As you know, one potential business tax reduction strategy is to hire independent contractors instead of employees. If a worker’s classification fits within the tax law, it’s a legitimate strategy that can save you thousands of dollars.

Sometimes the classification isn’t clear-cut.

You may think you have the independent contractor classification correct, but when the IRS does the audit, you learn that those contractors are W-2 employees. This can cost you a huge sum of money in back payroll taxes.

This happened to the Mescalero Apache Tribe: the IRS hit it with a large payroll tax bill when it reclassified many of the tribe’s contractors as employees. The tribe did us a big favor by making some new law and also highlighted some things that I wanted to share with you about classifying workers as independent contractors.

The law requires that you withhold taxes on the wages that you pay to your employees. If you don’t, you are liable for the withholding and FICA (i.e., Social Security and Medicare) taxes that you neglected to remit to the IRS.

Thus, if the IRS reclassifies your independent contractors as W-2 employees, you are on the hook for the taxes you should have taken from the paychecks.

However, you have a way out of a big chunk of this potential tax bill: if you can show the worker paid the taxes, then you aren’t liable for them. This rule prevents the taxes from being double-paid. For this favorable treatment, which is on a worker-by-worker basis, you need the worker to sign IRS Form 4669, Statement of Payments Received.

Of course, your first step should be to make sure that you classify your workers correctly using the law as your guide. You don’t want an IRS employee classification audit and the headaches that come with it.