Independent Contractor Compliance Blog - by Collabrus™

WASHINGTON, DC - According to a report issued June 25, 2009, by the Census Bureau, U.S. Department of Commerce, the nation added nearly 1 million new “nonemployer” independent contractors between 2006 and 2007.  This brings the total ICs in the US to a total of 21.7 million, as of 2007.*

What are “nonemployer” independent contractors?

“Nonemployer” independent contractors are defined in the U.S. Census Bureau report as, “self-employed individuals operating very small, unincorporated businesses, which may or may not be the owner’s principal source of income.”

Why unincorporated?  Why not include ICs who are incorporated?

A corporation would not be included in this definition because “nonemployers” includes only ICs who have no employees.  A corporation needs a president at the minimum.  Under federal law presidents of a corporation are employees of that corporation by definition, so all corporations have an employee.

Which types of Industries are most likely to have “nonemployer ICs”?

The Census Bureau report included nearly 300 different industries.  However, they found that three industry groups made up more than 40 percent of the total income and represented more than 33 percent of all nonemployer IC businesses.  The top three are:

1. Real estate services ($177 billion)
2. Professional, technical and scientific services ($130 billion)
3. Specialty trade contractors, such as construction ($97 billion).

These three sectors were comprised of 7.2 million individual businesses.

Where are the most ICs located?

Three states made up 29 percent of all nonemployer businesses in the United States:

1. California (2.8 million ICs)
2. Texas (1.8 million ICs)
3. Florida (1.6 million ICs)

Income of “nonemployer” ICs in these three states totaled nearly $308 billion, which is 31% of all income from “nonemployer” IC businesses nationwide.

The IRS and congress read these reports and formulate their policies, in part, based on the data.  So when the IRS is mapping out where to put resources for its enforcement program it will be looking at California, Texas and Florida and focusing on the above industry groups.

There are other ramifications to this data.

For years the IRS has been telling Congress that individuals and businesses that are not subject to third party withholding, such as 1099-ICs, are one of the major sources of the Tax Gap (estimated at over $345 billion per year).  Now they are hearing the number of these ICs is increasing.

In my opinion, excluding ICs from withholding has rubbed the IRS and Congress the wrong way for years because they believe ICs are just, too… well… independent.

In reports to Congress, the IRS states that quarterly estimated tax filing is relatively burdensome, especially for “less sophisticated and lower-income taxpayers.”  The IRS argues by the time estimated tax payments (or final tax payments) are due some independent contractors have not put aside the necessary funds, placing a “distressing burden on the IC.”  The IRS argues that withholding at the time each payment is made to the IC and depositing it with the IRS (the same process used for employees) would lift this burden from the IC.

What is the IRS’ real motive?

Is possible both the IRS and Congress are looking at this group of free entrepreneurs and seeing an additional source of cash flow?

IRS studies have shown that people who have a third party withhold and deposit taxes at the time compensation is paid are more likely to file tax returns and report those payments.  Requiring withholding on ICs, the IRS believes, will go a long way to closing the Tax Gap.  However, to accomplish this it takes a change in the law, which will not be easy at this time.

Final thought

Another way to get withholding on ICs (without a law change) is to make every IC an employee-it’s called increased enforcement.

*2007 is the latest year the Census Bureau has published information. This specific category of ICs does not include every IC operating in the US.  It only includes those who do not have subordinate employees.