A common source of payroll tax disputes is when the IRS disagrees with an employer's decision to classify a worker as an independent contractor as opposed to an employee.
In some situations, it may be fairly clear that a worker is an independent contractor, such as in the case of a business's regular plumber coming in from time to time to work on the toilets, sinks or pipes. In these situations, the employer does not have to withhold payroll taxes but may have to provide the plumber a 1099.
However, in other situations, the IRS may believe an employer misused the independent contractor label and thus should have withheld payroll taxes for Social Security and Medicare, as well as for estimated income tax, since the person involved in reality was an employee. Should the employer disagree, this can lead to a tax controversy.
To a large extent, whether a worker is an independent contractor or an employee depends on specific facts and circumstances. As such, should a business in the greater Chicago area have questions about classification or face a dispute with the IRS over the matter, the business should strongly consider speaking to an experienced tax attorney.
However, the general principle which the IRS uses to determine whether a worker is an independent contractor or an employee is to what extent the employer controls the terms of the business relationship as well as the work being done.
To return to the case of the plumber for instance, the plumber is likely an independent contractor since the employer does not care how the plumber does her job. So long as the employer's problem gets fixed, he will pay a reasonable bill and move on. The employer has limited control over both the plumber and her work.