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USING A 1099 INDEPENDENT CONTRACTOR

Care must be exercised when using Independent Contractors because the IRS and various government agencies seek to classify workers as W-2 employees so as to ensure that your business pays: FICA, Medicare tax, worker’s compensation insurance, unemployment tax and overtime for its workers.

Regardless, your business can utilize 1099 Independent Contractors if you follow three steps:

1. Require your 1099 Independent Contractor to form a Limited Liability Company or Corporation, and,

2. Enter into a written Independent Contractor Agreement drafted by a lawyer with the Independent Contractor’s Limited Liability Company or Corporation, and,

3. Pay the Limited Liability Company or Corporation formed by the Independent Contractor with a check, never pay the Independent Contractor as an individual.

BENEFITS OF USING AN INDEPENDENT CONTRACTOR

(This is only applicable if your Independent Contractor is an individual; avoid that arrangement at all costs. Require your Independent Contractor to form a Limited Liability Company or Corporation and follow the three steps above under the heading Using A 1099 Independent Contractor.)

When a business hires a worker as an independent contractor, it is often because the business intends to avoid the responsibilities that attach to an employment relationship, most notably, workers compensation insurance, employment tax and wage withholding responsibilities.

Additionally, when a worker is treated as an employee, the employer may also incur costs related to pension plans, health insurance and other fringe benefits, workers' compensation and state rules relating to employment taxes and regulation of the workplace over time, etc.

A worker may choose to be an independent contractor because he wants to work autonomously, because he places a low value on fringe benefits (e.g., health insurance), because that is the only way the business will hire him, or for other reasons.

From a tax perspective, a worker may prefer being classified as an independent contractor as opposed to an employee because employee business expenses are deductible only as itemized deductions and are subject to a 2% floor of adjusted gross income. In contrast, an independent contractor may be able to deduct expenses as ordinary and necessary business expenses on Schedule C (Form 1040). Also, the deductions and/or benefits available to the independent contractor under a self-employed pension (Keogh) plan might be preferable to the benefits that would be available under the pension plan (if any) of the company receiving the services.

In order for a corporation to use independent contractors they must meet the criteria used by the IRS to determine whether an independent contractor is, in fact, an employee. There are three main areas and 11 factors the IRS analyzes in order to determine the difference between an employee and an Independent Contractor.

The IRS examines Behavioral Control, Financial Control, and Type of Relationship:

Behavioral Control –

  1. Instructions the business gives the worker.
  2. Training the business gives the worker.

Financial Control --

  1. The extent to which the worker incurs business expenses which are not reimbursed.
  2. The amount of the worker's investment.
  3. The degree to which the worker makes services available to the relevant market.
  4. How the business pays the worker. (While most Independent Contractors are paid by the job, it is common practice for certain types of professions, such as law, to be paid hourly.)
  5. The extent to which the worker can realize a profit or incur a loss.

Type of Relationship --

  1. Is there a written contract describing the relationship the parties intended to create?
  2. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
  3. The permanency of the relationship
  4. The degree to which services performed by the worker are a key aspect of the regular business of the company

Spiegel & Utrera, P.A. is ready to draft an independent contractor agreement for your corporation to use with its independent contractors. The agreement will:

Caveat: It is very difficult to overcome the IRS’s requirements. At Spiegel & Utrera, P.A. many of our clients overcome the criteria set forth by the IRS by insisting that their independent contractor incorporate before they begin doing business with them. After incorporation of your independent contractor, you will be contracting with a business entity rather than an individual, thus avoiding the necessity of employment tax and wage withholding, and more importantly, avoiding the IRS test!

"Employee or Independent Contractor?"

The IRS’s 11 Factor Criteria with Industry Examples

An employer must generally withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.

Common-law rules.
To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. All evidence of control and independence must be considered. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.

Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties as shown below.

Behavioral control.
Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include:

The type and degree of instructions the business gives the worker. An employee is generally subject to the business' instructions about when, where, and how to work. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

Financial control.
Facts that show whether the business has a right to control the business aspects of the worker's job include:

The extent to which the worker incurs business expenses which are not reimbursed. Independent contractors are more likely to have non-reimbursable expenses than employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur non-reimbursable expenses in connection with the services they perform for their business. The extent of the worker's investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not required. The extent to which the worker makes services available to the relevant market. How the business pays the worker. An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job. However, it is common in some professions, such as law, to pay independent contractors hourly. The extent to which the worker can realize a profit or incur a loss. An independent contractor can make a profit or loss.

Type of relationship.
Facts that show the parties' type of relationship include:

Written contracts describing the relationship the parties intended to create. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee relationship. The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.

If you prefer to have the IRS determine whether a worker is an employee, file Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.

Industry Examples:

The following examples may help you properly classify your workers.

Building and Construction Industry

Example 1. Jerry Jones has an agreement with Wilma White to supervise the remodeling of her house. She did not advance funds to help him carry on the work. She makes direct payments to the suppliers for all necessary materials. She carries liability and workers' compensation insurance covering Jerry and others he engaged to assist him. She pays them an hourly rate and exercises almost constant supervision over the work. Jerry is not free to transfer his assistants to other jobs. He may not work on other jobs while working for Wilma. He assumes no responsibility to complete the work and will incur no contractual liability if he fails to do so. He and his assistants perform personal services for hourly wages. They are employees of Wilma White.

Example 2. Milton Manning, an experienced tile setter, orally agreed with a corporation to perform full-time services at construction sites. He uses his own tools and performs services in the order designated by the corporation and according to its specifications. The corporation supplies all materials, makes frequent inspections of his work, pays him on a piecework basis, and carries workers' compensation insurance on him. He does not have a place of business or hold himself out to perform similar services for others. Either party can end the services at any time. Milton Manning is an employee of the corporation.

Example 3. Wallace Black agreed with the Sawdust Co. to supply the construction labor for a group of houses. The company agreed to pay all construction costs. However, he supplies all the tools and equipment. He performs personal services as a carpenter and mechanic for an hourly wage. He also acts as superintendent and foreman and engages other individuals to assist him. The company has the right to select, approve, or discharge any helper. A company representative makes frequent inspections of the construction site. When a house is finished, Wallace is paid a certain percentage of its costs. He is not responsible for faults, defects of construction, or wasteful operation. At the end of each week, he presents the company with a statement of the amount he has spent, including the payroll. The company gives him a check for that amount from which he pays the assistants, although he is not personally liable for their wages. Wallace Black and his assistants are employees of the Sawdust Co.

Example 4. Bill Plum contracted with Elm Corporation to complete the roofing on a housing complex. A signed contract established a flat amount for the services rendered by Bill Plum. Bill is a licensed roofer and carries workers' compensation and liability insurance under the business name, Plum Roofing. He hires his own roofers who are treated as employees for Federal employment tax purposes. If there is a problem with the roofing work, Plum Roofing is responsible for paying for any repairs. Bill Plum, doing business as Plum Roofing, is an independent contractor.

Example 5. Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs additional electrical installations under contracts with other companies, which she obtained through advertisements. Vera is an independent contractor.

Trucking Industry

Example. Rose Trucking contracts to deliver material for Forest Inc. at $140 per ton. Rose Trucking is not paid for any articles that are not delivered. At times, Jan Rose, who operates as Rose Trucking, may also lease another truck and engage a driver to complete the contract. All operating expenses, including insurance coverage, are paid by Jan Rose. All equipment is owned or rented by Jan, and she is responsible for all maintenance. None of the drivers are provided by Forest Inc. Jan Rose, operating as Rose Trucking, is an independent contractor.

Computer Industry

Example. Steve Smith, a computer programmer, is laid off when Megabyte Inc. downsizes. Megabyte agrees to pay Steve a flat amount to complete a one-time project to create a certain product. It is not clear how long it will take to complete the project, and Steve is not guaranteed any minimum payment for the hours spent on the program. Megabyte provides Steve with no instructions beyond the specifications for the product itself. Steve and Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to pay Federal and state taxes, and receives no benefits from Megabyte. Megabyte will file a Form 1099-MISC. Steve does the work on a new high-end computer which cost him $7,000. Steve works at home and is not expected or allowed to attend meetings of the software development group. Steve is an independent contractor.

Automobile Industry

Example 1. Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works 6 days a week and is on duty in Bob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob also pays the cost of health insurance and group-term life insurance for Donna. Donna is an employee of Bob Blue.

Example 2. Sam Sparks performs auto repair services in the repair department of an auto sales company. He works regular hours and is paid on a percentage basis. He has no investment in the repair department. The sales company supplies all facilities, repair parts, and supplies; issues instructions on the amounts to be charged, parts to be used, and the time for completion of each job; and checks all estimates and repair orders. Sam is an employee of the sales company.
 
Example 3. An auto sales agency furnishes space for Helen Smith to perform auto repair services. She provides her own tools, equipment, and supplies. She seeks out business from insurance adjusters and other individuals and does all the body and paint work that comes to the agency. She hires and discharges her own helpers, determines her own and her helpers' working hours, quotes prices for repair work, makes all necessary adjustments, assumes all losses from uncollectible accounts, and receives, as compensation for her services, a large percentage of the gross collections from the auto repair shop. Helen is an independent contractor and the helpers are her employees.

Attorney

Example. Donna Yuma is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research linkup, fax machine, and photocopier. Donna buys office supplies and pays bar dues and membership dues for three other professional organizations. Donna has a part-time receptionist who also does the bookkeeping. She pays the receptionist, withholds and pays Federal and state employment taxes, and files a Form W-2 each year. For the past 2 years, Donna has had only three clients, corporations with which there have been longstanding relationships. Donna charges the corporations an hourly rate for her services, sending monthly bills detailing the work performed for the prior month. The bills include charges for long distance calls, on-line research time, fax charges, photocopies, mailing costs, and travel, costs for which the corporations have agreed to reimburse. Donna is an independent contractor.

Taxicab Driver

Example. Tom Spruce rents a cab from Taft Cab Co. for $150 per day. He pays the costs of maintaining and operating the cab. Tom Spruce keeps all fares he receives from customers. Although he receives the benefit of Taft's two-way radio communication equipment, dispatcher, and advertising, these items benefit both Taft and Tom Spruce. Tom Spruce is an independent contractor.

Salesperson

To determine whether salespersons are employees under the usual common-law rules, you must evaluate each individual case. If a salesperson who works for you does not meet the tests for a common-law employee, discussed earlier, you do not have to withhold income tax from his or her pay. However, even if a salesperson is not an employee under the usual common-law rules, his or her pay may still be subject to social security, Medicare, and FUTA taxes. To determine whether a salesperson is an employee for social security, Medicare, and FUTA tax purposes, the salesperson must meet all eight elements of the statutory employee test. A salesperson is an employee for social security, Medicare, and FUTA tax purposes if he or she:

  1. Works full time for one person or company except, possibly, for sideline sales activities on behalf of some other person,
  2. Sells on behalf of, and turns his or her orders over to, the person or company for which he or she works,
  3. Sells to wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments,
  4. Sells merchandise for resale, or supplies for use in the customer's business,
  5. Agrees to do substantially all of this work personally,
  6. Has no substantial investment in the facilities used to do the work, other than
  7. in facilities for transportation,
  8. Maintains a continuing relationship with the person or company for which he or she works, and Is not an employee under common-law rules.
Order an Independent Contractor Agreement

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