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Independent Contractor vs. Employee: I Got You Under My Thumb ….

When an employer is confronted with the potential reclassification by federal or state taxing authorities of its “independent contractors” to “employees,” the outcome can have huge consequences for the employer. If reclassified, the taxing authority(ies) can seek backup withholding taxes for one or more years, as well as penalties and interest. There are non tax consequences as well, such as the failure to provide Workers Compensation insurance as mandated by state law. With so much riding on such a determination, it behooves employers to take a sober look at whether an “independent contractor” is really an employee.

A Practical Approach:

Does the independent contractor (IC) under scrutiny follow anindependent trade? Individuals such as physicians, lawyers, dentists, contractors, and subcontractors, who follow an independent trade, business, or profession in which they offer their services to the public, generally are not employees. Look up the definition of “independent” in the dictionary. Read it carefully. Read it several times. Is the IC under scrutiny really “independent?” Really? Think of your physician, your lawyer, and your dentist. No taxing authority would ever think of reclassifying your physician, your lawyer or your dentist as your “employee.” Of course they wouldn’t. Why would they? You have absolutely no control over them. In fact, except when you go to visit them, you really haven’t the slightest clue how they spend their day, how they do their work. In other words, they are completely “independent” of you.

Now, imagine on one end of the spectrum is your aforementioned physician, lawyer or dentist. On the other end is one of those happy Wal-Mart employees that we see on television commercials wearing those fashionable blue vests. The Wal-Mart employee, perhaps with the exception of what color socks to wear and what to eat, is told by his or her employor exactly what to do the entire day right down to when to take lunch, when to take a break, where to punch the time clock, and what days and hours to work. Now, as you move across this spectrum from the complete independence of the physician/lawyer/dentist to the utter absence of independence of the Wal-Mart employee, there is a point at which the IC under scrutiny no longer has sufficient independence to support his or her being treated as an independent contractor for tax purposes. Where this point is may be different in each case, but the basic premise of independence does not change.

Ask yourself. Does he or she truly have an independent trade in which they offer their services to the public?

  • Does he or she have a fictitious business name?
  • Does he or she even have a business card? Letterhead? Website?
  • Does he or she have an office? Even a home office?
  • Does he or she have a business license?
  • Does he or she have other clients? Even if they are not all currently active?
  • How many other clients? One, two, more?
  • Does he or she just happen to work at your place of business every day?

You see where I am going with this? These days some of the above items, such as a fictitious business name, business card, letterhead, business license, or even a website do not cost a lot of money. If someone is truly in an independent trade in which they offer their services to the public wouldn’t they at least have these items?

Bottom line, if you are an employer and you currently have independent contractors, don’t wait for the taxing authorities to come asking you these questions. Ask them yourself. Ask them now. Try to develop a “feel” for whether your independent contractors are in fact independent contractors for tax purposes. If not, start to develop a plan for what to do about it. The taxing authorities know what they will do …

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