does not meet Section 530 relief provisions, the IRS examiner will proceed to determine if workers are independent contractors or employees using the Common Law rules (20 Factor Test)

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When Does CSP Get Offered?

If examiner determines that a reclassification issue does exist, examiner will consider whether or not CSP applies.

If examiners proposal is to reclassify workers as employees and business has timely filed Forms 1099

Examiner should make a CSP offer to taxpayer

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When Does CSP Get Offered?

It is mandatory that examiner present a CSP offer if all requirements are met

Taxpayer can accept or decline offer

Businesses that have not filed the required information returns are not entitled to CSP offer

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Cases Qualifying for CSP

Form 941/940 Non-Filers – Eligible for CSP if Forms 1099-MISC were filed

Statutory Employees – If business timely filed Forms 1099-MISC

Household Employees – If employer timely filed Forms 1099

Corporate Officers – If business treats corporate officer as IC and timely filed Form 1099-MISC

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Cases Excluded From CSP

Cases with Other Issues - CSP only available for worker classification. Not available for dividend or wages issues with S Corp reasonable compensation

Prior Closing Agreement – Taxpayer who has entered into a prior CSP is not eligible

CSP Non-Compliance – Business that isn’t in compliance with existing closing agreement

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Cases Excluded From CSP

Prior Coverage – Not available to a business that incorporated after the closing agreement was signed by principals, owners of the prior business that had worker classification issues.

Three Party Arrangements – No CSP is available if the correct employer can’t be identified

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Cases Excluded From CSP

Information Returns other than Forms 1099 Not available for any returns beside 1099s. Not available for K-1s if workers were treated as partners

Wage Issues – Not available for officer - shareholder compensation issues

Administrative or Judicial Proceeding – If prior year employment tax returns are part of an administrative or judicial proceeding No CSP

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Cases Excluded From CSP

Litigation – No CSP offer available if worker classification issue is resolved through litigation

Criminal Investigation – No CSP if tax return is part of an on-going investigation

Claims – No CSP for settlements available for cases closed prior to CSP implementation

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Cases Excluded From CSP

Government Employers – CSP not available to state and local government employers

Taxpayer No Longer in Business – CSP is only available to taxpayers still in existence. Closed business don’t qualify

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Taxpayer’s Rights To CSP Offers

Taxpayer participation in CSP is voluntary

Taxpayer can accept or reject offer at any time during the examination process

Declining to accept CSP offer allows taxpayer to retain all rights to an administrative appeal and all rights to judicial review

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Conclusion

IRS audit process is designed to select returns with a high probability of error for audit

Being selected for audit does not indicate there is a problem

A “No Change” in a worker classification examination is possible

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