I think it was back when George H.W. Bush was president that there was an effort to create a kinder, friendlier Internal Revenue Service (IRS). With the current budgetary pressures in Washington and the reluctance of Congress to reduce spending or to pass new taxes, there is an effort to make up a part of the shortfall with more collections through increased penalties and enforcement action.

An area where this has taken a vicious turn is the requirement for businesses to issue 1099’s to any person or business (except corporations) supplying $600 or more of services during the year. The 1099-MISC forms are available free of charge and they can be ordered on the website irs.gov.

It is necessary that you obtain the red ink 1099-MISC forms along with transmittal Form 1096 from the IRS versus downloading it. You’re required to furnish the service provider with the 1099 before the end of January and IRS with their copy by the end of February.

The penalty for failure to file a 1099 before the required date or to have missing or incorrect information on it is $100 per instance, up to a maximum of $1.5 million. California has its own penalty of $50 per information return (Form 1099).

A prime area for both federal and state audits is the misclassification of employees as independent contractors. The IRS or the California Employment Developement Department can drop in on a business, ask questions for half a hour and then possibly determine that individuals working for the business are actually employees and that back employment taxes are owed such as Social Security, Medicare, FUTA, UI, and ETT.

Often audits can be triggered by an “employee” filing for workman’s compensation and the state finding out that they were treated incorrectly as independent contractors and no workman’s compensation was paid.

There are several criteria for classification of employees. You will want to refer to IRS publications for the detailed criteria and illustrative examples.

Federal penalties are severe, although a new bill signed by Governor Jerry Brown in October takes the state penalties for worker misclassification to draconian levels. The new law allows the state to assess a civil penalty of $5,000 to $15,000 for the misclassification of a single worker.

If the Labor Commissioner or a court determines there is a pattern and practice of these violations, a civil penalty of $10,000-$25,000 for each violation may be imposed. These penalties can also be levied against a business’s accountant, tax preparer or any paid person that advised them.

The worker classification audits are easy for the federal and state governments to conduct and can reap a bounty of back taxes and astronomical penalties. Be forewarned.