Independent Contractors Or 1099 Employees – The Risks

The Independent Contractor standing of employees is being significantly challenged by the IRS. Between 1988 and 1992 the IRS reclassified greater than 400,000 Independent Contractors to staff and picked up over $52.5 Million ($52,500,000) in again taxes. In 1992 alone the IRS performed 1,700 audits of companies, reclassified 90,000 employees and picked up $19 Million ($19,000,000) in tax assessments. (Statistics from US Chamber of Commerce, 1993). If you’re a businessman who makes use of Independent Contractors in the course of the 12 months, your small business might be in jeopardy. Do not be lulled right into a false sense of safety by the IRS’s October 25, 1995 announcement that “Due to federal spending cutbacks, we will discontinue our long time practice of random tax return audits.”

Our topic right here is NOT about “random audits.” It’s a couple of particular, identifiable focused group. These audits have been very worthwhile to the US Treasury. It’s a scorching subject and never about to be forgotten or relegated to the again burner any time quickly. Stay awake on this one, people! This article just isn’t meant to be a unfavorable shot on the IRS, however fairly a warning to enterprise house owners who rent “Independent Contractors.” Be Aware and Be Prepared! Failure to take action may price you some huge cash, a whole lot of grief, and presumably even your small business.

Most enterprise individuals need to play by the foundations. But, WHAT ARE THE RULES on this recreation? If a employee is assessed as an “Independent Contractor”, the enterprise which hires him should file a Form 1099 with the IRS every time the gross compensation for that particular person exceeds $600 in a calendar 12 months. The Independent Contractor is then required to pay his personal revenue taxes, Social Security taxes (referred to as self-employment tax), Medicare, Unemployment taxes and employee’s compensation insurance coverage premiums. Oh, and do not forget the state revenue taxes (7.2% in Utah, as much as 11.3% in California). If a type 1099 is accomplished and despatched to an Independent Contractor any individual had higher be paying the taxes. Obviously, the one who did the work and acquired the 1099 type is chargeable for all of the taxes due. It is his accountability, however what if he does not pay? What if he has no cash, and no belongings? He then turns into an excellent candidate for standing reclassification. What meaning in plain English is, any individual goes to pay these taxes. Guess who? In this case the IRS will go after the particular person or enterprise who issued the 1099 type. Businesses who “hire” or use the companies of a subcontractor or “self employed” employee must be very cautious whose companies they use and in what method, or on what foundation, they use these individuals. Business is not easy; even probably the most sincere and nicely intentioned enterprise proprietor can get caught on this lure.

You by no means meet the IRS on a degree enjoying area, for they’ve an excessive amount of endurance, too many belongings to name upon. Even while you win, you lose. The time necessities of the battle, the emotional drain and trauma related to the motion are sometimes devastating to each the proprietor and the enterprise. Even massive and substantial companies which might be financially solvent face imminent hazard when confronted with employee reclassification. And, in the event that they determine to rent all the employees as staff, present them with the worker advantages, pay withholding taxes, employee’s compensation, and many others., they discover that they can not stay aggressive in at the moment’s market. As an instance, a contracting firm which used subcontractors discovered themselves on this pickle. They had been assessed $26,000 in employee misclassification taxes, together with $10,000 in curiosity plus penalties. They contested the IRS resolution, went to court docket and “won” their case. In order to prosecute their declare towards the IRS, they needed to pay their attorneys over $16,000. Although the court docket discovered of their favor they’re nonetheless ready, over 18 months later, for his or her $26,000 refund from “winning” their case. They had wonderful information, and all their subcontractors had signed nicely written Independent Contractor Agreements. They received the battle, however misplaced the struggle. The struggle with the IRS drained their sources, dried up their money movement and put them out of enterprise.

Independent Contractors are fairly often entrepreneurs by nature and are very heavy on the impartial half. They do not desire a boss to oversee them, and lots of are definitely accountable sufficient and expert sufficient to not want one. Thank goodness for these craftsmen, particularly the reliable ones. So you rent these mavericks, the job will get on schedule and also you pay them. At the top of the 12 months you ship off a 1099 and the ball is of their court docket. Okay, what if he drops the ball and does not pay, or does not even file a tax return? We have already mentioned the doable penalties of this situation above and that this a part of the story CAN get actual ugly, actual quick. Here are the doable prices which will fall to the “innocent,” or maybe extra precisely, the “uninformed” enterprise house owners: Hefty assessments which may return a number of years and can embrace again taxes, curiosity and penalties, and each halves of social safety and Medicare. These final 2 taxes alone presently complete as much as 15.3% of the staff revenue. Even in case your Independent Contractor pays all his taxes, this nonetheless won’t be sufficient to let the businessman off the hook. If a enterprise makes use of what they assume are “Independent Contractors” the IRS could decide whether or not this designation is right. The first questions the IRS will ask is does the enterprise have the suitable to CONTROL and DIRECT what the employees do. If so, the IRS could contemplate the employees to be staff and never Independent Contractors, and ZAP, reclassification happens! In this case, the IRS will demand all of the again taxes, penalties, pursuits, and many others. which had been mentioned above. In instances, this extra burden is sufficient to put you out of enterprise.

The IRS has a listing of standards from which it should decide whether or not the employee is an Independent Contractor or an worker. According to the IRS, not one of the listed standards is extra essential than the others, however fairly it’s the cumulative impact of the scenario which determines the standing of the employee. (In different phrases, the IRS does not need to inform us which of the factors are most essential in making this dedication). If the employee does the next, the IRS will classify the employee as an worker:

1. Must adjust to the employer’s instructions relating to the work;

2. Receives coaching from or beneath the route of the employer;

3. Provides companies which might be dovetailed into the enterprise;

4. Provides companies that have to be carried out personally;

5. Cannot rent, supervise or pay his personal assistants;

6. Has a unbroken relationship with the employer;

7. Must comply with set working hours;

8. Works full time for the employer;

9. Does all or most of his work on the employer’s premises;

10. Must do his work within the order outlined by the employer;

11. Must flip in periodic experiences to the employer;

12. Is paid for time labored, weekly, month-to-month, and many others.

13. Receives funds for journey and different enterprise bills;

14. Depends on the employer for his instruments and supplies;

15. Has no large funding in facility or instruments wanted for his work;

16. Cannot earn a revenue or endure a loss primarily based upon his personal companies;

17. Works for just one employer or firm at a time;

18. Does not provide his companies to different firms or the general public;

19. Can be fired by the employer;

20. May give up at any time with out struggling any legal responsibility.


The IRS presents Small Business workshops. Call your native IRS workplace and ask for the dates, occasions and locations. They even have written supplies similar to Publication 937; it free for the asking. Some firms throughout current years have referred their employees to third occasion payroll companies who truly employed the employee after which leased him again to the consumer firm. Under this association, the employee is chosen by the corporate, however the third occasion service pays his wages as directed by the consumer firm. The payroll firm points the W-2 and withholds all state, federal and FICA taxes. This concept is definitely artistic, But has not all the time held as much as scrutiny within the courts, and steadily, tax legal responsibility has been prolonged again to the true employer. The Courts and IRS firmly consider that “if it looks, acts, walks and quacks like a duck, it is a duck.”

The “C” company is without doubt one of the oldest, most tried and examined enterprise entities, and possibly presents the perfect resolution for this rising downside. Businesses ought to insist that each one Independent Contractors they make use of function as a “C” company and never a sole proprietorship. When correctly shaped and arranged, the company establishes a enterprise relationship that can forestall reclassification beneath the IRS questions requested above.

“Wait a minute, not so fast, ” you say. What does changing into an organization should do with the questions requested by the IRS (listed above)?” The answer is a firm “every little thing,” if properly operated as a privately held corporation (for the “duck” take a look at nonetheless applies). The employee is an worker of his company. The company, and never the employee is employed. Point by level, query by query, the occasion for whom the work is finished and the employee are clearly separated, and can cross the IRS take a look at with flying colours.

The company is its personal entity, to not be confused with a person or construed to be an worker. For instance, company officers should not commingle company and private funds. Billing statements have to be issued by the company and never the person. The employee turns into an worker of the company which pays him a wage and withholds all the suitable taxes. Stockholder conferences have to be held and correct information saved. “When savvy enterprise house owners come to grasp how this works, they’ll insist that each one their impartial contractors incorporate. Many California and Nevada enterprise individuals have been utilizing this package deal for years.” “Anybody who’s in enterprise at the moment, incomes a revenue and paying taxes should have a Nevada company of their money movement loop.” You may say, “Well, if all that is true, my CPA and/or legal professional would have instructed me, and would have arrange these obligatory protected guards.” WRONG! Your legal professional is educated to deal in historical past – he can defend your previous actions. Neither regulation faculty nor the precise observe of regulation in at the moment’s world prepares him to oversee your small business and recommend methods to raised shield your self. In truth, when is the final time your legal professional has referred to as you and given a suggestion which has benefited you, or your small business?

And, sadly, normally, your accountant has been decreased to a mere functionary, significantly with the elevated use of computerized tax preparation applications similar to Turbo Tax and others. Your accountant now merely plugs in your figures and the pc spits out the finished return. Also, do you know that your accountant is required to ask the IRS for an opinion letter within the occasion he disagrees with a deduction you need to use? Or, if he does not have adequate time to get the opinion letter, he has to ship a letter along with your return stating that he disagrees with the next deductions. I’m certain there are larger pink flags for the IRS, however I’d be onerous pressed to seek out one. This letter will actually open you as much as the distinct presumably of an audit. And, it makes your accountant much more conservative along with your return than regular. A enterprise proprietor at the moment who does not know all the foundations is sort of a particular person bowling at the hours of darkness. He has no concept what he’s doing. Don’t bowl at the hours of darkness, turn out to be knowledgeable as a substitute, as a result of the place the IRS is concerned, what you do not know can harm you! You’re by yourself on the market. It’s a jungle, and also you want all of the safety you may get.

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