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Old 03-06-2011, 11:47 AM
 
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I was asked by a former colleague to do some temp work at her new firm, but it seems they want me to submit invoices for my services rather than hiring me via payroll.

I have no clue where to start with what I need to do to become an independent contractor from a legal and fiscal standpoint, can anyone help me? Thanks!
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Old 03-06-2011, 04:38 PM
 
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This is an area of employment that has gotten a lot of scrutiny by the Fed in the last few years, because so many employers abused the reg's to avoid the reporting/witholding taxes associated with employees.

There are several means tests which must all be met to be truely "independent" as a contractor.

As a general qualifier ... if you haven't set up and are in business to provide the services which your colleague is asking you to do at "her new firm", you've already demonstrated that you're not "independent".

If you work her assigned tasks during regular business hours at her place of business, you're an employee. Does she provide materials, computers, resources to accomplish your tasks? or, do you supply all of those items to accomplish your work product? Do you itemize and bill her for those items? Another way of looking at this is are you being directed or told what to do, or are you being asked to use your creativity and independence of work product to accomplish results that her business requires?

Here's an example of the difference: If I ask you to build a bunch of cubicles in an office to my specification/design, and you give me a BID estimate for materials, labor, inspection fees/permits that you obtain for the work, finishing materials and installation disposables, using your supplied tools and equipment to accomplish the finished work done at your schedule consistent with the outage that the office can provide ... and you have your own sales tax account number with your state (and any local taxing authorities) so that you collect and submit sales taxes as a business from the taxable items supplied to her ... you're hitting the key points of being an "independent contractor". Note that you must comply with all of these aspects, not just one or two ... you've really got to be "independent" as to the scope of the project and the results desired to be an "independent contractor" and paid on an invoice for services/supplies/materials rendered. Another aspect of establishing "independency" is that you have purchased any and all materials & supplies for the project, including your clothing, protective gear, fuel and vehicle as a business expense to get to the place for the project, supply your own business communications/phone, and so forth. Independence means just that ... you bear all of the expense to provide your services, and provide you own place of business independently from her place of business (could be your home based business, but be careful about running into zoning requirements ...).

Now, OTOH, if she asks you to build cubicles in her office and says she'll pay you an hourly wage to do so on your own schedule of time/place for the project, but she supplies the materials, design/layout, obtains the building permits, misc materials, pays sales tax to others for the project ... you've crossed into a very gray area of whether or not you're an independent labor contractor. If you haven't offered such services to other businesses, and don't have your own tools/equipment to do the work ... it's not quite so clear cut anymore. The difference here is that you're now being paid to do tasks as directed by the employer and no longer fully independent. Another key aspect is that you're compensated by the hour as opposed to the project.

Let's try this from another standpoint of tests ... for example, it's strictly an intellectual work product that you need to create for her. If you do this on her equipment (computers?) using her company data sources, during her office hours (so that you are told when/where to report for work) ... you've really established that you are an employee. OTOH, if she says "I want you to design a logo for me" and you give her a Bid price to do so ... and you work out of your own office at your own schedule using your own equipment ... you've crosssed back into an independent business relationship and she can pay you for the project and 1099 you at year end.

Do you have your own business cards? A business name checking account? A DBA or business trade name on file with your sec'y of state? Do you advertise your services? All of these things are suggestive of an independent business, rather than an individual who is an employee ... although not necessarily all that it takes to comply as an independent relationship.

For the most part, what I've seen in the past few years is if there is any doubt whatsoever about your completely legitimate establishment of an independent business relationship providing goods and services to another business ... the Fed will classify you as an employee. Even if you and she agree that you are "independent" and choose to be paid that way, if the Fed finds differently, you and she will be subject to all the taxes/witholding and penalties for not having filed appropriately.

Since you've not disclosed what the nature of the work product is that you are being asked to produce, it's difficult to tell you at this point what exactly it would take to establish you ... if it is posssible ... as an "independent contractor". If you would post that, we can home in a little bit more closely about how you might go about this rather than speaking in generalities.

Of course, the best advice you can get if it's a little bit of a "gray" area for your business relationship to your colleague would be to contact your accountant. BTW, that's another indication that you are really independent ... that you have a business accountant, as opposed to your "personal" accountant.

Last edited by sunsprit; 03-06-2011 at 04:55 PM..
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Old 03-06-2011, 05:00 PM
 
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All of the risk of this status is on your employer, not you. Ther eis nothing bad that can happen to you other than the fact that it is you who is liable for payroll taxes such as the 15.3% self employment tax. You get no benefits or insurance coverages. Don't worry about it if you have considered the economic disadvantage of paying the employer share of social security (the consequence of self employment tax). You'll get a 1099 and report your income on Schedule C Form 1040.

If someone gets audited and you get reclassified, you'll get money back from the IRS.
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Old 03-06-2011, 05:21 PM
 
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Originally Posted by wilson1010 View Post
All of the risk of this status is on your employer, not you. Ther eis nothing bad that can happen to you other than the fact that it is you who is liable for payroll taxes such as the 15.3% self employment tax. You get no benefits or insurance coverages. Don't worry about it if you have considered the economic disadvantage of paying the employer share of social security (the consequence of self employment tax). You'll get a 1099 and report your income on Schedule C Form 1040.

If someone gets audited and you get reclassified, you'll get money back from the IRS.
I'll disagree with you on your assessment that "nothing bad that can happen to you" ...

Fact is, the burden is heavily upon you to prove to the IRS that you were, in fact, an independent business when you accepted payment as an independent contractor. Ignorance of the tax codes to say you are "independent" is no defense ... you are representing to the IRS that you are a legitimate business. If, in fact, it's clear that you aren't, you've got a bunch of "splaining to do". These aren't people you want to mess with these days ... they've made a big deal about the abuse of this type of employer/employee relationship over the last decade and they've lost their sense of humor, if not tolerance. The burden is as strongly upon you in your misrepresentation as it is upon the business that paid you improperly.

Hypothetically, if you accept the position on an independent basis, and you are responsible for the total witholding ...

and the Fed later determines that you were really an employee ...

you've paid them the employer's contribution (matching funds) for the FICA, etc, which wasn't your responsibility in your timely tax deposits.

If your friend goes out of business and doesn't pay their matching funds, the Fed will be very happy to keep your money. That's over 7% of what you earned.

Wouldn't be the first time I've seen employers go upside down on tax liabilities. For example, we have a regionally famous bakery that just got padlocked last week for over $26,000 in unpaid Fed taxes. The auction is scheduled for a couple of weeks from now ... and is unlikely to bring in enough money to cover their tax liability. The owner is bankrupt ... he already narrowly escaped being shut down by the State last month when they came after him for $12,000 of back taxes, which he scraped together.

The guy knew he was upside down financially early last month and was still accepting deposits from people for wedding cakes ($500 + deposits) early last week, knowing that he would never be able to deliver the product. "he's sorry", quotes the newspaper ... but there's no money left.

Keep in mind that if you are part of an obvious deception to the Fed on your independent business status, you'll be waving a red flag in their face as to your other tax situations. Do you really want to have the IRS breathing down your neck, looking at tax audits? Do you really think that you'll go through an audit at no cost to you? These folks get triggered from stuff as simple as arithmatical mistakes on your return ... give them some real fodder to get their attention and they are pro's at making your life less than a pleasure.

Questions, OP: Just how well do you know this former colleague of yours with their new business? Are you willing to throw your financial situation into her hands? Do you really want to be part of a scheme to defraud your state out of their UI and WC monies? Typically, the reason why a "new business" owner tries to hire folk on an "independent contractor basis" is because they don't have the money to pay all the UI and WC and business employee insurance and the employer witholding tax contributions ....

You need to look very closely at what it is you're being asked to do. The first "tip off" to me that your former associate is trying to play loose with the rules is that they've approached you about doing something that you haven't represented yourself to do as an independent business in the past. Plus, they're leaving it up to you to figure out how to make it work for you and them ... or you wouldn't be on this forum asking questions, she'd have walked you down to her accountant and figured out how to set up this business relationship on HER DIME rather than burdening you.

Last edited by sunsprit; 03-06-2011 at 06:33 PM..
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Old 03-06-2011, 07:10 PM
 
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By new firm I meant her new employer, which isn't about to go bankrupt anytime soon. It's a privately held but reasonably sized investment bank. They're not going bankrupt or trying to avoid taxes.

When we worked together previously, I was hired as a long term temp through an agency. As I took time off to have a baby I'm no longer registered with my previous agency but she wants to hire me anyway, and they preferred to hire me directly and pay me more rather than pay the 60% markup. But rather than have me as an hourly employee they want me to submit invoices.
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Old 03-06-2011, 07:25 PM
 
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Quote:
Originally Posted by sunsprit View Post
I'll disagree with you on your assessment that "nothing bad that can happen to you" ...

Fact is, the burden is heavily upon you to prove to the IRS that you were, in fact, an independent business when you accepted payment as an independent contractor. Ignorance of the tax codes to say you are "independent" is no defense ... you are representing to the IRS that you are a legitimate business. If, in fact, it's clear that you aren't, you've got a bunch of "splaining to do". These aren't people you want to mess with these days ... they've made a big deal about the abuse of this type of employer/employee relationship over the last decade and they've lost their sense of humor, if not tolerance. The burden is as strongly upon you in your misrepresentation as it is upon the business that paid you improperly.

Hypothetically, if you accept the position on an independent basis, and you are responsible for the total witholding ...

and the Fed later determines that you were really an employee ...

you've paid them the employer's contribution (matching funds) for the FICA, etc, which wasn't your responsibility in your timely tax deposits.

If your friend goes out of business and doesn't pay their matching funds, the Fed will be very happy to keep your money. That's over 7% of what you earned.

Wouldn't be the first time I've seen employers go upside down on tax liabilities. For example, we have a regionally famous bakery that just got padlocked last week for over $26,000 in unpaid Fed taxes. The auction is scheduled for a couple of weeks from now ... and is unlikely to bring in enough money to cover their tax liability. The owner is bankrupt ... he already narrowly escaped being shut down by the State last month when they came after him for $12,000 of back taxes, which he scraped together.

The guy knew he was upside down financially early last month and was still accepting deposits from people for wedding cakes ($500 + deposits) early last week, knowing that he would never be able to deliver the product. "he's sorry", quotes the newspaper ... but there's no money left.

Keep in mind that if you are part of an obvious deception to the Fed on your independent business status, you'll be waving a red flag in their face as to your other tax situations. Do you really want to have the IRS breathing down your neck, looking at tax audits? Do you really think that you'll go through an audit at no cost to you? These folks get triggered from stuff as simple as arithmatical mistakes on your return ... give them some real fodder to get their attention and they are pro's at making your life less than a pleasure.

Questions, OP: Just how well do you know this former colleague of yours with their new business? Are you willing to throw your financial situation into her hands? Do you really want to be part of a scheme to defraud your state out of their UI and WC monies? Typically, the reason why a "new business" owner tries to hire folk on an "independent contractor basis" is because they don't have the money to pay all the UI and WC and business employee insurance and the employer witholding tax contributions ....

You need to look very closely at what it is you're being asked to do. The first "tip off" to me that your former associate is trying to play loose with the rules is that they've approached you about doing something that you haven't represented yourself to do as an independent business in the past. Plus, they're leaving it up to you to figure out how to make it work for you and them ... or you wouldn't be on this forum asking questions, she'd have walked you down to her accountant and figured out how to set up this business relationship on HER DIME rather than burdening you.

Just about everyting you have posted is wrong. I barely know where to start.

Let's start with the most important item. If the IRS reclassifies the "IC" as an "Employee" the withholding obligation is not on the employee it is on the employer. And, it is possible, likely even, that the IRS will credit the income tax withholding that the Employee should have had withheld without it coming out of her check. And she would then get credit for the withholding tax that was not actually withheld and it will be refunded to her. That is what they are supposed to do to the employer. And they will certainly refund half of the self employment tax. Want to see the IRM references for this? I've only been doing this as a CPA and tax attorney for 40 years.

The rest of your rhetorical questioning is just upside down. And, the issue about whther she is an employee or not is a complex one. We don't have close to enough facts to make that call. The good news is that we don't have to. Go with it OP, its their problem. Just make sure the amount on your Schedule C equals the 1099 they give you and while you're at it, ask them to raise your pay about 10% to cover your additional taxes (both halves of self employment/social security) that you will have to pay as described above.
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Old 03-06-2011, 07:30 PM
 
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Originally Posted by chicagojlo View Post
By new firm I meant her new employer, which isn't about to go bankrupt anytime soon. It's a privately held but reasonably sized investment bank. They're not going bankrupt or trying to avoid taxes.

When we worked together previously, I was hired as a long term temp through an agency. As I took time off to have a baby I'm no longer registered with my previous agency but she wants to hire me anyway, and they preferred to hire me directly and pay me more rather than pay the 60% markup. But rather than have me as an hourly employee they want me to submit invoices.
Thanks for your clarification. It's not uncommon for a company to use the services of a "long term temp" through an agency and then decide that they'd like to have that person on staff as a hired employee. Typically, the company then pays a modest fee to the temp agency for the personnel services.

If your services are at their place of business during their regular business hours using their equipment and they assign you tasks to complete and pay you hourly, you're an employee, not a contractor. Another key test would be if you are supervised by their employees.

What type of services/work product does the bank want you to perform?
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Old 03-06-2011, 08:20 PM
 
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I'll be helping out their accounting department with a backlog of work they have initially, but there is a possibility of it turning into a permanent employee position if I play my cards right. I actually have senior management experience in the international banking industry but in this country I'm not hirable on paper because I don't have the necessary qualifications. It's an unfortunate situation.
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Old 03-06-2011, 09:12 PM
 
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Originally Posted by chicagojlo View Post
I'll be helping out their accounting department with a backlog of work they have initially, but there is a possibility of it turning into a permanent employee position if I play my cards right. I actually have senior management experience in the international banking industry but in this country I'm not hirable on paper because I don't have the necessary qualifications. It's an unfortunate situation.
"helping out" sounds strongly like you'll be doing work under their direction, supervision, and on their premises.

This situation, especially where you acknowledge that you're "not hirable" because you don't "have the necessary qualifications" ... which I infer means an accounting degree or CPA or other professional level of independent service ... appears to be an employee situation, not that of an independent contractor.

The fact that they'd suggest that you could turn it into a "permanent employee position" alludes to them wanting to hire you on the cheap for now as an "independent contractor" and then convert you to a legitimate employee at a future time of their convenience ... if it's suitable for them to add you to their staff. In essence, they're acknowledging that you are performing employee work from the beginning ... since you acknowledge that they're not able to qualify you with professional level credentials, and it doesn't sound like you're doing a management function (which would be an employee job, not a contractor job).

Frankly, I'd be p'oed that an "investment bank" of some financial soundness would make an offer to work as an independent contractor to skirt the IRA regs and employee costs like this. These people have legal staff and accounting professionals who know better than to play these games ....
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Old 03-07-2011, 04:33 AM
 
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^^^^^This person is mistaken. For those who would like to know how IRS actually treats these cases, please read the following

Internal Revenue Manual - 4.23.8 Determining Employment Tax Liability

I particularly draw your attention to the following

4.23.8.5.3 (08-11-2009)
Employee's Liability Under IRC 3509


  1. The employee's liability for FICA tax under IRC 3101 is not affected by IRC 3509. The employer is not entitled to recover from the employee any part of the tax assessed under this section. Treas. Reg. § 31.3102–1(c) provides that an employee is responsible for the employee's share of FICA until it is collected from him or her by the employer. Since IRC 3509 bars the employer from collecting the tax from the employee, the employee remains liable for the FICA tax on their individual Form 1040 return. See Rev. Rul. 86-111, 1986-2 C.B. 176.
  2. The employee may file a claim for refund of any self-employment tax which is attributable to the reclassification. Notice 989, Commonly Asked Questions When IRS Determines Your Work Status is "Employee," provides instructions to the reclassified worker on how to file a claim for refund.
  3. The amount of SECA tax refund is offset by the amount of the employee's share of the tax imposed on the employee under IRC 3101 as a result of the application of Treas. Reg. § 31.3102–1(c). The reclassified worker can use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to compute the amount of FICA taxes due. It should be used as an attachment to Form 1040 or 1040X. Ultimate liability is on the employee until collected from either the employee or the employer. See Rev. Rul. 86–111. For example, if a worker paid self-employment tax on a net profit of $35,100 ($45,000 less $9,900 related business expenses) and during a subsequent examination of the payor, the IRS reclassified those earnings from self-employment income to gross wages of $45,000, the worker would be entitled to a SECA tax refund calculated as follows:
    $35,100 × 92.35% (Net earnings from SE) $ 32,415.00 $32,415 × 15.3% (SECA tax) $ 4,959.50 $45,000 × 7.65% (Employee FICA tax) $ 3,442.50 Allowable SECA tax refund $ 1,517.00

-----------------------------


And Notice 989 which can be found here:

www.irs.gov/pub/irs-pdf/n989.pdf

Last edited by Wilson513; 03-07-2011 at 05:05 AM.. Reason: Be even nicer than usual
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