The IRS and state taxing agencies want everyone on W-2s to allow Big Brother can better control it citizenry. Independent contractors (ICs) have a measurable benefit to business owners include workforce flexibility, limits of liability, reduced federal and state taxes, and non-applicability of federal and state labor laws including Obamacare.
The problems for the IRS are the reduced compliance for ICs. No withholding safety net and no 1099 requirement for payments to corporations contributes to the tax gap.
IRS, in Rev. Rul 87-41, uses a “common law” definition of an employee – “Who controls the workplace and the manner in which the work is performed.” State tax agencies often use a harsher statutory definition…in CA, for instance, if the IC lacks a contractor’s license, they face a threshold to overcome and draconian penalties.
The key to protecting ICs is to have a contract. However, contracts will not guarantee against reclassification because the IRS and the courts evaluate “substance over form.”
The agreement should specify that worker is performing services as an IC. If IC must follow company guidelines, undergo training or supervision, the employee status is indicated. Lack of power by IC to delegate/hire assistants indicates employee status. IC should set own schedule with fixed completion date.
IC should be able to offer services to the public and not be expected to work fulltime for the company. Agreement should allow IC to determine where to perform the work; if IC is required to do the work company’s premises, it indicates employer control.
An IC should be paid in lump sum or progress payments rather than compensation by hour, week or month. They also must provide all tools and equipment necessary to perform their hired task without aid from the company.
No single factor controls how to determine IC from an employee. Over-arching consideration is who controls the workplace and how the work is performed.
Dana M. Ronald
Tax Crisis Institute
7/24/13