IRS Eyes Consultants

by Mike Godfrey, Tax-news.com, Washington

03 July 2001

The Internal Revenue Service recently announced that it would be keeping a close eye on US based consultants, and issued auditors with specific guidelines on how to audit them. The Bureau of Labor Statistics estimates that at least 8.5 million people work as consultants in the States, accounting for 6.7% of the country's workforce. That number is growing due to the faltering US economy, the rise in entrepreneurship, and various other socioeconomic factors, and the IRS wants to make sure that it doesn't get left behind.

However, it is not going to be easy. 'The IRS has quite a challenge on its hands,' said Krish Krishnan, CEO of NetCompliance, Inc. 'The consulting industry is very broad and billions of dollars are spent each year by companies outsourcing work to consultants and contractors. This IRS decision could have a chilling impact on businesses which outsource, because they run the risk of not knowing whether or not their practices are in compliance with IRS auditors.'

The IRS has stated that it is concerned that many companies are laying off workers and then hiring them back as consultants, thus pushing them off the payroll, and allowing the company to cut benefit costs and shift payroll taxes to the worker. There are also benefits in this set up for the independent contractor, in that they report expenses on Schedule C (as opposed to employees, whose expenses are reported on Schedule A, and are only deductible if they exceed 2% of gross income). Contractors are also subject to fewer limitations than high income tax paying employees.

In order to ascertain whether a worker is a consultant or an employee, the IRS has told its auditors to be alert to those that take family or companions on business trips, to pay particular attention to the limitation of meals and entertainment while travelling, to sample invoices or contracts and cross check the income and reimbursed expenses, and to determine the employer/employee status of consulting firms that subcontract work out to others.

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