Discussion:Employee vs Independent contractor
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Discussion Forum Index --> Tax Questions --> Employee vs Independent contractor
| 11 May 2006 | |
| I have a client who is a service business primarily doing healthcare related system design and programming etc. for several customers. They have about 20 programmers working for them - all as independent contractors but are all incorporated. They are all doing business as a Sub S Corp. and contracting with my client. They basicly just do work for my client. One question is whether they should really be considered employees, and second question is - is the fact that they are incorporated themselves help in classifying them as independent contractors? | |
| 11 May 2006 | |
There are three control tests to evaluate: behavior control, financial control, and relationship control. These tests will let you know who controls the employees' work schedule, assignments, training, etc. Here is the IRS training material to determine who is an employee and who is a contractor. Based on the limited information you've provided, my answer is that they are all employees. Incorporating doesn't provide any relief.
IRS Training Manual | |
| 11 May 2006 | |
| This is an old issue. Back in the 80's and 90's, Silicon Valley companies got tired of the IRS coming in and reclassifying independent contractors as employees. To ensure that it would not be a problem in the future, they forced individuals to incorporate and the problem went away. Companies would not contract with anyone that refused to incorporate. This was an issue I personally dealt with in the IRS San Jose office. We had many taxpayers that would owe self-employment taxes and they didn't really understand why. At that time a few Revenue Officers operated the Employment Tax Examination program. It was later taken over by the Examination Division and Revenue Agents were given the responsibility.
I don't know if there was a tacit agreement or the exact mechanicism by which this came about, but essentially the IRS and the Silicon Valley employers agreed that the best way to handle it was to have the individuals incorporate. The bottom line is the arrangement is perfectly legal. | |
| 11 May 2006 | |
| I'll mildly disagree with Arch. While he's correct about the tests...I've not heard of a challenge to the relationship when the service providor is incorporated. To go to that trouble and expense generally wipes out the issues, since there is an opportunity to generate profit or loss based on salary levels, etc. within their own corps. And how would you pay a W2 to a corp? But I'd be sure that in fact, the company isn't controlling all aspects of the relationships so that it isn't an issue. And what an opportunity to get more businss from those 20 S corps! | |
| 11 May 2006 | |
| There was one. faulty memory thinks Sargent? Professional athlete assigned salary to Corp. Tax Court ruled against. Later overruled by eighth circuit in a different case, I think. Independent contractor corp needs at least one non-tax related purpose, but generally corporate structure will hold. Control is not the issue in these cases -- contract with corp provides everything. | |
| 12 May 2006 | |
| Hi just because one incorporates doesnt make anything bullit proof as to whether one is an employee or independent contractor. If it was that easy everyone could avoid payroll taxes. It is a facts and circumstances situation based upon the IRS 20(?) factor tests etc. Incorporating just hides the 1099-misc reporting the corps had to give a self employed individual and makes it harder to "find". If it quacks and walks like a duck it is a duck. One needs to make sure the "employer" understands the risks and it is in writing to avoid blaming the cpa later. bye | |
| 12 May 2006 | |
| Interestingly, Arch has provided a citation that disagrees with his position. Page 94. I've only seen state level examinations, but corporate status has prevailed 100%. Skassel's experience as a Revenue Agent indicates that the IRS could care less so long as payroll taxes are paid on some level.
Anyone with direct contrary experience? | |
| 12 May 2006 | |
| What if you know that an independent contractor should be considered an employee, but the owner has paid him as an independent contractor all year long? What is done is done, does the owner go back and try to fix the situation, or correct it for the following year? | |
| 12 May 2006 | |
| Dennis - I came to the position based on the limited facts provided. I provided the citation to AABB so that he/she can figure out if the persons are employees or independent contractors. Like the old fable goes, you can't dress a wolf in sheep's clothing.. | |
| 12 May 2006 | |
| And no, Skq...but this was debated at length in another thread...oh, mid to late March I'd guess. A couple folks here were kind of militant against the company, going to far as to file a substitute W2 for the employee and submitting it with the 1040! Dennis will probably reference the thread here in mere moments.... | |
| 12 May 2006 | |
| Hopefully the payments are being made in the name of the corporation and not the individual. | |
| 12 May 2006 | |
| Work should be performed pursuant to an independent contractor agreement which sets forth both the status as an independent contractor and that compnay does not control the manner in which they perform the services. I agree with WesR, this is a facts and circumstances anaylsis and the mere fact of incorporation, although relevant and helpful, is not going to carry the day. They need to carry on a business which includes holding themeselves out to work for other people and having the ability to make or lose money, etc. It is important to get this right because other issues lurk here - a big one, at least in PA where I am admitted to practice, is workers compensation - criminal penalties arise (I know of one such case being litigated right now) out of the improper classification of an individual as an independent contractor (where there is no requirement to have WC insurance). Also, unemployment issues arise as one time independent contractors (who quack like a duck) attempt to litigate their IC status at the unemployment level when they lose thier "jobs." If successful, watch out for Wage and Hour problems, Fair Labor Standard Act (overtime) issues. Be very careful here- more than meets the eye. | |
| 12 May 2006 | |
| But you're missing the point. When incorporated, the presumption changes. | |
| 12 May 2006 | |
| Form over substance - Too dangerous an area, with all the collateral issues to stake your claim on a presumption. Must be documented carefully and must be made to looka nd operate as if corporation has a purpose other than shifting burdens. | |
| 12 May 2006 | |
| Exactly, JR. According to the IRS manual there would have to be special circumstances to disregard independent contractor's corp. New York is one of the more aggressive states. The unemployment division is constantly auditing businesses for independent contractors. Corporate status carries the day 100% of the time. I repeat my question. Does anyone have actual experience with a case decided differently? | |
| 12 May 2006 | |
| My point is that there are non-tax issues which lurk in this question. Although, state workers comp and UC examiners "use" the IRS guidelines, they are not bound by them. Be careful. Disgruntled or injured former IC can come back to bite you in places you little expect. | |
| 12 May 2006 | |
| OK Then does anyone have any experience or even an apocryphal story where an incorporated independent contractor has come back to bite? | |
| 12 May 2006 | |
| I think an incorporated independent contractor is pretty safe. But I think it is important that the contract should be with the corp and the payments should be made to the corp. Having the contract with the individual could be a problem even if the money is deposited to the corp bank account. | |
| 12 May 2006 | |
| Well eyell beee it is a duck...c m wings?
I do have a former friend who incorporated to be a behavior analyst in Florida for a larger group that only hired subs to perform services for children with disabilities. She was an independent contractor and incorporated to help defray the se taxes....2 years ago, (in Florida mind you), she had enough of the firm she worked for. She went to the division of labor and unemployment in Florida and she met the rules of an employee. Prior to her incorporation, she received monthly checks in her name...she incorporated and to keep from having to file fictitious name, she left her business name as her legal name with corp at the end of it. Her employer paid checks to her in her name and her bank honored them in the corporate account. At end of it all, it was determined that she was indeed an employee; by virtue of what services she performed, the schedule her employer set up, etc. There was, as far as I know, any adverse consequences for the employer tax wise, her sub paid her taxes and that was a moot issue. But I have no knowledge of what happened with the employers business. All I am aware of is my friend is not incorporated any longer and she gets a salary check from another behavior intervention provider. I think if the sub even if incorporated can deposit checks into their accounts with their legal name attached, it may give pause to think the provider of the fees is opening themselves up for a large battle here. The employer can then be forced to pay the fica taxes, etc. and it can cause unbelievable concerns with w/c exemption at least in Florida... | |
| 12 May 2006 | |
| Hi I think the fact that these people just basically only work for one employer/contractor one will find when you dig into all the facts they probably are employees. Form over substance hasnt won too many cases I am aware of. It is a duck whether incorporated or not with or without a contract. If it is just camouflage it wont coverup the substance of the working relationship. The penalties are too great. I have seen cases where payroll taxes are assessed on s/e people improperly classified and the "employer" got no credit for their s/e tax paid. So everyone should advise their clients accordingly and make sure you carry insurance. bye | |
| 12 May 2006 | |
| Sandy, with NO due respect, that woman is evil walking and should be...something. She took full advantage of the situation because it suited her and then when it didn't, got it both ways. Those are the people who make this country suck. I have no pity on her, and shame shame for helping her. Sorry, this makes my blood boil. She is no innocent victim, but a co-conspirator, and received the benefits of having done so.
Argh......these people. That kind of thninking. No offense to you, I know it wasn't your fault..... | |
| 12 May 2006 | |
| I agree JR....This "friend" as you read in my post is a former "friend". She also took advantage of other people that I know and care about, me included and we don't see eye to eye on most things. I don't know the outcome for the employer, but I do know that the taxes were paid by my friend and so this much was an issue that did not need resolve.
What happened and how it happens is indeed people looking for a way to keep from paying their legitimate taxes....I did not take offense JR. | |
| 12 May 2006 | |
| Sandy's situation is more common than you may expect and often employers who think they are wise to the system will ensnare unsuspecting "employees" by requiring that they becoame IC's. I agree that in forming a corporation you have gone fairly far down the road to demonstrating IC status; however, it does not rise to the level of an irrebuttable presumption - notwithstanding whatever has occurred in NY. For example, I form a corp to do IT consulting work, come only to your company, during normal business hours, work on your computers, do not hold myself out to the public for work, have no advertising or business cards, and after two years of this, while at your office a computer I am working on blows up and injures me. I cannot work for you for several weeks so you terminate my services, I go out of business and file for UC/WC because I am up the river without a paddle. On direct examination I testify that the only reason I formed corp was because you told me to do it. UC/WC finds I am an employee. Will the fact that I am incorporated help you inlater litigation with the IRS -doubtful, in fact, issues of collateral estoppel or res judicata may prevent you from even arguing the point. If there is sufficient $$ on the table, I suspect you will have wished you never treated me as an IC. Caveat emptor . . . | |
| 12 May 2006 | |
| Sandy's facts are not clear. Going to unemployment indicates a desire to collect benefits. She was clearly an employee of someone, so the question only becomes whose account gets charged. Sounds to me that the ruling was even though incorporated she was effectively unemployed once arrangement with this "larger group" ended. In that case the benefits would have been charged to her corporation's account.
Given that we already have the IRS position that form clearly overrides substance, does anyone have anything concrete? Everyone agrees that forcing subcontractors to incorporate is skuzzy, but it does seem to work. I also see a lot of contractors forcing nominal employees to carry their own workers' comp and provide a d/b/a. | |
| 12 May 2006 | |
| For sure Dennis!! W/C insurance can be very costly depending on what services people perform and many cannot even get W/C insurance for a one or two man team. Many people go to leased employee services to bypass this or go to Paychex or ADP to have their umbrella policy take effect.
Yes, my friend did go to collect benefits and since it was determined that she was "employed" by the larger group, I am sure this larger group got the hit for the unemployment. The reasons she did it were that she was not being compensated for additional work she did at home and so thereby did not see that she was self employed. She had a point, but only to the extent that she should have been able to charge a "fee" for her services and not be paid an hourly rate for only the hours spent in a clients home. She was compensated well, but in her opinion, not enough for the extra time spent that she felt she could have been paid by another provider....still and all a grey issue and one I don't like to be involved with :) | |
| 12 May 2006 | |
| Which sounds like justification for termination of employment relationship and why she was eligible to collect. She didn't get a refund for the unemployment taxes she paid on her salary from her own corporation, did she? I wouldn't be so sure the larger group got hit here. | |
| 12 May 2006 | |
| Nope; as far as I know, she did not get a refund for UCT6 or 940 taxes. I just assumed that the larger group paid for the unemployment with higher rates, but perhaps she herself paid her unemployment....interesting at best :) | |
| 12 May 2006 | |
| Which brings us back to the original question. In New York we get a ton of audits on this stuff. Unemployment is active and workers' comp is annual. The State Insurance Fund does comprehensive audits inclusive of disbursement records. Payments to corporations are not questioned. Ever. Payments to individuals are allowed upon proof of self insurance. Always. Enough quacking about form and substance. Does anyone have anything concrete? | |
| 12 May 2006 | |
| Quacking and concrete do not mix well, Dennis. I can say that from personal experience in IL with the evil IDES...that they don't even bother reviewing cancelled checks written and endorsed to/by corps. Only personals. Hand endorsed checks will get yanked and discussed every time. The corps/rubber stamped endorsements don't get a second glance. I have been thru a few of these, but none with a lot of independent corps providing services... | |
| 13 May 2006 | |
| I'm only responding to this because I was just faced with the situation. I've not had anything happen nor do I want to take that chance. A new client, a residential builder, an S corp, has been paying his workers as subs for years. He has decided that his business is in position for moving up to a new level and he wants to do everything right. Good for him. He's engaged my services, a business manager and hired someone to keep his books (I offered!). The 'bookkeeper' asked if they should be paying their workers as subs or as employees and I gave him the general info that certainly pointed to them being employees. He asked whether having them incorporate would keep them sub contractors, I told him that this was not a good idea and why and they will now all be set up as employees. Yeah! Can you imagine a builder, a painter, etc. going through the incorporation costs and process, then having to do their own payroll, right! The bottom line is, if you have a business that is working and you want it to continue and grow, forget cutting corners and taking risks and do things right! The potential savings will never be worth the potential risks. | |
| 13 May 2006 | |
| I don't think there is any disagreement on the advice we would give our clients who might want to avoid employer relationships. Do note, however, that Microsoft apparently judged differently and was successful. Primarily we want to be looking at the other side of the coin. Our client comes to us and says "this guy is willing to guarantee three years worth of work at really good money, but only if I incorporate and contract as a sub." Do we advise him that by doing so he will be giving up any right to claim employee status? | |
| 13 May 2006 | |
| I believe that subs incorporating help save the employer *the contractor* so much money that with them being employees, he could not be in business any longer. To get w/c exemption in FL, most contractors here only hire subs because w/c insurance for contractors is sooo very high and is almost impossible to get unless you have a large staff. The rates are about 30.00 per hundred dollars in wages, so it is to say the least not advantageous to the contractor to have employees.
The subs do have benefits in incorporating and even though they are not technically employees, they can still pay in fica etc and be treated as employees of their own corporations. Mixed emotions about this as many of these contractors who hire employees do so with paychex or leased employees and put them on the books for minimum wage or little above that. They then pay them in cash for additional wages and/or overtime. Yes, they are standing by the letter of the law as it pertains to employee taxes, but in order to stay in business and be profitable, the wages are little more than adequate. I have many contractors as clients in my business and so many of them had to incorporate for the w/c issue. Most of them are honest, hardworking and just want to make a living. If the w/c insurance was not an issue, most of these contractors would prefer to have employees I think. Just my humble opinion :) | |
| 13 May 2006 | |
Back in the seventies, I was involved in a rather large case, albeit only on the New York State level. Hospitals began to find themselves unable to staff emergency rooms because they had no way of avoiding an employer relationship with the individual shift doctors. (Average shift doc was making about $150K at the time) They started to subcontract the entire ER operation to a separate operating entity which would then contract with the individuals. This held nicely, but state unemployment went after the entities essentially finding an employer-employee relationship which no one could afford to fight. (The rates were low and the tax came out something in the range of $21 per doctor.) At this point the state went after these entities for withholding taxes, a case we won on the basis of standard industry practice.
The agreed upon solution was universal incorporation for the shift doctors, and in New York that is the way things still are. | |
| 13 May 2006 | |
| WOW; this is pretty incredible stuff Dennis. So many times taxes and especially insurance leads people to have to do other things to save money and make a living. I like paychex for the opportunity to use the umbrella w/c insurance, but I think more than taxes, the insurance dollars are the ones hitting people the hardest. I would imagine ER doctors have high w/c insurance rates as well. Does NY also allow people to opt out of w/c if they are over 10% s/h of a corporation or own more than 10% of an llc? | |
| 23 January 2008 | |
| Guys, what do you think of this.....
I have a current customer who has an S Corp (2 partners/owners). Through that S Corp, partners get a salary for their services. At the same time, partners have 2 other S Corporations, where they bill the first S Corparation, almost this working as a distribution. What do you guys think? LPailolu 15:21, 23 January 2008 (CST) | |
PostingFromWork (talk|edits) said: | 24 January 2008 |
| The first S-Corp 1 will need to pay it's shareholder/emplpoyees reasonable compensation for the work they performed for S-Corp 2 and S-Corp 3, on behalf of S-Corp 1.
No such thing as a FICA free lunch. | |
| 24 January 2008 | |
| Thanks "Postingfromwork". Reasonable compensation..... The eternal question. 24k each (yearly) is their compensation. 10k each (monthly) is what they get through the other 2 S Corps.
Abusive? | |
Johnhuddleston (talk|edits) said: | 25 January 2008 |
| I'm not sure from the fact which corp they are working for. I don't see multiple corps as successfully insulating them from reasonable comp requirements. The IRS would probably not do anything with Corp 1 since there are no distributions. However, the distributions from corp 1 and 2 could likely be recharacterized is they are taking $10K monthly and paying a salary of $24K annual. It sounds like corp 2 and 3 should be paying salaries.
John Huddleston Seattle Bellevue Tax Accountant | |
| 25 January 2008 | |
| Here's a related issue - clients are in a business where the industry practice is to treat workers as independent contractors, and therefore for federal purposes they rely on Section 530.
But, the state rules for defining who is subject to unemployment taxes are more restrictive and Section 530 doesn't apply for state purposes. Therefore, I think the employers should be including the independent contractors' compensation on their unemployment tax returns. Has anyone addressed this issue? (The client's payroll service's response to the issue is Huh?). Thanks. | |
Death&Taxes (talk|edits) said: | 25 January 2008 |
| On that same tangent, the City of Philadelphia defines a musician who is hired by a contractor as an employee, though 1099s abound in this town [unlike New York City where the AFM is stronger]. The City feels the contractor, or the orchestra leader, is the employer. As an employee, the musician is very limited in deductions, but often I file Earned Income tax for the City, attaching 1099s, while putting the income on Schedule C for the 1040 and state. | |
PostingFromWork (talk|edits) said: | 25 January 2008 |
| Smokey, I agree that they should be on the SUTA return.
Since most Departments of Labor in the country use broader definitions of employee and employer then the common law test used by the IRS and other tax authorities, you can get some comtridicting results. | |
