Independent Contractor or Employee?
(Note: Whenever you see a water droplet, try a left click. There are many water droplets (aqua spheres or aqua ovals) that allow you to collapse or enlarge the topic)
Note - This page is still being drafted - I have posted this for urgency for some of my clients
Usually the focus of this consideration is entirely too narrow. The management will usually focus on (as does the person offering the services) the compliance with the federal tax laws for payroll taxes. There are other considerations, some of which at times might be more crucial or entail more risk than the payroll tax compliance risks.
Description/Scope: Determining whether there may be a danger the IRS or other party would consider the person working for you to be an employee when the business has treated the relationship as an independent contractor status. Learning the risk of adverse decisions by other parties. This paper does not include the subject of payroll calculation, cutting payroll costs, or the requirements of reporting for employees. Only the reporting requirements for non-employees are covered in this paper.
Purpose: To teach the business owner how to control costs, and risks associated with independent contractor determination.
Who This Applies to: Any business owner or independent contractor.
When to Perform: Before establishing the association with the worker and at a minimum annually.
Special Circumstances: There are special circumstances for some occupations and industries.
Why This Is Important: Being faced with an adverse decision or being sued because of the action of an independent contractor and discovering insurance did not cover the incident or discovering the business owner has business or personal responsibility can be financially devastating.
General Benefits Objectives: Control the events before being faced with an adverse decision.
Note: The general rule with respect to an independent contractor is that the "employer" has the right to control only the result of the person's work. FURTHERMORE - the title or naming applied by either the worker or the employer has no bearing or impact to define the classification. The IRS will LOOK ONLY AT THE DUTIES PERFORMED BY THE WORKER. The IRS will use standard procedures developed by the IRS after many examinations of taxpayers, court cases, state law, common conventions and federal law. The IRS will ask questions of both the worker(s) and the employer and have IRS personnel make personal observations. Furthermore the business making payments to all attorneys, for any healthcare and for any other unincorporated business must file annual reports informing both the IRS and the worker/recipient of the amount paid for the calendar year (only total / gross payments less than $600 and workers who are incorporated {however payments to attorneys and healthcare services are not exempt} are exempt from the filing requirements.)
Backup withholding. You generally must withhold 31% of certain taxable payments if the payee fails to furnish you with his or her correct taxpayer identification number (TIN). This withholding is referred to as backup withholding.
Payments subject to backup withholding include interest, dividends, patronage dividends, rents, royalties, commissions, nonemployee compensation, and certain other payments you make in the course of your trade or business. In addition, transactions by brokers and barter exchanges and certain payments made by fishing boat operators are subject to backup withholding.
This entire site is for educational or informational purposes only. You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional. The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas. At times, information is taken from other sources and is believed to be accurate, but no verification or confirmation is performed. Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply. In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida. Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. .......
Learn how the IRS will decide what the person doing the work should be classified as for federal payroll tax purposes. Learn the risks of adverse decisions. Learn how to take control and how you might lose control. Learn how to monitor the ongoing relationships of workers and the business they perform services for. Learn that there are considerations other than payroll tax and reporting. Learn the IRS is the one making the decision and the challenge, or a worker is the one making the challenge and that your decisions are not relevant. The only relevant factors are certain facts which you will learn to watch for by reading this paper.
IRS Guidelines - Employer Liability/Risks - Employer Safe Harbors
Related Articles:
The status of the worker as employee or independent contractor can affect many aspects of the risks and costs of doing business, or costs and risks of the employee. Here are some thoughts before a final decision is made by the business. Usually, the business is the entity with enough control to make any changes.
Product Liability
Casualty losses - damages to persons or property of the customer of the person hiring the contracting, damages to persons or property of the person rendering the services, damages to persons or property of the person hiring the contracting.
Civil Liability - harassment,
Negligence
Personal liability or personal negligence
Wage and Hour compliance
ERISA Compliance
Personal injury - third parties; vehicular accidents
Personal injury - the person furnishing the services; injury on the job
Internal Revenue Service - Payroll Compliance
Fair Labor Standards Act
Federal minimum wage and overtime purposes. Factors:
1) The extent to which the services rendered are an integral part of the principal's business.
2) The permanency of the relationship.
3) The amount of the alleged contractor's investment in facilities and equipment.
4) The nature and degree of control by the principal.
5) The alleged contractor's opportunities for profit and loss.
6) The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
7) The degree of independent business organization and operation.
National Labor Relations Act
employees have a right to collectively bargain, independent contractors do not. The statute generally adopts the control test - " an employer-employee relationship exists when the employer reserves the right to control not only the ends to be achieved, but also the means to be used in achieving such ends." For an interesting case where a company called their drivers "franchisees" but the National Labor Relations Board held they were employees
Internal Revenue Service - Payroll Compliance
IRS GUIDELINES FOR DETERMINING RELATIONSHIP The IRS has identified 20 factors to be used as guidelines in determining whether sufficient control is present to establish an employer-employee relationship or the person providing the services is an independent contractor. It is important to note that the factors are to be considered only as guidelines and that not all factors will be applicable in every case. All relevant factors are considered in making a determination, and no one factor is decisive. Further, no agreement between the parties, written or otherwise, may control whether or not a factor is to be applied; the IRS will apply all relevant factors depending on the facts of the relationship. IRS Publication 937, Employment Taxes. The IRS has stated that special scrutiny is required in applying the 20 factors to assure that formalistic aspects of an arrangement designed to achieve a particular status do not obscure the substance of the arrangement. Rev. Rul. 87-41, 1987-1 C.B. 296. The 20 factors indicating whether an individual is an employee or independent contractor, set forth in IRS Publication 937, Employment Taxes, and also referred to in Rev. Rul. 87-41, 1987-1 C.B. 296, are as follows:
Law (commentary and citation)
Regs (commentary and citation)
Cases (commentary and citation)
§§§ Law §§§
§274(d)
§§§ Regs §§§
§§§ Cases §§§
This is about Activity Based Taxplanning - maximizing deductions, minimizing cash outlay and maximizing the amount of cash retained and the net worth.
Tax is a subject that many view in order to cut costs. Taxes are a cost just as any other cost. It happens this cost is somewhat intangible and is defined by legislation without a tangible item to view and control. The money is spent and the control of the expenditure is more appropriately administered by someone trained in the law.
IF the business can firmly establish the worker is in fact and in practice an independent contractor, there will be significant savings in tax costs. Furthermore, the costs of compliance and administrative costs will be cut.
This is about Activity Based Costing - methods to cut costs, management accounting, management information systems, decision support systems - in general about being a manager.
Controlling the cost of nonemployees and employees alike will provide management a challenge. The policies and procedures set by the management must be applied to all workers fairly and equitably. Failure to treat everyone the same will increase the risks from litigation.
Monitoring production will help to establish who should be rewarded. Monitoring loyalty to the company will help to establish who should be rewarded. Without incentive, production will fall. Consider many forms for incentives. Non-taxable benefits, flexible work schedules, bonuses, appreciation banquets, compensatory time off, and management's recognition that the worker normally works to care for a family (and does not work for the sake of work) will each serve to cultivate contented and loyal worker willing to work/produce.
From Banking Records
If the IRS is examining your business records, then you will need to locate all the canceled checks for this expense, but only if the Revenue Agent is requesting proof of this category of deductions.
From Customer Records
IF there is anything in the customer records that proves the worker was an independent contract, then copy it and make that a part of the records proving the worker is an independent contractor.
From Signed Documents
Engagement Letters, Job estimates, Independent Contractor Agreement and any other signed (or if not available, use unsigned documents)
From Your Other Business, or Financial Records
From Corporation or Organization Records (meetings, etc.)
Overview the corporate records book and other documents that establish any facts proving the worker is an independent contractor.
Assistance - What to do
Determination of Status
Gather all the information about the facts and circumstances of the worker and business arrangement. The most important fact is for both the business and the worker to be unbiased. Making clear, critical and independent realization of facts will be (perhaps) the most difficult part of this task.
The following will be the steps to determine the facts and therefore whether the arrangement is employee or non-employee. There are some circumstances in which the general treatment of the industry will govern the result. For example
Real estate - the worker/agent is an independent contractor (those working in the office that are not agents may be employees)
Beautician or barber - the worker is an independent contractor (those working in the office that are not beauticians/barbers may be employees)
Forms - Checklists - Etc.
Memorandum - Summary |
This list looks impressive. Please don't memorize these. They don't always apply! For instance, if you look at Per Diem Accountants, at times, they certainly look like employees. There are industry-specific exceptions to this set of rules. It is common in the Accounting profession to pay by the hour. This does not make the worker an employee. There are other professions with exceptions. This is still a gray area in tax law, check with a professional concerning your profession. |
There is a list of questions used by the IRS to gather facts about the status of any worker and the employer. Following is the list of questions. You may click on any blue sphere to expand or collapse the section. The collapsing helps to read the paper, as the individual topics can be read all on one screen. The questions are obvious and the decision from the facts furnished will be intuitive.
What does the business do? INTEGRATION. An employee's services are usually integrated into the business operations because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control.
What does the worker do? INTEGRATION. An employee's services are usually integrated into the business operations because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control.
Obtain any written agreements between the worker and the business. If there is no written agreement then write about the work arrangement.
List differences between the actual working arrangement or work done and the written or agreed upon procedures or policies.
Does the business train or instruct the worker? INSTRUCTIONS. An employee must comply with instructions about when, where, and how to work. Even if no instructions are given, the control factor is present if the business has the right to control how the work results are achieved. TRAINING: An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods and receive no training from the purchasers of their services.
What type?
How often?
What instructions are given about the way the work is to be done?
Provide any written instructions or samples of instructions.
Can the business or does the business have authority to change the methods used by the worker, or how to perform the work?
Is the worker supervised in the performance of the services?
How is the arrangement setup - please expand this it is important. SERVICES RENDERED PERSONALLY: An employee renders services personally. (Employees cannot hire another to perform the services in his or her place. This shows that the employer is interested in the methods as well as the results. CONTINUING RELATIONSHIP: An employee generally has a continuing relationship with an employer. A continuing relationship may exist even if work is performed at recurring although irregular intervals.
To perform and complete a job
To work at a job for an indefinite time
Other?
Is there a routine or a schedule set by the business that must be followed? SET HOURS OF WORK: An employee usually has set hours of work established by an employer. An independent contractor generally can set her own work hours.
Does the worker report to the business?
How often
Why
How - by telephone, in person, in writing, etc.
Obtain report forms used to report to the business
Does the worker furnish a time record to the business? Furnish copies
Tools - Equipment - Supplies - Expenses - Insurance. An employee is normally furnished significant tools, materials, and other equipment by an employer.
List, describe and value those provided by the business
List, describe and value those provided by the worker
Does the business reimburse the worker for any expenses - describe and value
Workers and related helpers - HIRING ASSISTANTS: An employee works for an employer who hires, supervises, and pays workers. An independent contractor can hire, supervise, and pay assistants under a contract that requires him to provide materials and labor and to be responsible only for the results.
Will the worker perform the services?
Are there helpers?
Who hires the helpers? Who pays the helpers? Who approves the engaging of the helpers? Who pays the payroll taxes on the helpers' pay? Who reports the helpers' pay to the IRS? What services do the helpers perform?
Are the services performed on the premises of the business? The worker? Customer? Other? WORK DONE ON PREMISES: An employee usually works on the premises of an employer or works on a route or at a location designated by an employer.
How is the worker paid? PAYMENTS: An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job or on a straight commission.
Does the business guarantee the worker a minimum amount of pay?
Are there any expenses or other advances? An employee's business and travel expenses are generally paid by an employer. This shows that the employee is subject to regulation and control.
Is the worker eligible for pension, bonus, paid vacation, etc.
Who pays the workers' compensation insurance? What workers' compensation report includes the workers' pay?
Are any Medicare or social security amounts withheld from the workers' pay?
How many hours per day does the worker work for this business? FULL-TIME REQUIRED: An employee may be required to work or be available full-time. This indicates control by the employer. An independent contractor can work when and for whom he chooses.
Does the worker have employment with other businesses?
Does the worker set the hours or does the business?
Can the worker be discharged without the business incurring any liability? An employee can be fired by an employer. An independent contractor cannot be fired so long as he produces a result that meets the specifications of the contract. An employee can quit the job at any time without incurring liability. An independent contractor usually agrees to complete a specific job and is responsible for its satisfactory completion or is legally obligated to make good for failure to complete it.
What is the business name of the worker?
Does the worker offer the same services to the general public? An independent contractor is generally free to provide his services to two or more unrelated persons or firms at the same time.
Is a license necessary for the work? Who is licensed?
Does the worker have significant financial investment in offering the services? An independent contractor has a significant investment in the facilities s/he uses in performing services for someone else.
Can the worker incur a loss in performing the services? An independent contractor can make a profit or suffer a loss.
Are any of the services performed away from the business?
The following applies only to salespersons or if the worker provides a service directly to the customer:
Who obtains and/or pays for sales leads?
Does the business establish and maintain the prices, terms and conditions of the sale?
Must the business approve the sale?
Is the worker required to attend sales meetings?
Is there an assigned territory?
Is the presentation in a home or establishment other than a permanent retail space?
What are the products or services?
Did the worker pay for the territory or privilege of selling or serving?
How does the worker find or contact new customers?
Is this selling of life insurance?
Other insurance?
Items of use: Independent Contractor Agreement; W9; W4; W2; 1099 & 1096; In some cases the 941 form and payroll tax deposit coupons; I-9; 945
The following form shall not be used - the reader must consult with an adviser before using this form and may not use this form without the advice of an adviser and appropriate revisions.
INDEPENDENT CONTRACTOR AGREEMENT
This Agreement is entered into as of the [ ] day of [ ], 199[ ], between [company name] ("the Company") and [service provider’s name] ("the Contractor").
If to the Contractor: [name]
[street address]
[city, state, zip]
If to the Company: [name]
[street address]
[city, state, zip]
Any party hereto may change its address for purposes of this paragraph by written notice given in the manner provided above.
IN WITNESS WHEREOF the undersigned have executed this Agreement as of the day and year first written above. The parties hereto agree that facsimile signatures shall be as effective as if originals.
[company name] [contractor’s name]
By:_______________________ By:____________________
Its: [title or position] Its: [title or position]
SCHEDULE A
DUTIES, TERM, AND COMPENSATION
DUTIES: The Contractor will [describe here the work or service to be performed].
[He or she] will report directly to [name] and to any other party designated by [name] in connection with the performance of the duties under this Agreement and shall fulfill any other duties reasonably requested by the Company and agreed to by the Contractor.
TERM: This engagement shall commence upon execution of this Agreement and
shall continue in full force and effect through [date] or earlier upon completion of the Contractor’s duties under this Agreement. The Agreement may only be extended thereafter by mutual agreement, unless terminated earlier by operation of and in accordance with this Agreement.
COMPENSATION: (Choose A or B)
A. As full compensation for the services rendered pursuant to this Agreement, the Company shall pay the Contractor at the hourly rate of [dollar amount] per hour, with total payment not to exceed [dollar amount] without prior written approval by an authorized representative of the Company. Such compensation shall be payable within 30 days of receipt of Contractor’s monthly invoice for services rendered supported by reasonable documentation.
B. As full compensation for the services rendered pursuant to this Agreement, the Company shall pay the Contractor the sum of [dollar amount], to be paid [time and conditions of payment.]
Drug Testing Consent Form
I have applied for employment with [Your Business] in a position that requires me to operate an automobile or truck. As a condition for my application being considered, I understand and agree to undergo substance screening. I understand that if my test results are positive, I shall not be considered further by [Your Business] for a car or truck driver position.
I hereby authorize any physician, laboratory, hospital or medical professional retained by [Your Business] for screening purposes to conduct such screening and to provide the results to [Your Business], and I release [Your Business] and any person affiliated with [Your Business] and any such institution or person conducting the screening, from liability therefor.
Applicant's signature: _________________________________________________
Applicant's name: ____________________________________________________
Date: ______________________________________________________________
These forms may be helpful to you: W9; 1099 & 1096; In some cases the 941 form and payroll tax deposit coupons; I-9; 945
You may have to file information returns to report certain types of payments made during the year. For example, you must file Form 1099-MISC, Miscellaneous Income, to report payments of $600 or more to persons not treated as employees (e.g., independent contractors) for services performed for your trade or business.
Filing Requirements (even for payments to independent contractors)
A person engaged in a trade or business generally is required to file an information return and provide a statement to the recipient if it makes payments of salaries, wages, commissions, fees, non-employee payments for services and other forms of compensation aggregating $600 or more, or payments of interest, rents, royalties, annuities, pensions, and other gains, profits and income aggregating $600 or more, that constitute fixed and determinable income to another person (other than a corporation) in a calendar year. Code Section 6041 and Section 618.2(a)(1)] for payments required to be reported under this section, and Section 618.2(a)(2) for persons who are required to report.
The information return is required to include the amount of the payments and the name and address of the recipient. Code Section 6041(a). The statement provided to the recipient of the payment must include the aggregate amount of the payments required to be shown on the return, and the name, address, and phone number of the information contact of the person required to make the return. Code Section 6041(d).
In the case of payments made other than in cash, the amount required to be reported is the fair market value of the property. Reg. Section 1.6041- 1(e). The recipient is required to furnish his name and address if requested so that the return can be made. Code Section 6041(c). If the recipient is not the actual owner of the income received, the recipient must supply the actual owner's name and address, or he may be liable for penalties for failure to furnish information. Reg. Section 1.6041-5. And Section 618.1
The information return and statement generally is made on a Form in the
1099 series, unless the payment is made to an employee. See Section 618.2(a)(3) for details on which form must be used, and when the returns and statements must be made.Who is required to report
Returns and statements must be made by all persons engaged in a trade or business, as well as officers and employees of the United States. Code Section 6041(a). This includes organizations whose activities are not for the purpose of gain or profit, such as exempt organizations and state and local governments. Reg. Section 1.6041- 1(b). However, returns are required only for payments made in the course of a trade or business. Thus, for example, no return is required for an amount paid by the proprietor of a business to a physician for medical services rendered to the proprietor's child. Reg. Section 1.6041-1(b). Similarly, payments made to household help are not required to be reported, because they are not in the course of a trade or business. Rev. Rul. 56-46, 1956-1 C.B. 560.
Agents and other middlemen generally are subject to the reporting requirements if they exercise oversight and management functions with respect to a payment. Thus, for example, an escrow agent that performs an oversight function with respect to a construction project and makes payments on behalf of the owner and the general contractor of the project, is required to report the payments, whether or not the escrow agent is a bank. Rev. Rul. 93-70, 1993-2 C.B. 294. Similarly, an attorney that makes payments from a client's trust fund account is required to report the payments. PLR 9744002. However, a paying agent who merely passes along payments is not required to report the payments. PLR 9635012. A person such as a nominee or middleman who receives a statement reporting amounts that belong to another person must file a report (and provide a payee statement) reporting the amount as paid to the other person. Instructions for Forms 1099, 1098, 5498, and W-2G (1999).
(a)(3) Filing requirements
Payments subject to this reporting requirement generally are reported on a form in the 1099 series, as follows (Reg. Section 1.6041-1(a)(2)):
(1) Form 1099-G, Certain Government and Qualified State Tuition Plan Payments, is used to report government payments, including agriculture payments, crop insurance, taxable grants, income tax refunds. Instructions for Forms 1099, 1098, 5493, and W-2G (1999).
(2) Form 1099-INT, Interest Income, is used to report interest reportable under these requirements (as well as interest reportable under the interest reporting requirements discussed in Section 618.3). Instructions for Forms 1099, 1098, 5493, and W-2G (1999).
(3) Form 1099-OID, Original Issue Discount, is used to report original issue discount reportable under these requirements (as well as under the interest reporting requirements discussed in Section 618.3). Instructions for Forms 1099, 1098, 5493, and W-2G (1999).
(4) Form 1099-R, Distributions from Pensions, Annuities, Retirement, or Profit-Sharing Plans, is used to report these distributions, as well are military retirement pay and death benefits not paid under a qualified plan. Reg. Section 1.6041-2(b).
(5) Form 1099-Misc, Miscellaneous Income, is used to report other payments, including payments of compensation, commissions, expense reimbursements, and other amounts to non-employees; damages; directors' fees; payments for health care services; prizes paid to non-employees; rents; and attorneys' fees reportable under this provision (as well as those reportable under the separate reporting requirements discussed in Section 618.2(b). Instructions for Forms 1099, 1098, 5493, and W-2G (1999).
However, returns with respect to distributions to beneficiaries of a trust or an estate are made on Form 1041, U.S. Income Tax Return for Estates and Trusts, as discussed in Section 605.11, and payments to employees by employers (other than distributions under qualified plans which are reported on Form 1099) and by a supplemental employee benefit trust to employees are made on Forms W-2, as discussed in Section 605.12 <5> The payee statements that is required to be made to recipients of the payment can also be made using these forms. See Rev. Proc. 99-34, 1999-40 I.R.B. 450, for the rules on using original and substitute forms.
The person making the reports also must file Form 1096, Annual Summary and Transmittal of U.S. Information Returns, or an electronic transmittal form (as explained in Section 618.1). Reg. Section 1.6041- 1(a)(2).
The return generally must be filed with the IRS by February 28 of the year following the year in which the payments are made. Reg. Section 1.6041- 6. However, after 1999, the due date is delayed until March 31 for returns that are filed electronically (as explained in Section 618.9). The statement must be provided to the recipient by January 31. Code Section 6041(d). Returns required under this provision are subject to the rules on electronic filing (discussed in Section 618.9). Reg. Section 1.6041-7.
In general, each person that makes reportable payments is responsible for information reporting for those transactions. However, a successor business entity and a predecessor business entity can agree that the successor will file information returns reporting payments made by both under some circumstances. See Section 618.1 The information return penalties discussed in Section 607.4 apply if the returns and statements required under these rules are not filed and issued. Code Section 6724.
(b) PAYMENTS IN CONNECTION WITH LEGAL SERVICES
Any person who makes a payment to an attorney in connection with legal services in the course of a trade or business is required to file an information return and provide a statement to the payee, whether or not the services are performed for the person making the payment. Code Section 6045(f). See Section 618.2(b)(1) for discussion of what must be reported and Section 618.2(b)(2) for discussion of who must report. However, amounts are not required to be reported under this provision if they are subject to reporting under the rules on payments of $600 or more in the course of a trade or business discussed in Section 618.2(a) (or would be except that they are less than $600) or the rules on wage reporting discussed in Section 605.21(l). Code Section 6045(f)(2)(B).
OBSERVATION: Unlike amounts that are required to be reported under the provisions discussed in Section 618.2(a), amounts paid for legal services must reported even if the payment is a gross amount and it is not known what portion is the attorney's fee.
The information return reporting the payment must include the name, address, and taxpayer identification number (TIN) of the person making the payment, the name, address, and TIN of the attorney to whom the payment was made, the aggregate amount of payments for the calendar year, and any other information required on the form. The information statement provided to the person receiving the payment must contain the same information. Under regulations proposed to be effective after 2000, <9> a payer that is required to make an information return under this section must solicit the attorney's TIN at or before the time the payment is made. If the attorney does not furnish the payer with the TIN, the payment is subject to backup withholding, unless an exception applies (as discussed in Section 111.7). Prop. Reg. Section 1.6045- 5(e).
The information report required under these rules is made on Form 1099-MISC, Miscellaneous Income. See Section 618.2(b)(3) for rules on filing the return.
Nonpayroll income tax withholding must be reported on Form 945, Annual Return of Withheld Federal Income Tax. Form 945 is an annual tax return and the return for 1999 is due January 31, 2000. Separate deposits are required for payroll (Form 941) and nonpayroll (Form 945) withholding. Nonpayroll items include:
All income tax withholding reported on Forms 1099 or W-2G must be reported on Form 945. All income tax withholding reported on Form W-2 must be reported on Form 941, 943, or Schedule H (Form 1040).
Backup withholding. You generally must withhold 31% of certain taxable payments if the payee fails to furnish you with his or her correct taxpayer identification number (TIN). This withholding is referred to as backup withholding.
Payments subject to backup withholding include interest, dividends, patronage dividends, rents, royalties, commissions, nonemployee compensation, and certain other payments you make in the course of your trade or business. In addition, transactions by brokers and barter exchanges and certain payments made by fishing boat operators are subject to backup withholding.
Note: Backup withholding does not apply to wages, pensions, annuities, IRAs (including simplified employee pension (SEP) and SIMPLE retirement plans), section 404(k) distributions from an employee stock ownership plan (ESOP), medical savings accounts, long-term care benefits, or real estate transactions.
You can use Form W-9, Request for Taxpayer Identification Number and Certification, to request payees to furnish a TIN and to certify that the number furnished is correct. You can also use Form W-9 to get certifications from payees that they are not subject to backup withholding or that they are exempt from backup withholding. The Instructions for the Requester of Form W-9 includes a list of types of payees who are exempt from backup withholding. For more information, see Pub. 1679, A Guide to Backup Withholding.
Use the form SS-8
Use the form SS-8 anytime you believe the IRS might question the type of arrangement for the worker.
A very brief summary of the SS-8 [The IRS Opinion] is whether a worker:
- can earn a profit or suffer a loss from the activity
- can be fired by the hiring firm
- furnishes the tools and materials needed to do the work
- is paid by the job or by the hour
- works for more than one firm at a time
- invests in equipment and facilities
- pays his or her own business and traveling expenses
- has the right to quit without incurring liability
- receives instructions from the hiring firm
- is told in what sequence or order to work by the hiring firm
- receives training from the hiring firm
- performs the services personally
- hires and pays assistants
- sets his or her own working hours
- works full-time for the hiring firm
- provides regular oral or written progress reports to the hiring firm, and
- provides services that are an integral part of the hiring firm's day-to-day operations.
What legal tests do agencies besides the IRS use to determine whether a worker is an employee or an independent contractor?
State workers' compensation, unemployment compensation and tax agencies use various tests to determine worker status. Many use the common law right of control test, but emphasize different factors than the IRS. Some use an economic reality test that focuses on whether a worker is economically dependent upon a hiring firm.
Many state unemployment compensation agencies use a special statutory test, also called the ABC test.
This test focuses on just a few factors:
Financial Statement Presentation
The normal presentation for expenses is adequate for non-employee compensation. Classify the amounts paid so that management will have the information it requires for controlling the costs.
Notes to Financial Statements
Not usually an unusual item or not usually any unusual reporting requirement for financial statement purposes.
How to Make Entries
For payments by check or cash debit the expense account and credit the appropriate bank or other account.
What Kind of Records to Keep
Keep all records of employment taxes for at least 4 years. These should be available for IRS review. Records should include:
To notify the IRS of a new business mailing address or business location, file Form 8822, Change of Address.
You can use certain private delivery services designated by the IRS to mail tax returns and payments. If you mail by the due date using any of these services, you are considered to have filed on time. The most recent list of designated private delivery services was published in August 1999. The list includes only the following:
The private delivery service can tell you how to get written proof of the mailing date.
Bookkeeping Methods - Cash, Accrual and Other
How the Business Entity Affects the Recording
Sole Proprietor
Corporation - C & S
Partnerships - General, Limited, Limited Liability Company, Registered Limited Liability Partnership or Company
Trusts
Tax Exempt
As a starter you will find very good information in the IRS SS-8 Form. After reading, printing or saving, press the back button on your browser to return here. Please read the Alerts and Dangers Section of this paper. See the Reporting Section for the compliance with the Tax Code.
Use written agreements - be certain the worker sends you bills, and only pay when you receive the bill, keep all in the required documentation for non-employees and file the annual forms required by the IRS.
Do not treat the worker like an employee.
Alerts & Dangers - Risks
A proper determination of the status of an individual providing services as either an employee or independent contractor is of serious consequence to an employer. If an employer erroneously classifies an employee as an independent contractor and has no reasonable basis for doing so, the employer is liable for taxes determined under the income tax and social security and Medicare tax withholding provisions. Code Section 3509.
Further, the individual person responsible for withholding and paying over the tax to the IRS could be held personally liable for a penalty equal to the amount of taxes that should have been paid. Code Section 6672. The determination may also affect any retirement or benefits plans maintained by the employer. See Planning Article, Dealing with Worker Reclassification -- The Employer's Perspective.
Asset Protection
FIRST: An employer may rely upon judicial precedent or published rulings, or technical advice, letter rulings, or a determination letter from the IRS pertaining to that employer.
SECOND: An employer may rely upon the fact that a past IRS audit (whether or not pertaining to employment tax issues) did not question the employment tax treatment of individuals holding positions substantially similar to those whose status may be at issue. For periods after December 31, 1996, however, for this safe haven to apply, the audit must involve an examination for employment tax purposes of whether the worker involved or workers holding a position substantially similar to that of the worker involved should be treated as an employee.
THIRD: An employer may rely upon a long-standing recognized practice of a significant segment of the industry in which the employer is engaged, whether or not the practice is uniform throughout the entire industry. For periods after December 31, 1996, a significant segment of the industry includes any figure over 25 percent of the industry and may be established as an even smaller percentage depending on the facts and circumstances. A practice that has continued for at least ten years will be considered long-standing, and a shorter period may be considered as such depending on the facts and circumstances. An employer who fails to meet any one of these three safe havens nevertheless may be entitled to relief if some other reasonable basis for not treating the individual as an employee can be demonstrated. Rev. Proc. 85-18, 1985-1 C.B. 518, Section 3.01. The legislative history indicates that Section 530 is to be "construed liberally in favor of taxpayers."
For any period after December 31, 1978, however, even if the employer falls within one of the safe haven situations, relief will not apply if the appropriate Form 1099 has not been timely filed with respect to the workers involved. Rev. Proc. 85-18, 1985-1 C.B. 518, Section 3.02.
If an employer is relieved of liability under Section 530 of the Revenue Act of 1978, any liability for taxes as well as any personal liability for a penalty is no longer applicable. Rev. Proc. 85-18, 1985-1 C.B. 518, Section 3.07.
Thus, an employer who erroneously treats an employee as an independent contractor may escape the liability for taxes and the personal liability for a heavy penalty if there is a reasonable basis for treating that individual as not an employee and that employer has consistently treated the individual and others holding substantially similar positions as other than employees.
Your Defense
As a starter you will find very good information in the IRS SS-8 Form.
Gather the information indicated in the organizer section, of this paper. Retain that documentation and evidence in your files permanently.
Keep all canceled checks
Keep bills from the worker presented to you
Keep copies of all agreements and other documents establishing non-employee status
Be certain to meet all reporting requirements for payments non-employees.
Absolutely. Using a written agreement avoids disputes by providing a written description of the services you're supposed to perform, when they are to be performed and how much you will be paid.
A written independent contractor agreement can also help establish your independent contractor status. Although an agreement by itself is never enough to make a worker an independent contractor, it will help show the IRS and other agencies that both you and the hiring firm intended to create a hiring firm-independent contractor relationship, not an employer-employee relationship.
IRS training materials state that where all the other factors are evenly balanced, a written client agreement may tip the scale to the independent contractor side. But remember, an independent contractor agreement is only useful if it's obeyed. It will be useless if you act and are treated like an employee.
Contact BOB PARRISH CPA PC for a second thought or independent opinion on the issue.
Setup a separate file for those workers that the IRS might question. The file should contain all the information to support the answers to the questions on the IRS SS-8 Form.
Be certain (in writing) the worker understands his or her responsibilities for the taxes, insurance and other items. Be certain the worker fully understand and acknowledges to you the non-employee status and that a form 1099 will be filed with the IRS showing the amount you are paying to the worker. (Note: The requirements for the filing of and reporting of all payments you make for services rendered to your business are covered in a section above - Reports Required )
Know and account for all the risks:
Payroll taxes can be quite high. Add to the taxes, the IRS charges for interest and penalties. However, if the payment you are concerned with is small in your opinion and not a concern, make the decision to treat as employee or non-employee to convenience you. For example, if the payment to the worker is a total of $10, the taxes, interest and penalties would not be so large as to bankrupt you or force you to lose your business. Whatever decision you make be certain you have the documents and evidence to support and prove that you used prudence, business care, due diligence and have a reasonable basis of assurance your decision is correct.
Comply with the Fair Labor Standards Act
Comply with the National Labor Relations Act
Comply with Wage and Hour Act and Regs
Consider the following:
Product Liability
Casualty Losses
Damage caused by the worker to the customer, customer's property or others. (May not be covered in your insurance policy)
Civil Liability
Negligence
Personal Injury or Property Damage, third parties, vehicular accidents, injury to the worker, injury on the job (Probably not covered in your policy, unless you notify the insurance carrier, have a written addendum and pay the extra premium)
ERISA Compliance
Using the type of business entity to shelter you assets not in the name of the business
The choice of business entity will NOT shelter your personal assets. The IRS has the authority to transfer the liability for payroll taxes to any person making the decision to not pay over or not withhold the correct amount of payroll taxes.
Some other types of liability MAY be limited to the business and not transferred to you. HOWEVER - consider that if you become personally negligent, some other manner caused directly or perhaps indirectly the event, or if the court can be convinced that it would be against public policy to shelter your personal assets, then you WILL LOSE. This topic is too voluminous to cover in this paper and is presented to you in another paper.
Here is a reminder for your payroll and personnel files:
Eligibility for employment. You must verify that each new employee is legally eligible to work in the United States. This will include completing the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. You can get the form from INS offices. Contact the INS at 1-800-375-5283 for further information.
Income tax withholding. Ask each new employee to complete the 2000 Form W-4.
Name and social security number. Record each new employee's name and number from his or her social security card. Any employee without a social security card should apply for one.
independent_contractor_or_employ_intro.htm