Independent contractor or employee?

[DavidEBSmith]

Assume you had a profession in which the question "are you an independent contractor or any employee?" could go either way. Assume also that someone wanted to pay you to engage in that profession, and could classify you as either.

 

Which would you rather be classified as - independent contractor or employee?

 

There's an obvious question of SE tax vs. FICA deductions.

 

There's the question of ownership of work product and work-for-hire but lets assume the prospective employer is willing to be flexible and agreeable on that.

 

There's the question of client development and customer referrals, but the prospective employer is agreeable to you having your own independent client base outside the employment relationship. Clients developed through the employer would belong to the employer, clients developed privately would be yours.

 

Professional liability & insurance is a concern but in this case it ends up being the same either way.

 

 

What else would factor into your decision?

 

[ShovelStrokeEd]

Non-disclosure and no competition clauses have always been the sticking point for me on this stuff.

 

I'm getting ready to enter into a similar relationship with my current employer. I'll retire from full time work in another year or so but we are negotiating some contract work to keep my hand in and do some additional stuff as well.

 

We are not going to have any problems as this has been a long-term, 12+years, relationship and has been very cordial.

[Bob Palin]

Rate of pay is a big consideration. Though for the last few years I have been making an hourly rate that works out to be about the same as my corporate salary I am netting quite a bit less. SE tax, medical coverage, paid vacations, equipment and tools all make quite a dent in my self-employment income. And I got matching 401K, stock options and sometimes profit sharing from the corporation, education benefits too.

 

On the other hand I work when I want to where I want to, which is worth quite a bit after 25 years in a cube.

[Dave McReynolds]

As a CPA, I've always viewed this as more of a risk for the employer than for the employee. If it "could go either way," then it is possible that if the "independent contractor" became injured on the job or was let go, he could apply for workers comp or unemployment compensation. In California, EDD would then make a determination as to whether the person was an independent contractor or an employee based on all the facts and circumstances, one of which would be the existence of a contract. But a signed contract in itself is not determinative; their decision would be based on the extent of control over the person being employed, based on many factors. If EDD determined that the person was in fact an employee, and the employer had not paid unemployment or worker's comp, he would be in deep $hit. The feds would make a similar determination, which could result in assessment of unpaid SS taxes, etc.

 

Someone might prefer to be an independent contractor because they could file a business schedule with their tax return (Schedule C), which would allow them to claim their business expenses as a direct offset to their business income. An employee must claim business expenses as a misc itemized deduction, subject to a 2% floor and often causing alternative minimum tax. Also, an independent contractor may be able to defer more earnings into a retirement plan than an employee could. An independent contractor can incorporate and his corporation could elect to cover him and his family under a medical reimbursement plan, greatly enhancing his medical deductions. Sometimes income can be split between a corporation and the individual, resulting in lower overall income taxes.

 

Assuming there is valid support for paying the person as an independent contractor, it is vitally important to issue 1099's on time. The penalties for failing to file a 1099 have been increased, and include losing the underlying deduction.

[Whip]

Someone might prefer to be an independent contractor because they could file a business schedule with their tax return (Schedule C), which would allow them to claim their business expenses as a direct offset to their business income. An employee must claim business expenses as a misc itemized deduction, subject to a 2% floor and often causing alternative minimum tax. Also, an independent contractor may be able to defer more earnings into a retirement plan than an employee could. An independent contractor can incorporate and his corporation could elect to cover him and his family under a medical reimbursement plan, greatly enhancing his medical deductions. Sometimes income can be split between a corporation and the individual, resulting in lower overall income taxes.

 

 

What he said...

[upflying]

I was an independent contractor for a few years after I retired. It's an easy way for an employer to hire someone without actually hiring you. "Employer" avoids payroll witholding, social security, disability insurance and paying you benefits. You just get a 1099 and you figure out the taxes.

I figured 50% on my gross income went to taxes as an IC. You definitely need to pay estimated taxes if you are getting income this way.

[Dave McReynolds]

As Bob said, you need to gross up your fees for employer paid taxes and benefits. In addition, employees usually get paid for attending meetings, admin chores, and a certain amount of standby time, which you will need to build into your basic rate, since you may not be able to bill for these things as an independent contractor. I figure you should bill for about 3X the rate you would otherwise get paid as an employee to come out even or maybe a little ahead. Of course, the employer may not be willing to pay that, and then you just have to decide if it's worth it.

[Tom R.]

Something to think about - Congress adjourned last year without taking action on The Fair Playing Field Act of 2010 (FPFA) which would have put the Independent Contractor status in jeopardy. And, with the current makeup, it is unlikely that any similar legislation will move forward in the 112th Congress. However, if you are contemplating a long term arrangement, this issue could resurface.

 

 

[Bob Palin]

Something to think about - Congress adjourned last year without taking action on The Fair Playing Field Act of 2010 (FPFA) which would have put the Independent Contractor status in jeopardy. And, with the current makeup, it is unlikely that any similar legislation will move forward in the 112th Congress. However, if you are contemplating a long term arrangement, this issue could resurface.

 

I was a bit concerned about my IC status a few years ago so I formed an LLC, really easy to do and as long as you do everything in the LLC's name there doesn't seem to be any question of status.

[Dave McReynolds]

Something to think about - Congress adjourned last year without taking action on The Fair Playing Field Act of 2010 (FPFA) which would have put the Independent Contractor status in jeopardy. And, with the current makeup, it is unlikely that any similar legislation will move forward in the 112th Congress. However, if you are contemplating a long term arrangement, this issue could resurface.

 

I was a bit concerned about my IC status a few years ago so I formed an LLC, really easy to do and as long as you do everything in the LLC's name there doesn't seem to be any question of status.

 

I'm not so sure of that, assuming you formed a single-member LLC which is a disregarded entity for tax purposes. Since it is a disregarded entity, the IRS (and certainly California, since CA is more aggressive on this issue than the IRS - can't speak for Utah) would still look at the factors to determine whether the balance of control tilted in favor of independent contractor or employee.

 

OTOH, if you formed a corporation and were an employee of your own corporation, it would be a significant factor in your favor as an independent contractor.

 

However, from what I understand about your circumstances, you work remotely in Utah, probably set your own hours, probably work in your dirty underwear, for all I know. I doubt the people you contract with have much control over you, so you're probably an independent contractor, regardless.

[Twisties]

...probably work in your dirty underwear, for all I know.

 

Or worse, and he kept a scanner bedside too... Janet has straightened him out though. He's only about as independent as a Billy Goat now.

 

 

 

Utah uses a similar set of factors to make a determination as you have described Dave.

[Bob Palin]

I doubt the people you contract with have much control over you, so you're probably an independent contractor, regardless.

There can't be much doubt about my status in the latest contract, I sometimes didn't even speak with my customer for weeks on end. Before that though it might have been an issue as I was working on the same product as I had been for the corporation, albeit now owned by a different corporation, and for my old boss as well! It was actually at their urging that I formed the sole-proprietorship LLC, their lawyers seemed to think it would help (I'm an engineer not a lawyer or accountant so nobody should take my word for it).

 

Right now I'm working all hours solely for myself with no income at all, I have a little timer clock on my desk that is a hard taskmaster, it's not running right now but it's making me feel guilty...

[Bud]

I worked for the Illinois Department of Employment Security for a lot of years and retired as Revenue Manager.

 

We did a lot of audits which determined that the IC's in fact were employees under Section 212 of the Illinois Unemployment Insurance Act. I can not speak for any other state.

 

I would advise anyone who has any doubt as to their status consult with someone who specializes in employment law in their state.

 

To the state, it doesn't matter what the parties call the arrangement, that is not controlling. The facts are examined and compared to the three part requirement of the Act.

 

If it is determined that the so called IC was an employee, we went back 4 years and assessed back taxes and interest. In addition, we reported to the Feds so they followed up with taxes of their own.

 

There certainly are true Independent Contractors and they meet the test. There are a lot of folks who think they are, and, in fact don't meet the test and therefore are not for tax purposes.

 

As an employee of the Department, I had no vested interest in the outcome. It made absolutely no difference to me if someone was or was not an IC.

 

As a potential employer, be advised that some of those who said they were an IC went to the Unemployment Office and filed a claim as soon as their income stopped. They wanted Unemployment Insurance benefits.

 

In lay terms the three parts are: 1. Free from direction and control, 2. Outside the usual course of business and 3. Be independently established in a trade, profession or occupation.

 

The funniest case I can remember was a strip club. They made all of their dancers become IC's or they couldn't dance. They argued that it was outside the usual course of business of a strip club to have dancers. Of course, they lost.

 

But right now I am just looking forward to kayaking tomorrow and seeing some large alligators in S. Florida.

 

Pictures at 11.

[Francois_Dumas]

Rate of pay is a big consideration. Though for the last few years I have been making an hourly rate that works out to be about the same as my corporate salary I am netting quite a bit less. SE tax, medical coverage, paid vacations, equipment and tools all make quite a dent in my self-employment income. And I got matching 401K, stock options and sometimes profit sharing from the corporation, education benefits too.

 

On the other hand I work when I want to where I want to, which is worth quite a bit after 25 years in a cube.

 

+1

 

You'll probably 'net' a lot less, but have your 'freedom' to starve to death :-)

 

I prefer to starve in freedom.

[BFish]

fellow CPA dave has touched on all the points. both of you need to be aware of the IRS procedures for determinging status. as dave pointed out, the employer is most at risk.

 

it's not a black and white issue. an LLC treated as a disregarded entity is not a fail safe option.

 

the issue arises many times when the "employer" is audited by the state for routine payroll or unemployment matters. the taxing authority looks at all payments to non-employees specifically to determine if an IC is possibly an employee. the IRS joins the party should the state decide a reclass is necessary. Bud's comments support this.

 

just be careful and do your research.

[steve.foote]

Brian, as I understand it in Georgia, a person can't be considered an IC if they work exclusively for one company in a full-time capacity. I don't know where the limits are to be considered 'full-time' but it is a potential flag for payroll tax authorities. We have looked at hiring technicians as contractors and our accountant recommended against it.

[BFish]

Brian, as I understand it in Georgia, a person can't be considered an IC if they work exclusively for one company in a full-time capacity. I don't know where the limits are to be considered 'full-time' but it is a potential flag for payroll tax authorities. We have looked at hiring technicians as contractors and our accountant recommended against it.

 

if an IC only has one customer it could be problematic. in that situation the IC entity (i.e. corp. LLC, individual, etc) MAY be helpful/detrimental. also, the professional status of the IC. i.e. licensed, practicing atty, cpa, etc would stand a better chance than a receptionist. extreme example, but illustrates the point.

 

also, a red flag to go from employee to IC. the opposite can and does happen, but even the past IC classification will be scrutinized.

 

in your situation should you need subcontractors to fulfill a large or lengthy contract, are not supervised or controlled by you, you'd prolly be ok. i'd want them to be incorporated, have other customers, etc. as individuals to fill manpower needs i agree with your accountant.

 

[upflying]

One common IC example are newspaper delivery people who are "employees" for a publisher. They work part-time, seven days a week and deliver papers to subscribers on their doorstep.

That occupation is now being threatened due to on-line access to news.

[Green RT]

This isn't the OP's problem, but employers need to be very careful with treating people as independent contractors. States are aggressive at questioning that determination. I had a friend whose business received a big fine for treating her 50 or 60 part-timers as contractors. It seemed like a legitimate choice given the nature of their work, but California didn't agree.

[sgendler]

I had a company insist that I work as an IC, despite the fact that I worked for them full-time (and then some), was required to work from their office, and they refused to pay an hourly rate, insisting that my contract be flat rate (ie: salary). I also had to actually sign a timesheet every week, despite working for a flat rate, and then submit an 'invoice' for the flat rate amount. Of course, I got no benefits, no PTO, and no overtime, and had to pay both halves of the payroll tax. They eventually spun my project out as a company and hired me as an employee (for the same flat rate, effecting a raise equal to half the payroll tax) and then when the new company ran out of money, they attempted to force me to do work for them for free after a (flaky and not at all trustworthy) investor offered more money if we could reach a sales milestone which required certain features. They contacted me repeatedly (after laying me off the day AFTER I closed on my first house) and made veiled threats about blacklisting me in the local economy - a threat they may have carried out, but I don't know since I've been working with a friend on our own project since leaving.

 

I went into the project with my eyes open to what they were doing and wasn't particularly concerned, since the spinout was always the intention, though it took far longer than they promised up front. But the attempt to force me into working for free (and they took abusive advantage of the flat-rate thing, too - my timesheets average 65 hours per week and would have been higher except that I sometimes just wrote down 9-6 for the sake of speed) has had me thinking about sending the Dept. of Labor after them. The spinout company is no longer a legal entity, but the spinout actually hired me as an employee, so didn't break the law. The company which hired me as a 'contractor' and financed the spinout is still very much a going concern. The question is just how hot I want to burn my bridges to a fairly influential company in the area (which is funded by Kleiner-Perkins, perhaps the most influential VC firm in silicon valley).

 

edit: I just had a look at my timesheets and they work out to 25 weeks at an average of 62 hours per week. That's 550 unpaid hours of overtime plus half of payroll tax for 6 months of work. Something tells me I probably ought to pursue it.

[BFish]

you could make life miserable for them.

[Twisties]

you could make life miserable for them.

 

But I doubt you'd get any back pay. Perfectly legal for an exempt employee to be on salary.

[Bob Palin]

Sam, while you are undoubtedly in the right the best thing to do is just to move on and focus on the present opportunity. You may be able to create considerable trouble for that company but it's unlikely that you'll get much financial compensation, maybe a refund of your SE tax but I bet the state/IRS doesn't make that easy!

 

Aggravation, even when financially cheap, is expensive in other ways. (I'm a past expert, hopefully past anyway)

[Gregori]

Regarding Sam:

OTOH - if they started the strong-arm tactics / blackmail threats to his livelihood, then he's really only protecting himself to pursue the compensation due him. If they've been trying to undercut his employability, having a documented dispute with them frames their badmouthing as more sour grapes than legitimate criticism.

Just my $.02... The local situation/dynamics/personalities might change the equation. That's something only Sam can gauge for sure.

 

While back-wages for 'overtime' to a salaried employee is probably not recoverable, the relief from tax liability MIGHT be substantial.

 

 

To the OP: In my opinion, it's generally not to the advantage of the 'employee' to be an independent contractor. It's easier for the employer (if they play it properly) which is why they like to do it.

 

If it were me - if (after carefully calculating it out) the compensation works out to be essentially the same net either way, I'd go the employee route. Aside from moving a lot of the bookkeeping workload and responsibility to the company, there are other considerations (unemployment, workers comp are the biggies.)

The fact that "it could go either way" is a big red flag for me. (And probably for the IRS/state as well.)

 

If you're kept busy by the company, how likely are you to be able to have 'privately developed' clients?

If a company-owned client steered you other customers - do those new clients belong to you, or your employer? How about if your contact at a company-owned client moves to a different firm and hires you from there?

 

I've worn that hat, and it can get very sticky. In my case, I was fortunate - when we parted ways, the agency I worked with (for?) ultimately said that they only wanted to retain the clients to whom they DIRECTLY sent me. We also negotiated a referral fee for the clients of theirs who wished to continue a working relationship with me.