In the 1980s, right after I graduated from veterinary school, I borrowed a pile of dough at 11 percent and bought a big practice. The previous owner was a great old guy. He shared two pieces of advice with me about what I had to do to keep labor costs under control.
First, he said, anybody who wasn't a veterinarian was really a bookkeeper. Second, any veterinarian who wasn't full time was almost certainly an independent contractor.
If I hadn't already been a lawyer at the time, I might have been confused by those suggestions. However, I understood exactly what he meant. What doc was suggesting were guaranteed money-savers.
Payroll tax in the good ol' days
Regarding the bookkeeper recommendation, he was implying that I could cultivate huge savings if I listed all nondoctors as office workers for unemployment insurance purposes. Back then, the scheme probably would have worked out fine. Insurance carriers almost never conducted on-site audits. And if you did happen to get caught, all they were likely to do was to throw you into the state insurance fund pool for a couple of years.
The small increase in premiums from a trip to the pool would be minimal. Especially compared with the giant premium savings accrued after years of categorizing technicians and assistants as workers whose biggest workplace hazard might be a paper cut.
And the independent contractor ruse? Another big money-saver. If you called part-time veterinarians (we had plenty in those years) "independent contractors," your practice could avoid paying Social Security payroll tax on them. You could probably skip unemployment insurance premiums and workers' compensation payments on their behalf as well. What a deal! All you had to do was print out a 1099 form for part-time doctors and you could save an instant 10 percent to 30 percent.
But woe is me. After years of knowing I've never been able to get away with anything my whole life, and of course, being an inherently honest guy in general, I elected to call a technician a technician and pay the freight on all part-time doctors.
It's expensive being honest.
Uncle Sam is watching
Fast-forward to 2011. Today you don't have to be a goody two-shoes to justify full compliance with payroll-tax laws—you just need a desire to stay out of prison. Payroll-tax enforcement has gone from spotty and sporadic to software-based and space age. Today, if you're inclined to cheat, you barely stand a chance. Let me give you an example of just how Big Brother has grown in tax enforcement with an example from healthcare:
My son recently moved from New York to Massachusetts after graduating from college. He hadn't been with his company long enough at the time of the move to qualify for its health insurance program, so we kept him on our policy for a few months under COBRA (until his probationary period ended and he had his own). When he went to file his 2010 Massachusetts income tax return, the state would not accept it without a stiff penalty unless he included information about where his health insurance had come from during tax year 2010. The state wanted the name of the company, his policy number and the Federal tax ID number of the company providing the coverage. The moral of this story is: As inquisitive as 21st century government is, don't even think about trying to cheat on employee payroll taxes or workers' compensation insurance.
Reclaiming taxes of the past
The rest of my column this month is devoted to enlightening readers about an intriguing new Internal Revenue Service program that reclaims the lost souls of veterinarians and other businesspeople who've cheated on their payroll taxes in the past. In mid-September, the IRS announced a new incentive for small businesses—including veterinary practices—to come clean on prior mischaracterization of employees as "independent contractors." Under the new regulations, Treasury will permit firms to reclassify independent contractors who should've been considered employees for payroll tax purposes in prior years. If you notify the IRS that your practice's characterization of employees was incorrect, you'll pay a small penalty instead of ponying up all the unpaid payroll taxes (FICA, Medicare and so on), which were avoided through the original improper classification.
Two important points to think about when considering the government's offer of quasi-amnesty: First, there may not be any analogous program in your state, so uncollected state payroll taxes may still be due and penalties may be associated with the improper classification when it is revealed. U.S. and state tax authorities are joined at the hip when it comes to tax information sharing.
Also, if the veterinarian/independent contractor has taken advantage of his or her 1099 form status in such a way that he or she only paid income tax on the amount shown on the form, notifying the IRS of the clinic's improper classification may bring even more things to the service's attention. For example, it may alert the IRS to that employee's failure to pay self-employment tax (the independent contractor's version of FICA and Medicare). And again, state tax departments are likely to become aware of any federal investigation of that veterinarian.
Finally, be advised that Treasury is using this offer of reduced penalties for businesses that have wrongly classified employees as contractors as an amnesty of sorts before it starts vigilantly evaluating how businesses classify workers in the future. For example, we could see a more scrupulous screening of veterinary practices filing form 1120S (income tax form filed by subchapter "S" professional corporations) to determine if there's a large expense for "relief veterinarians" or simply for "nonemployee compensation."
Small business corporations have historically enjoyed a relatively small amount of audit activity by the IRS compared with larger firms whose potential audit revenue is greater. However, remember that with each passing year, the hardware and software the government uses to identify potential audit targets becomes more sophisticated. It won't be difficult for the Tax Man to spot cheating through the use of "improper employee classification."
Figuring out what legally constitutes an independent contractor vs. what constitutes an employee is complex, and I've written about it frequently. However, with the government drawing new attention to the subject and the potential cost to veterinary practices involved, I intend to re-visit the topic in the not-too-distant future. In the meantime, talk to your tax preparer and accountant to see where you stand.
Dr. Allen is president of the Associates in Veterinary Law P.C., which provides legal and consulting services to veterinarians. Call (607) 754-1510 or visit firstname.lastname@example.org 
For a complete list of articles by Dr. Allen, visit dvm360.com/allen