Are You Really An Independent Contractor?
Are you an independent contractor or an employee?
Raise your hand if you’re an independent contractor. Good. That’s a significant number of my readers.
Now raise your hand if you think that your clients are working within the law. Hmmm…I thought so. Some of you who raised your hands with the first question didn’t raise them again.
Oh, only if I could really see what everyone’s response is when they read this article….
What Are You?
Seriously, the problem of independent contractor versus employee classification is a significant one, an issue that looms large with at least one government agency – the Internal Revenue Service (IRS). The IRS, like so many taxing authorities in the western world, has been looking at this issue for many years, especially since the mid-1990s when online internet access began its surge and more people started to make money online.
Today, millions of Americans make at least some of their money online, usually small amounts by selling something on eBay, or by featuring a service on Craigslist, or in picking up a gig or two on a freelancing site, and the like.
Then, there are people like myself whose entire livelihood is cyber-connected, meaning that we interact with clients online, sell advertising, and use other forms of work to get by.
No Benefits, Just Work
In a down economy, which is exactly where we find ourselves today, many employers have cut back on staff only to replace some of their workers with independent contractors. The advantage to employers is obvious: loosen up the relationship you have with certain key people and you don’t have to pay benefits.
Social security, disability, unemployment insurance as well as your personal health, dental, life, and retirement benefits no longer apply. The employer is now a client, while the employee is now a business partner. But that relationship isn’t always so clear.
The IRS has one good reason to warn everyone that some independent contractor relationships are in violation of the law: government coffers are running low. In a tough economy this problem is magnified as higher unemployment means fewer tax dollars. And with the federal government running at debt levels never before seen, the IRS will be looking at extracting funds wherever possible.
Test Your Relationships
As a freelancer, you should employ the same tests that the IRS uses to determine your relationship with your clients. The operative word here is relationship which means that there are three characteristics the IRS looks at: behavioral control, financial control, and the type of relationship. Each of the quoted descriptions following have been taken directly from the IRS website; my comments follow:
Behavioral Control – “Does the company control or have the right to control what the worker does and how the worker does his or her job?” Many of us are in gray area territory here. If you blog for someone do they come up with specific subjects, titles, links, and a schedule that you must follow? If so, the client may have crossed a line somewhere. Familiarize yourself with IRS guidelines regarding independent contractors.
Financial Control – “Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) ” Regular and steady payments from one party to the other could signal to the IRS that some more than a freelancing arrangement exists here. Ask your accountant if it appears that one or more clients exerts financial control.
Type of Relationship – “Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?” Top clients care about their contractors and sometimes extend special privileges (benefits) to them. Those benefits, however, might be taxable and could recast your entire relationship with them. Tell your accountant about any sort of “side benefits” offered with your gigs.
Substantial Tax Bills
If the IRS discovers that you are, indeed, an employee then your client is actually your employer which means that they can “end up with substantial tax bills.” Moreover, they could be saddled with penalties for not paying employment taxes as well as for failing to file the required forms. Workers can recoup lost benefits and trim their tax bills accordingly.
I’m not sharing this information with you in order to strike fear into your heart. You work hard and you pay your taxes, but certain relationships may be in violation of the law.
Either you or your client may ask the IRS to make a determination regarding your relationship by filing Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding – with the IRS. The IRS says that this determination can take as long as six months, therefore be prepared for the worst, but hope for the best.
Yes, I know what you’re thinking: taking this step could open up a fresh can of worms for you. Then again, if you strongly believe that your business relationship violates IRS guidelines, don’t think for a moment that you’ll never be found out.
1099-Misc Forms
If you believe that your relationships with your clients passes IRS tests, then make sure that you have all of your 1099-MISC forms in your possession when you file your taxes next year. You may have been performing work without these forms under certain circumstances, but if your income exceeds $600 with any one client, then insist on getting this form from them before January draws to a close.
Visit www.irs.gov to review related publications as well as to download a copy of the form.
Resources
Internal Revenue Service: Employee vs. Independent Contractor — Ten Tips For Business Owners
Los Angeles Times: Get jump start on next year
The Wall Street Journal: The Ins and Outs of Hiring an Independent Contractor
Photo Credit: IRS
Tags: 1099-misc, employee, freelancer, independent contractor, IRS, taxes
Development | Matthew C. Keegan, 1 Dec 09
By LD Jackson, December 1, 2009 @ 6:35 am
This subject is one that is dear to my heart. I am acquainted with several men who used to employ young men as sub-contractors. Most of them are in construction or related businesses. They had a practice of hiring these young men because they could hire them cheaper, but they also required these young men to pay their own taxes. They also were not very upfront about that little piece of information. The result was that my brother-in-law spent a good part of his young adult life paying off the IRS.
Even though it smacks of manipulation to me, it is an acceptable business practice among these men. It is one thing to do that to an adult who knows what they are getting themselves into, but to do it to a young man who is just learning how the world operates is a travesty. I have gotten myself into trouble with some of these people because I spoke out against it so strongly.
LD Jackson´s last blog ..The Public Option: What’s the Big Deal?
By Matthew C. Keegan, December 1, 2009 @ 6:42 am
@LD Jackson
Thank you Larry. I certainly appreciate your account of what your brother in law went through. How unfortunate that he had to learn with much difficulty how the system works.
I work strictly as a freelancer and have several clients who I have relied upon for one or more years. I am aware of the law and make sure that the boundaries remain in place; if changes come up to threaten my work status I alert my clients.
Too bad that the onus of law wasn’t placed on the shoulders of the employer in your brother-in-law’s case. These people knew what they were doing and should have been held accountable by paying fines, interest payments, back taxes, and more. Not criminal prosecution, but restoration including what the employees owed.
By Bob, December 5, 2009 @ 9:46 am
I am paid monthly on commission, I have a boss who writes my checks & I only work for one company.
They are in another state and I act as their field representative ensuring their product gets on the shelf they send me a 1099misc. And claim I am not employed by them, yet they tell me when and how I should work, they set the hours, no vacation or sick time.
No reimbursement for travel expenses, no benefits, no workman’s comp.
I am on my own to pay all taxes, health insurance etc yet they demand me to work everyday at the same establishment and at set hours.
I feel I am being taken advantage of and they are indeed my employers
trying to get out of paying the IRS what do you think?
By Matthew C. Keegan, December 5, 2009 @ 9:57 am
Bob, it sounds like you are being taken advantage of. Importantly, it also sounds like this company is treating you like an employee which would put them in clear violation of IRS guidelines regarding independent contractors.
Please check the first link offered in my Resources section as the IRS offers detailed information about employee v. independent contractor. In addition, when you go to that page, you’ll find information about Form SS-8. You may want to fill it out and submit it to the IRS for a ruling, which can take six months to be finalized.
I hope things work out for you. It makes me mad when companies cross a boundary line and take advantage of people who are, in fact, employees.