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Text File | 1996-11-06 | 17KB | 377 lines

@165 CHAP 9

           ┌─────────────────────────────────────────┐
           │  INDEPENDENT CONTRACTORS OR EMPLOYEES?  │
           └─────────────────────────────────────────┘

As pointed out elsewhere in this program, there are some
major tax and other advantages in hiring independent
contractors 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. Unfortunately,
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
      directions 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
      indicates 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
      business 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
      worker 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
      indicative 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
      furnishes significant tools, materials and other
      equipment, it strongly points to an employer-employee
      relationship.

    . SIGNIFICANT INVESTMENT.  If the worker invests
      significantly in facilities that are not typically
      maintained 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
      independent 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 persons
      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 general
      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
      dim-witted Revenue Agents.)

    . RIGHT TO DISCHARGE.  The right of a company to
      discharge 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
      incurring 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
employees (such as secretarial work, for example), and
whether 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 careful
about hiring someone as a so-called independent contractor.
The consequences of being wrong can be severe, and few
people ever suspect the enormous risks in using independent
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 small business
@IF121xx]owner, even though @NAME is incorporated.
@IF120xx]owner of @NAME, a @ENTITY.
@IF113xx]
@IF113xx](Even though, as an LLC, your company has limited liability.)

The IRS "business plan" has recently 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
assessment was $68,000, according to one report, and some 90%
of the IRS audits found misclassified independent contractors
working for the firms that were audited.

           ┌─────────────────────────────────────────┐
           │ HARD FACTS:  During the period from 1988│
           │ to 1995, the Internal Revenue Service   │
           │ performed 12,983 employment tax audits, │
           │ which resulted in re-classification of  │
           │ some 527,000 workers as employees. Their│
           │ employers were assessed $830 million in │
           │ back taxes, penalties, and interest.    │
           └─────────────────────────────────────────┘

Some of the things (none of them good) that can happen if
your "independent 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
      contractor, 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).
      Furthermore, 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
      penalties 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.

Needless to say, if you try to hedge your bets by covering
your "independent contractors" under workers' compensation
and your qualified retirement plans, you are also virtually
admitting that they are actually employees.

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 "independent
contractors" shown on such forms should in fact be considered
employees.

   ┌───────────────────────────────────────────────────────┐
   │BOTTOM LINE:  Don't let yourself be stampeded into the │
   │independent  contractor game  by friends and  business │
   │associates who tell you how  simple and easy  it is to │
   │avoid paying all those payroll taxes---unless  you are │
   │planning to become a part of the subterranean economy. │
   └───────────────────────────────────────────────────────┘


   "SAFE HARBOR" EXEMPTION FOR CERTAIN COMPANIES TREATING
  WORKERS AS INDEPENDENT CONTRACTORS SINCE 1977 OR EARLIER
  ────────────────────────────────────────────────────────
Section 530 of the Revenue Act of 1978 provides an exemption
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 contractor for tax
purposes.  This exemption, which is sort of a "grandfather
clause," is available only if all the following 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.

(CAUTION:  In 1986, Congress amended the Section 530 safe
harbor, eliminating its protections for the engineering and
computer industries.)

Obviously, this safe harbor exception will not be of much
use to companies that did not begin business or begin
hiring 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 imposed
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 treating 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
           ────────────────────────────────

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 every
case, and a number of these steps, if implemented, may
require some significant changes in the way you do business.
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,
     which 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
employee of the general contractor.  The state has started
cross-checking, by computer, all 1099 forms filed by
licensed 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 to
require withholding on payments made to nonresident
independent contractors for services performed in California,
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.

@CODE:EN