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I just found that it is illegal for Employer to give form 1099 to workers who could potentially be classified as Employees. Also, Employer can end up being punished with imprisonment and/or heavy monetary penalties by IRS and EDD for such violation.

So I am left with four options:

  1. Terminate business; Hope that eventually statutes of limitation kick in and no one ever finds out about this potential worker misclassification. This means that I would have to look for new job myself as well.
  2. Keep issuing form 1099. However, from now on pay closer attention that workers indeed maintain their independent contractor status (e.g. I would have to make sure that I don't provide supplies and tools, allow them to choose work hours freely ...).
  3. Simply start to classify these workers as Employees without giving heads up to IRS, EDD or any other government agency.
  4. Participate in the IRS Voluntary Classification Settlement Program.

I am trying to realize risks for each option and if I have missed any other options.

Personally, I would prefer option #3, but I think that is quite risky choice. If I understand Voluntary Classification Settlement Program's eligibility criteria correctly, then I would not be eligible to enroll in this IRS program if IRS somehow found out about this violation before I had a chance to make voluntary disclosure with IRS. Is my understanding right about this and are there any other risks with this choice?

In that case, I am left with option #4. However, it seems that EDD does not participate in this IRS program. The worst case scenario could be that if I tried to fix the misclassification with IRS, then IRS might still notify EDD and I would still have to pay EDD penalties and would lose all tax deductions that I claimed after paying their "salaries". Is my understanding right about this and are there any other risks with this choice?

P.S.

  1. This is low margin business with 3 employees.
  2. I am not abusing workers in any way. They get paid holidays. I am paying more than minimal salary and they obviously can keep all the tips.
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    It seems to me that the risks here are large enough that your next move should be to talk to a tax professional. – Ben Miller Apr 15 '16 at 12:55

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