Happy Tax Day! Monday was the 15th of April and as we know, official “pay up your taxes” day unless you are good with penalties. This is also the time of year that contractors realize their self-employment tax bill. Unfortunately, not all of them have put aside the cash. And some of them never will. Why? Because they will claim they really were employees after all. And the business owners, the non-profit executives and the start-up entrepreneurs will be looking at a penalty filled bill for unemployment, FICA, FUTA and withholding. Wait? What? This is not the meaning of my life!
We have seen it far too many times and while we have helped clients untangle the mess, messes are expensive. Especially IRS messes as they will levy fines.
It’s time for my annual please, please, please classify correctly blog. If you classify someone as a contractor, but your behavior toward that person says “employee,” you can be held accountable not only for unemployment compensation, but also back taxes, federal income tax, Social Security tax and Medicare tax that you should have paid for that employee. Not to mention access to benefits. Of course, you can’t take any of that out of the contractor’s paycheck now, I mean “invoice payment.” It’s too late. It comes out of your pocket. So let’s make sure you know exactly what constitutes a contractor before hiring one.
Remember that classification as an employee or contractor is a legal relationship defined by labor law, not a private agreement between an employer and worker. The Department of Labor and state employment agencies have conveniently defined it for us.
- The employer focuses not just on deliverables and deadlines, but on where, when and how the work gets done. If you give the person a workspace where they’re expected to report to daily, you may have an employee.
- The employer directs how the work is done rather than a frame of the final product. Instructions, hourly rates and a required schedule of time in and time out are all clues this is not a contractor relationship.
- If the employer provides training, uniforms and supplies, an employee is what you have.
- Hiring an independent contractor who used to be an employee is a huge red flag to the IRS as well as other agencies.
- Hiring a contractor for an on-going relationship of 30+ hours a week looks an awful lot like giving the contractor a job in the eyes of the courts. And we have the proof.
Consider this “contractor” who performed bookkeeping services for the employer’s clients. He worked only on jobs assigned to him by the employer and was paid a commission for the work; the commission was based on fees paid by the clients to the employer, and the employer determined the level of fees. The claimant was paid on a weekly basis. He used the employer’s office space, equipment and supplies. The employer reviewed the claimant’s work and returned faulty work to the claimant for corrections before delivering the work to clients.
Analysis: This claimant was not an independent contractor. Several factors lead to that conclusion:
- The claimant’s work was directly integrated in the primary service of the employer. A business hires an independent contractor in order to get expertise it is not in a position to supply for itself, and this business was definitely in a position to supply bookkeeping services, since it was an accounting firm.
- The claimant did not secure his own jobs, as a true independent contractor would, but rather worked on assignments given to him directly by the employer.
- The claimant had no control over the factors of the profit and loss equation, since he had no substantial investment in an independent business enterprise, but rather used the employer’s facilities, supplies and equipment. In addition, the claimant had no role in setting the price for his work or the level of his commission pay, as a true independent contractor would.
- Finally, the employer checked the claimant’s work for accuracy and returned mistakes to the claimant for corrections. In a true independent contractor situation, the “employer” (who would thus be the independent contractor’s customer) would be in no position to make such judgments about the accuracy of details of the contractor’s work. The fact that the employer was so concerned about the accuracy of the claimant’s work before releasing it to the clients strongly indicates that the employer felt it had the primary responsibility for the work in question. A true independent contractor would not only be delivering his work directly to his clients, but would also have the primary responsibility and liability for the work.
Our second “employee” was paid on an hourly basis to serve as a contract office manager; her main duties were to train the employer’s employees on how to do their jobs, monitor the quality of their work, and to perform clerical duties in the office. The claimant had signed a written agreement specifying that she was an independent contractor.
Analysis: An hourly pay rate is strongly indicative of an employment relationship, whereas most independent contractors are paid by the job or project. In this case, the claimant had no opportunity for a profit or loss, since all materials and facilities were supplied by the employer. Since the claimant’s job was to train the employer’s employees and monitor the quality of their work, she essentially functioned as their supervisor – it is difficult to imagine a job function that would be more directly integrated into the employer’s business. In addition, the fact that the claimant also performed a number of routine clerical tasks associated with the employer’s business raises a presumption that she was an employee. The fact that the claimant had agreed in writing that she was an independent contractor is irrelevant, since the facts show that she was an employee. The claimant’s wages should have been reported as wages from employment.
Believe me, these real examples resulted in real monies paid to the Texas Workforce Commission. So how do you make sure you’re not fudging the line, even on the least detail about the relationship between your company and the people you hired? Well, you can get an expert to help you. Hint, hint, it’s time to give us a call!