@165 CHAP 9 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � INDEPENDENT CONTRACTORS OR EMPLOYEES? � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� As pointed out elsewhere in this program, there are some major tax and other advantages in hiring independent con- tractors rather than employees to work in your business. Not only do you effect considerable payroll tax savings (no FICA, FUTA or state unemployment tax), but there are fewer administrative headaches, since you don't have to withhold income and payroll taxes from payments to an independent contractor (generally), you don't have to provide workers' compensation coverage for them, you don't have to worry about the Age Discrimination in Employment Act and the Americans with Disabilities Act of 1990 (since both Acts apply only to employees, not independent contractors), and you don't have to cover them in your retirement plan or other employee fringe benefit plans. Too good to be true? Yes, if the people in question don't qualify to be treated as other than employees. Unfortunate- ly, just because you agree with someone you hire that they will be an independent contractor does NOT make it so for tax and legal purposes. Thus, before you attempt to hire anyone to work for you as an independent contractor, you need to take a hard look at whether the IRS or a court of law would consider that person to be your employee, rather than an independent contractor. The IRS uses the following 20 factors to test and evaluate whether or not a person is an employee: . CONTROL. If a worker is required to comply with di- rections about when, where and how the job is to be done, he or she is usually an employee. (This is the key factor to consider.) . TRAINING. Where the owner trains a worker, it indi- cates that control is being exercised over the means by which results are to be accomplished. Ergo, the worker is an employee. . WHO MUST RENDER SERVICES? If the services must be rendered personally, it suggests that the employer controls both the means and the results of the work. . INTEGRATION. When the continued operation of a busi- ness depends on the rendition of certain services by the worker, those services are necessarily subject to a certain amount of control by the business. . HIRING, SUPERVISING & PAYING ASSISTANTS. Control is exercised if the company hires, supervises and pays assistants of the worker in question. . CONTINUING RELATIONSHIP. A continuing relationship between the worker and company is indicative that an employer-employee relationship has been created. . HOURS OF WORK. If set hours of work are established, it suggests control, and therefore is indicative that an employer-employee relationship exists. . FULL TIME REQUIREMENT. If the worker is required to devote full time to the one "client," it strongly indicates that the "client" is exercising control over the worker's time, and is thus his or her employer. . WORKING ON EMPLOYER'S PREMISES. Control is indicated if the work is performed on the company's premises. . ORDER OR SEQUENCE OF WORK IS SET. If the worker is not free to choose his or her own pattern of work, but must perform services in the order or sequence set by the company, it is indicative of control by the company. . ORAL OR WRITTEN REPORTS. A requirement that the wor- ker must submit regular oral or written reports to the company suggests control by the company. . PAYMENT BY THE HOUR, WEEK, OR MONTH. Payment by the hour, week or month usually (but not always) is in- dicative of an employer-employee relationship. . PAYMENT OF BUSINESS/TRAVELING EXPENSES. Payment of the worker's business and/or traveling expenses gives the appearance that the worker is an employee. . FURNISHING OF TOOLS & MATERIALS. If the company fur- nishes significant tools, materials and other equip- ment, it points to an employer-employee relationship. . SIGNIFICANT INVESTMENT. If the worker invests sig- nificantly in facilities that are not typically main- tained by employees (such as an office rented at fair market value from an unrelated party) he or she will usually be considered to qualify as an independent contractor. . RISK OF PROFIT OR LOSS. If a worker can make either a profit or a loss (in addition to the profit or loss ordinarily realized by employees), it indicates in- dependent contractor status; if he or she cannot, then the worker is an employee. . WORKING FOR MORE THAN ONE FIRM. If a worker performs significant services for a number of unrelated per- sons at the same time, he or she is an independent contractor, not an employee. . MAKING SERVICES AVAILABLE TO THE GENERAL PUBLIC. A worker is considered to be an independent contractor if making his or her services available to the gener- al public on a regular and consistent basis. (Just printing up some business cards won't do the trick, however, and will not fool any but the most thick- skulled Revenue Agents.) . RIGHT TO DISCHARGE. The right of a company to dis- charge a worker indicates the worker is an employee. . RIGHT TO TERMINATE. A worker is an employee if he or she has the right to end the relationship with the company at any time he or she wishes without in- curring any liability. Other factors that the courts may look at in deciding this issue include a determination of whether the kind of work the person does for you is of a kind normally done by em- ployees (such as secretarial work, for example), and whe- ther the worker is a licensed professional of any type (such as a lawyer, architect, etc.). Unless you are quite clear that the work relationship will not be considered that of employer-employee, be VERY care- ful about hiring someone as a so-called independent con- tractor. The consequences of being wrong can be severe, and few people ever suspect the enormous risks in using in- dependent contractors until it is too late. A state or federal audit that disallows independent contractor status can mean personal financial disaster for you as a business @IF121xx]owner, even though @NAME is incorporated. @IF120xx]owner of @NAME, a @ENTITY. The IRS "business plan" for 1993 is focused heavily on the independent contractor vs. employee issue, and the IRS is generating large amounts of revenue from this issue on tax audits. In recent audits, the average reclassification as- sessment was $68,000, according to one report, and some 90% of the IRS audits found misclassified independent contrac- tors working for the audited firms. Some of the things (all bad) that can happen if your "in- dependent contractor" is held to be an employee include the following: . You are liable for not only the employer payroll taxes you failed to pay, but also a portion of the employee taxes you failed to withhold (income taxes, FICA). If you treat someone as an independent con- tractor, you should report payments of $600 or more to that person on IRS Form 1099-MISC. If you do, and the IRS later determines that the person was really an employee, the back taxes you are liable for are limited to: (a) the employer payroll taxes, (b) 20% of the employee's FICA tax you failed to withhold, and (c) income tax withholding equal to only 1.5% of the wages you paid the person. But if you do NOT file a Form 1099-MISC and the person is re-classified as an employee by the IRS, you are liable for 40% of the employee's FICA tax and income tax withholding equal to 3% of the wages (twice as much as where you have filed the 1099-MISC). Fur- thermore, there is now a $100 penalty for failure to file the 1099-MISC and you will owe interest on the taxes due. You may also be assessed other penal- ties if you did not have a reasonable basis for treating the person as a non-employee and may be liable for up to 100% of the FICA and income tax which you failed to withhold. . If the person is hurt on the job and you have not provided workers' compensation coverage, you could be liable for extensive legal damages. . If your firm has a qualified retirement plan and you have not contributed to the plan on behalf of the person because he or she was not thought to be an employee at the time, the retirement plan could be disqualified for tax purposes for failing to cover the employee in question. Be aware that if you do take the precaution of filing the 1099-MISC form, you will be inviting an IRS investigation, if not a full-blown audit. The IRS has recently instituted a major "search and destroy mission" for following up on 1099-MISC filings to determine if the so-called "independ- ent contractors" shown on such forms should in fact be considered employees. 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� 쿍OTTOM LINE: Don't let yourself be stampeded into the � 쿶ndependent contractor game by friends and business � 쿪ssociates who tell you how simple and easy it is to � 쿪void paying all those payroll taxes---unless you are � 쿾lanning to become a part of the subterranean economy. � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� "SAFE HARBOR" EXEMPTION FOR CERTAIN COMPANIES TREATING WORKERS AS INDEPENDENT CONTRACTORS SINCE 1977 OR EARLIER 컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴 Section 530 of the Revenue Act of 1978 provides an exemp- tion or "safe harbor" from reliance on the 20 common law factors that are ordinarily used to determine if a worker is to be treated as an employee or an independent contrac- tor for tax purposes. This exemption, which is sort of a "grandfather clause," is available only if all the follow- ing conditions are met: . Since December 21, 1977, the hiring company has consistently treated all similar workers as independent contractors, not as employees; and . the hiring company has filed all required IRS forms relating to such workers (Form 1099-MISC, for example); and . the hiring company has a reasonable basis for treating the workers in question as independent contractors, because of the existence of any ONE of the following three factors: - a prior judicial precedent; or - reliance upon a prior IRS audit; or - long-standing industry practice of treating such workers as independent contractors. Obviously, this safe harbor exception will not be of much use to companies that did not begin business or begin hir- ing persons as independent contractors before December 21, 1977, but if your company has been around that long and meets the above requirements, this can be a very important shield against devastating liabilities that might be im- posed on you as a result of an IRS audit, where the persons your firm treats as independent contractors do not qualify under the 20-factor test. If you meet the above "safe harbor" requirements, it will be crucial that you continue to timely file Forms 1099-MISC and be consistent in treat- ing all such workers as independent contractors, in order to maintain your eligibility to utilize the Section 530 exemption. WAYS TO AVOID HAVING INDEPENDENT CONTRACTORS TREATED AS EMPLOYEES 컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴 There are a number of steps you may be able to take to make a stronger case for someone who does work for you being treated as an independent contractor. Obviously, not all of the following steps will necessarily be feasible in ev- ery case, and a number of these steps, if implemented, may require some significant changes in the way you do busi- ness. But if you can follow most of the suggestions below with regard to a given worker, you should at least improve your odds against having that worker reclassified as an employee. . Have a written agreement, signed by both parties, that makes it clear that the company doesn't have the right to control the methods or procedures for the worker to accomplish the work contracted for. Include language in the agreement that it is the worker's obligation to pay income and self-employment taxes on amounts earned, and that he or she will receive a 1099 reflecting amounts earned, if $600 or more. . Try to avoid setting working hours by day or week. It would be acceptable to specify starting and completion dates for the work. . Make it clear that if additional workers are needed to help, the contractor will hire and pay them. . If tools are needed, the contractor should provide and select them for the job. . The arrangement should make it clear that the contractor is not limited to working exclusively for you, but is free to take on other work from other customers. . Compensation should be based on what work is performed rather than the time spent to do it. This may require careful estimates so that the worker is fairly paid, and not overpaid for the work done. . Avoid providing office space to the contractor on a regular basis. . Let the workers be responsible for their own training, if that is possible. . Each worker should be advised, in writing, to provide for their own liability, workers' compensation, health and disability insurance coverage. . Costs such as meals, transportation, and clothing should be built into the contract price of the job, rather than being billed directly to your account. . It should be clear in your agreement with the worker that he or she can't be fired, and can't quit. Their job is to fulfill a given work contract. . Don't give the worker other work to "fill in" during downtime. This may mean, of course, that you will have to pay the workers somewhat more for the work done than you otherwise would, if you wish to keep them happy. . Don't EVER pay bonuses to a person you treat as an independent contractor. @CODE: CA @CODE:NF Note that in California, the rules are even tougher. Under California law, any construction worker who does not hold a valid California contractor's license is treated as an em- ployee of the general contractor. The state has started cross-checking, by computer, all 1099 forms filed by li- censed contractors, and if the subcontractor on a 1099 is not a licensed contractor, the EDD will treat the general contractor as an employer and hold it liable for payroll and withholding taxes with regard to the unlicensed payee. NOTE ALSO: California's Franchise Tax Board has begun (in 1991) requiring withholding on payments made to nonresident independent contractors for services performed in Cali- fornia, IN ALL INDUSTRIES. Withholding is required with regard to any nonresident payee for whom a Form FTB 1099 information return is given, and the tax is to be remitted on Forms FTB 591 and 592. 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� �"Hire an independent contractor, go to prison."� � -- Motto of the California Franchise Tax Board� 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� @CODE:EN