Independent Contractor Compliance Blog - by Collabrusâ„¢

Why does providing items like a computer, email, telephone, office supplies, tools, software applications, workspace, etc. tend to make someone an employee? 

Many would argue that since “direction and control” is the primary factor that as long as you let the consultant have freedom on how to do the work he/she is an independent contractor. They would say it is just being practical to provide the above items. 

There is some merit to this argument; however, before we go further remember that no single factor will determine the outcome on its own. The total picture must be viewed to determine if a consultant is an independent contractor or an employee.

In general, the tools, equipment supplies and work space are normal items and expenses an independent contractor (or business) traditionally pays for as a normal cost of doing business.  Employees expect to receive this support as part of the employment relationship. Independent contractors should not.

For example, if you engage an independent contractor, who operates his own construction company, to build your dream home you wouldn’t expect to provide him with a hammer, power saw or a truck to haul materials. You would expect him to provide all his own tools and equipment. That’s because he’s an independent business and is expected to have these items as part of his business investment. The same principle applies for independent contractors in any industry.

I’ve heard two arguments why this is true.

1. Investment in a business is a cornerstone characteristic of an independent contractor (or business). IC’s, and other independent businesses, typically have a monetary investment in their business (time spent working does not count). On the other hand, employees show up for work and expect the employer to provide the necessary materials, tools and the supplies to get the job done. This is one sub-factor of the IRS’ Financial Control element.
2. When the principal provides the materials, supplies, work space or other tools (including proprietary hardware or software) to perform a job, there is an implied right to control how those assets are utilized in doing the job. If the principal can control how the tools, etc, are used then he is also controlling how the job is performed. This implies the principal has the right to direct and control the work. This is one sub-factor of the IRS’ Behavioral Control element.

It adds up…

So in effect, it can be argued that if you provided the tools and other assets needed to perform the work you have begun to move two of the IRS’ Three Elements of Law over to the employee side.

• Financial Investment
• Behavior Control

Which only leaves “Relationship of the Parties” to sort out and make it unanimous. It’s like coming up to bat with two strikes already against you.

Remember the primary rule.

No single factor alone will decide the status of a working relationship. All factors must be considered and they can be weighted differently depending on the profession and the circumstances of the project. That’s why it takes a true expert to make these calls with the confidence of being correct.

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WASHINGTON - The IRS recently announced that, “Workers who lose their jobs during January and February may qualify for a 65-percent subsidy on their COBRA health insurance premiums, and these newly-eligible individuals, along with those already receiving the subsidy, can now receive it for up to 15 months…”

This is an opportunity to help those who lost their COBRA health coverage because of the poor economy.

This is an extension of the current program.

The American Recovery and Reinvestment Act of 2009, originally set up a special provision for qualified individuals to receive a COBRA subsidy for nine months. Under that law the subsidy was scheduled to expire at the end of 2009. However, on December 19, 2009, Congress extended the provision as part of the Department of Defense Appropriations Act, 2010. As a result, workers who are involuntarily terminated from employment between September 1, 2008, and February 28, 2010, may be eligible for a 65% subsidy of their COBRA premiums for a period of up to 15 months.

“Assistance-eligible individuals” are generally defined as “involuntarily terminated employees who had a qualified COBRA plan when employed and who pay 35% of the COBRA premium and meet certain other requirements…” Coverage may also include family members of those individuals.

Employers can take tax credit for required COBRA contributions

Under the law, employers provide COBRA coverage to “assistance-eligible individuals.”  Employers can then be reimbursed for the 65% contribution by claiming a credit on their federal payroll tax returns, such as:

• FORM 941, Employers QUARTERLY Federal Tax Return,
• FORM 944, Employer’s ANNUAL Federal Tax Return,
• FORM 943, Employer’s Annual Federal Tax Return for Agricultural Employees.

Be sure to maintain supporting documentation for the claimed credit. If you are audited you will need to prove the individual qualified and that you contributed the 65% you claimed as a credit.

Employers are required to notify eligible individuals.

Under the law the administrator of a group health plan or “other entity” must notify assistance-eligible individuals of the extension by February 17, 2010. Even if the nine months of subsidy has already ended, the new law provides an extended period for the retroactive payment of their 35% share during a transition period.

For more information I recommend you talk with your tax expert, or check the IRS website.

WASHINGTON, DC - President Obama signed a presidential memorandum to stop companies who are delinquent in their taxes from collecting on government contracts. While signing the memorandum he stated, “(they are) gaming the system…We need to make sure every tax dollar we spend is going to address our nation’s urgent needs and to make a difference in the lives of our people. ”

It’s about Closing the Tax Gap.

Obama’s memo stated, “The Federal Government pays more than half a trillion dollars a year to contractors and has an important obligation to protect American taxpayer money and the integrity of the Federal acquisition process. Yet reports by the Government Accountability Office (GAO) state that Federal contracts are awarded to tens of thousands of companies with serious tax delinquencies. The total amount in unpaid taxes owed by these contracting companies is estimated to be more than $5 billion.”

In his oral statement the president added, “This is not simply a matter of signing a piece of paper or taking a bureaucratic act….All across this country, there are people who meet their obligations each and every day. You do your jobs. You support your families. You pay the taxes you owe — because it’s a fundamental responsibility of citizenship. And yet, somehow, it’s become standard practice in Washington to give contracts to companies that don’t pay their taxes. ”

More importantly, the President then indicated stronger actions are coming.

Possibly most significant he then said, “Beyond these steps, I’m also calling on Congress to build on the kind of legislation that Senator McCaskill, Congressman Ellsworth, and Chairman Towns have introduced  — and that I introduced when I was senator — legislation that will crack down on tax cheats by allowing the IRS to share information about tax delinquency with contracting officials. And by the way, when I introduced that Senate bill, Claire stood by me, and Brad led the way in the House…”

The President is referring to Senate Bill 2044, that he co-sponsored.  It was introduced during the 110th Congress and was titled, `Independent Contractor Proper Classification Act of 2007′.

Some of the major provisions of that bill are:

1. Grants the IRS the authority to force employers to reclassify IC’s to employees.
2. Authorizes the IRS to issue regulations and revenue rulings establishing standards for properly classifying workers as IC’s.
3. Eliminates a major protection provision of the IRS’ Safe Harbor
4. Requires DOL to create a poster that must be posted by businesses that informs workers of their right to challenge their classification as independent contractors.
5. Sets up a procedure by which workers can challenge their classification as independent contractors.
6. Provides protections against retaliation for workers who take advantage of the challenge procedure.

For items 4, 5 & 6 read; encourages workers to ask for an IRS audit of the company.

1. Requires the IRS to report employers to the Department of Labor (DOL) if an audit found misclassified workers.
2. Requires DOL to investigate industries that are revealed by IRS data to have high rates of misclassifications.
3. Requires businesses to notify independent contractors of their federal tax obligations and of their right to obtain a determination of their independent contractor status from the IRS.  The notice must also inform IC’s of the labor and employment law protections that apply only to employees-not to IC’s.
4. Requires employers to keep detail records relating to independent contractors (hours, days worked, rate of pay, etc) for three years.

The time to prepare is now-before laws like this are passed and the government knocks on your door.

The recent Federal Ninth Circuit Court ruling holding the Americans with Disabilities Act and the Rehabilitation Act apply to independent contractors could just be the tip of a huge IC compliance iceberg.

Several synopses of the federal appeals court decision granting an independent contractor the right to sue a client company for discrimination reflect a deeper issue. Most refer to the client company being sued as “the employer.” One even states, “The U.S. 9th Circuit Court of Appeals recently overturned an earlier court decision when it ruled in favor of a contractor’s right to sue the Yuma Regional Medical Center in Yuma, Ariz., after being turned down for a job there“ (emphasis added).

Independent contractor and employee are mutually exclusive events

Employees apply for jobs. Independent contractors bid for jobs or contracts. A client company engaging an independent contractor is not an employer of that individual. 

Could it be the court believed this “contractor” was a misclassified employee and wanted to make a “fair’ decision?

I know I’m speculating here, but just go with me for a paragraph or two. 

Could it be that the court saw a person applying for a job like any other would-be employee and being discriminated against based on disability; however, the job never got off the ground, so they couldn’t rule on the worker’s classification before deciding if he could sue for discrimination. So maybe this was an end run by the court? (Isn’t speculation fun?)

If there is any truth to my speculation, why would the court stretch so far? 

There has been a government trend for several years to toughen up IC enforcement. I’ve reported before that IC’s are disliked by those who regulate the business world. In general, most government bureaucrats don’t like the free, uncontrolled nature of an IC in the business world.  Independent contractors are more difficult to tax and taxes are what sustain the government, including the court system. I think most of these bureaucrats believe businesses skirt the law, avoid taxes and cut costs by classifying employees as IC’s.

It’s not just the bureaucrats.

There are numerous examples of bills being introduced at both state and federal levels to make it more difficult to misclassify workers as IC’s. If you are interested in the details I recommend you search through my prior blog postings where I’ve reported on many of them in the past.

I’m not the only person to see this trend. 

As far back as 2006, the Washington Legal Foundation saw this current push to limit the use of IC’s. In their publication The Legal Backgrounder, Vol. 21 No. 19, June 2, 2006, they reported, “The “independent contractor” model of conducting business affairs is coming under increasing assault from government regulators, labor activists, and plaintiff’s attorneys…” 

The world is changing.

In my opinion the belief that businesses skirt the law by classifying individuals as independent contractors motivates bureaucrats, lawmakers and courts to make it tougher to engage an individual as an independent contractor. Many believe most IC’s are just employees being taken advantage of by “employers.” Because of this belief courts are becoming more likely to allow an IC the same legal standing as an employee to “level the playing field” and make it “fair.” This latest ruling seems to do just that.

It is so important to protect your company in this changing world.

Businesses can no longer operate with the “let’s shoot from the hip on classification issues until we’re challenged then deal with it” policy. It is too expensive and they are too likely to be wrong.  Smart business people make sure they properly classifying ICs and can prove it when challenged. As the challenges become tougher, the preparation and proof must be stronger. 

Up until now, as a general rule, employees enjoyed a series of protections and benefits that independent contractors did not receive. In part, that accounts for IC’s receiving a higher rate of gross reimbursement for their services over their employee-counterparts. Independent contractors are not entitled to unemployment insurance benefits, wage and hour protections, workman’s compensation protection, most discrimination protections or other benefits. Avoiding those benefits generally lowers the cost of employing an IC. However, this distinction could be evaporating.

Can independent contractors be protected from discrimination?

The Federal Ninth Circuit Court recently held that Section 504 of the Rehabilitation Act of 1973, a federal law prohibiting discrimination on the basis of disability by any program or activity receiving federal financial assistance, also applies to independent contractors. This is a distinctive concept not found in most other federal jurisdictions around the US. 

Section 504 reads in part:

No otherwise qualified individual with a disability in the United States, as defined in section 706 (20) of this title, shall, solely by reason of his or her disability, be excluded from the participation in, be denied the benefits of, or be subjected to discrimination under any program or activity receiving Federal financial assistance or under any program or activity conducted by any Executive agency or by the United States Postal Service.

Do you have a federal contract or receive federal funds?

This ruling applies to any company that has a federal contract or in some other way receives federal funds.

Special accommodations for IC’s.

Under the Americans with Disabilities Act (ADA), companies are responsible to accommodate individuals with disabilities in several ways. As a result of the Ninth Circuit’s ruling the ADA may apply to IC’s the same as it does to employees.

For example if you engage an IC with a disability:

• You should assess any special needs he/she may have.
• You should determine and implement any reasonable accommodations required to provide equal participation, benefits, or to eliminate any discrimination connected with disability.
• You may need to make structural alterations to existing facilities for the purpose of assuring program accessibility.

If this ruling stands it could open up other new protections to independent contractors that before were only available to employees.

The ruling may (or may not) be appealed and overturned. However, if it stands who knows what benefits will be extended to IC’s next? 

I make it my responsibility to stay current on changes. I believe staying on the cutting edge is only one of the traits that defines an expert. At Collabrus we make it our business to stay current and maintain our expertise in IC compliance so you can focus on your expertise and your business. 

What’s next?  I’m predicting withholding on IC’s and the repeal of Safe Harbor…

For years there has been talk in Washington of “amending” the Safe Harbor Provision of the Internal Revenue Code and of requiring income tax withholding on payments to independent contractors (those who receive a 1099). Looks like the politicians are making a serious run on it this year.

All of the following were outlined in federal budget proposals for Fiscal Year 2010:  

• Information Reporting (Form 1099) on payments made to corporations.

STATUS: This appears to be destined to be signed into law (H.R. 3590) after a long period of lobbying by the IRS.

• Repeal/amend the Safe Harbor provisions of the Internal Revenue Code.

STATUS: Introduced as Senate Bill 2882 on December 15, 2009, following a bill introduced on July 30, 2009, in the House (H.R. 3408), after a long period of lobbying by the IRS. Both bills are practically identical and effectively repeal Safe Harbor.

• Require withholding on all 1099 payments the same as is currently required for employee wages.

STATUS:  Although I’m not aware of a current bill, the IRS has been lobbying Congress to create third party withholding on IC’s for several years. All of the following statements have been made in IRS reports to Congress within the past two years…they should give you insight into the IRS’ position on IC Withholding:

•   …it would help sole proprietors and small corporations to withhold at the time payments are made to them.
• (The current system of)…quarterly estimated tax filing is relatively burdensome, especially for “less sophisticated and lower-income taxpayers.”
• …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.
• (If there was IC Withholding)…when tax time came they wouldn’t be caught unable to pay their tax debts…

It’s all about “Leveling the playing field” and (more importantly from the IRS’ perspective) closing the “Tax Gap.”

The primary stated motivation for these proposals is to make it fair and easier for all.  However, all of the above proposals also:

1. Insure everyone is identified in “The tax system”
2. Make it more difficult to misclassify workers
3. Speed up/capture/increase tax revenue flow to the government

The need for increased tax revenue flow leads to more aggressive tax enforcement.  More aggressive tax enforcement leads to more tax audits and IC misclassification challenges. 

I am also predicting there will be other bills introduced to tighten down compliance for independent contractors. 

You need to be ready now. You should establish a proven system that insures proper IC classifications and maintains the necessary documentation to prove your case if challenged. Collabrus can help you implement this necessary system now, before it’s too late. 

It is too late after the tax auditor is knocking on your door.

Under today’s law, if you engage a corporation, or a consultant through his corporation, to perform a service for your company there is no requirement to issue a Form 1099 for the payments made to the corporation. That’s about to change!

H.R. 3590, Section 9006, the Heath Care Bill passed by the House of Representatives on December 24, 2009, and currently in the Senate for reconciliation, changes the current 1099 reporting requirements.

H.R. 3590, Section 9006, requires Form 1099 Reporting for Incorporated Service Providers.

Included in the health care bill is a section that amends the Internal Revenue Code to require that businesses who pay over $600 to a corporation for services must file a Form 1099 reporting those payments.

I told you so…I’ve been reporting for the past year and a half on the IRS’ 1099 lobbying efforts to require third party reporting on corporations (also on IC withholding-see below). 

The IRS has been lobbying Congress for several years to get this law.

A written statement by Nina E. Olson, the IRS’ Taxpayer Advocate, dated February 16, 2007, presented to the Committee on the Budget for the U.S. House of Representatives about closing the Tax Gap, said:

“Under current law, an individual taxpayer can escape information reporting by incorporating. This is true even if the taxpayer is performing the same services that would be subject to Form 1099-MISC (Miscellaneous Income) reporting if the taxpayer were conducting business as an unincorporated entity.

For Form 1099-MISC information reporting purposes, I believe there should be no distinction between taxpayers providing the same services for compensation merely because one taxpayer has incorporated and another has not.” 

Also in her report to Congress for 2008 she again recommended that Congress require service recipients to issue Forms 1099-MISC to incorporated service providers and increase the penalties for failure to comply with the information reporting requirements. 

Why does the IRS want this?

The IRS tells Congress that, “Generally compliance increases significantly for payments that a third party reports (W-2 or 1099)…Moreover, the longstanding regulatory exception from information reporting for payments to corporations has created compliance issues…”

The IRS finally is getting its wish. 

This provision of the health care bill, which appears destined to be passed into law, will take effect for payments made to corporations for services by another business, after December 31, 2011.

What’s next?

I’m predicting that withholding on payments to IC’s and maybe corporations isn’t far behind, but I’ll cover that next time.

An auditor is deep into your worker classification practices and you realize you really weren’t ready for this.  So you decide to call your elected politician and ask for reasons.  You ask your state assembly member, governor, US Congressman, or US Senator, “Please get the tax auditor off my back.”

In the over 30 years I spent working on the Other Side, I saw this happen many times.  Taxpayers and business owners, who weren’t ready for an audit, trying to get help by contacting their elected official.

Contacting your elected official is almost always a dead end.

It shouldn’t be a surprise.  Not many of us today are happy with our politicians, on any level, or on any topic.  In this case the elected representative will probably never personally see your letter or receive your telephone call.

Let me explain:

1. A staff member will listen to your complaint or read your letter.  Each elected official has staff whose primary responsibility is to handle complaints.  Either the agency is too aggressive, or the government isn’t doing enough.  These employees spend basically their whole day taking complaints and coordinating the responses.
2. On the tax agency side there are people dedicated to communicating with the staff members of the elected officials.  So these government employees spend their whole day coordinating responses to the staff of the elected officials.  Many times these “opposing staff members” have worked together hundreds of times and are friends.
3. The government has a carefully designed procedure for handling these issues and everyone is careful not to “step over the line.”  They follow a detailed, formalized ritual to resolve the issue you have raised.
4. Unless you really have a powerful, or personal, connection you will most likely receive a carefully crafted letter, with the elected official’s “signature,” supporting the tax agency’s position and the audit will go forward.

How does this happen?

A true case of the fox investigating the raid on the henhouse.

Typically:

• The elected official’s staff member asks the agency’s staff member you are complaining about to draft a letter for the politician’s signature, because they have no knowledge of the issue.
• The agency’s staff member really isn’t an expert on the topic so he/she asks the auditor’s manager to craft the letter and send it back up the line.  The manager, of course asks the auditor…
• The letter you receive will read as if the politician wrote it personally and explain his findings supporting the agency’s actions.

But that’s not all.  Most politicians, especially at the federal level and the higher offices in the state, use a signature machine, so the politicians never even see the letter.  That’s why I say calling an elected official for help is usually a dead end.

Ultimately, the best defense is hiring a dedicated expert to help you be ready now, before you are the subject of an employment tax audit or a worker misclassification challenge.

The State of California’s interest rates drop.

How does this work?

If you overpay your federal taxes the interest rates due to you are:

• Four (4) percent if you overpaid your taxes
• Three (3) percent in the case if a corporation overpays
• However, the IRS only pays one and one-half (1.5) percent for the portion of a corporate overpayment exceeding $10,000

If you underpay your federal taxes (as in an assessment for misclassified workers) the interest rates you must pay are:

• Four (4) percent of the amount underpaid
• Six (6) percent for large corporate underpayments

Since in today’s environment almost all tax assessments against a corporation would be over $10,000 (the IRS doesn’t usually spend much effort ferreting out smaller amounts), most IRS tax assessments against businesses will carry an interest rate of 6%, compounded daily.

The State of California’s Interest Rate for 2010 Taxes

California’s interest rate for 2009 is 5%, also compounded daily; however, effective 1/1/2010, the rate will drop to 4%. 

The size of the assessment or type of business does not affect California’s rate.  Also, California pays the same rate if it pays out interest as it charges on tax liabilities.  California’s rate will remain unchanged through June 30, when it will be adjusted based upon the prime rate at that time.  California adjusts its interest rate effective in July and January of each year.

It’s the daily compounding…

Both federal and state law provides for interest owed to be compounded daily from the time the tax agency determines the money should have been deposited in the government’s bank account until it is paid. 

Audits are conducted by reviewing the past (the statutory period is three full years, unless intent to evade or fraud is involved then there is no statute of limitations).  Therefore there is always a lengthy time period that interest has already accumulated before the assessment is made and before you have an opportunity to pay.  Neither state nor federal law allows for interest to be waived.

This is a silent killer for businesses that receive an assessment for misclassifying workers.  I’ve seen interest alone double liabilities owed because a company made an error in classifying their workers.  This cost factor significantly raises the stakes in properly classifying your consultants and contractors.

A reported recent ruling in a New York federal district court held that payments made to a worker, who was both an independent contractor and an employee with the same business, could not be combined to avoid paying overtime compensation under the FLSA.

She was an employee but also provided a separate service in her established independent business and her employer happened to be one of her clients

The problem was the company failed to pay her for her overtime work as an employee. The company argued that her combined earnings as an employee and an independent contractor (over $100,000 in a year) totaled enough to more than cover all overtime requirements and placed her in the “highly compensated” category of worker, making her an “exempt employee.”  Therefore, she was not entitled to overtime.

The court disagreed, ruling that earnings as an independent contractor do not contribute to overtime wage requirements as an employee under FLSA.

Caution:  This ruling sends a mixed message

It confirms that it is legally possible for an employee to receive both a W-2 and a 1099 from the same business in the same year.

It also confirms employing the same person as an IC and an employee presents a special set of dangers.

It is possible

It is legally possible but it is very unusual for an employee, who receives a W-2, to also correctly receive a 1099 from the same employer.  To qualify for an IC status he must meet the common law test as an IC, which includes but not limited to, such things as:

• The individual has a legitimate independent business (including other clients not connected to the employer)
• The work as an IC is not the identical, or even similar, to what he does as an employee.
• He is free of direction and control while performing this service.

For example, a software engineer also does work as an independent sign painter on weekends.  It’s his artistic expression.  He advertises and has dozens of other clients and gets calls regularly for jobs.  The software company he works for as an employee-engineer during the week hires him to paint some signs for a special occasion-a one time job.  He quotes a flat price for the work (say $2,000), which is not connected to the pay rate he receives as an engineer during the week.  He does the work on the weekend, at his own time, and using his own materials and supplies at his own expense.  He is paid for a completed job, not by the hour and not for any rework.  Nobody supervises his work-the company is only interested in the final product as agreed to.  In this case it would be correct for the employee-IC to receive a 1099 MISC for the $2,000 and a W-2 for his regular salary as an employee.

Doing so presents a special set of dangers

The IRS, and other enforcement agencies, usually looks at a 1099 and W-2 in the same year as a red flag, raising your probability of being audited and a tax assessment.

Also, since the work as an IC is a completely separate event from the work as an employee, do not mix the two works in any way including minimum wage, overtime, fringe benefits, termination, and especially the right to direct and control the work. 

One final caution

If you do have an employee who is also providing an IC service, be sure to clearly document and save your evidence.  You will need to prove you are right.