Local government can’t have IRS problems, right? Wrong!

If you are a mayor, commissioner, trustee, or other local official, you may feel of all the problems you have, IRS is the least of them. After all, you don’t generate income and pay no taxes.

Not necessarily so! IRS takes a lot of money from local government in the form of payroll withholdings, and mistakes on your part can be very costly.

What is the biggest mistake you can make? It might surprise you that your greatest liability is treating a person as a contractor when IRS says he or she should be treated as an employee.

Sure, your unit can also get into trouble by withholding wrong amounts, filing forms late, and other technical problems. Those are primarily the concerns of fiscal officers, and they are not trivial.

However, as a local government executive, your biggest liability is misclassifying contractors.

You may feel, what could be easier? If we just pay the person “on contract” there should be no withholding and no problem. Too bad it is not that simple! IRS may not accept your definition of a “contractor.” It is their definition that counts, not yours.

Here is a link to the IRS definition of a contractor versus and employee. This is the definition you must follow!

IRS Definition: Independent Contractor vs. Employee

You may also feel there is little chance IRS will audit a unit of local government, especially a small one. Wrong again. IRS knows that local government is a rich source of payroll withholdings. A unit that is small by government standards may be large by private sector standards. IRS can often get a lot more payroll tax out of a city, county, or township than from a local business.

The IRS has set up a special office to ensure federal tax compliance by local government. Click here for the link.

Finally, you may feel withholdings are not important as long as the employee pays his or her taxes. Again wrong. When IRS audits your unit, it does not necessarily audit the returns of your employees. IRS will ignore their tax situation and focus on the withholding you should have remitted. It will not matter if you can prove the taxes were paid by the employee. IRS will still want the withholdings from you, and they will not hesitate to add penalties.

If you have questions about this article, please contact us at: Coonrod@CoonrodCPA.com

Revised May 5, 2010.

This article is intended to provide information of general interest to local government officials in Indiana . The information is not guaranteed to be applicable or appropriate in particular circumstances. Local officials should consult competent professionals before acting on any information contained in this article. We are not attorneys. Advice of a legal nature should be sought only from qualified attorneys.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.