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In times of growth small business owners have often had to determine whether they should outsource work to independent contractors or hire additional part time or full time employees. Now with the implementation of the Obama Patient protection and Affordable Care Act, entrepreneurs are looking to cut costs by hiring independent contractors instead of full or part time employees.
The Internal Revenue Service (IRS) always has something to say about how we spend our money and how much of it we get to keep. The determination of whether a worker is an employee or independent contractor is no different and the burden is on employers to verify the status of those workers, with an IRS assumption that everyone is an employee. In order to make the determination, the IRS has what we call the 20 Point Direct and Control IRS Test (the “IRS Test”) which is essentially as follows:
1. Is instruction given to the worker about how, when, and where the work is to be performed?
2. How much training is provided by the company/employer?
3. Are the services performed by the worker integrated with the company’s operations or not?
4. Is the worker required to perform the services personally, or not?
5. Does the worker supervise, hire, and pay his or her own assistants?
6. Is the relationship with the company a continuing relationship or is it infrequently recurring?
7. Does the worker set his or her own working hours?
8. Does the worker work full-time for the company?
9. Does the worker work at the company’s location or not?
10. Does the worker set or determine the steps in which the work will be performed?
11. Is the worker required to submit written or oral reports?
12. Is the worker paid by the job or by the week or month?
13. Is the worker reimbursed for business or traveling expenses?
14. Does the worker provide his or her own equipment and supplies to perform the work?
15. Has the worker invested in the facilities used for doing the work?
16. Will the worker realize a profit or loss as a result of performing the services?
17. Does the worker work for many different companies at the same time?
18. Are the worker’s services available to the general public on a regular basis?
19. Can the worker be fired or not, as long as he or she produces the requested work?
20. Is the worker able to terminate the relationship with the company until the work is complete?
A recent case in which the employer characterized the relationship with his workers as that of an independent contractor was recently decided in U.S. Tax Court (Atlantic Coast Masonry, Inc., August 2012). In that case, a company hired masons as independent contractors but the IRS charged that they were really employees and assessed the company $700,000 in back taxes. In some respects the workers acted as independent contractors as they provided their own tools and were free to work for other businesses. However, the company always delivered instructions to the workers prior to the commencement of a project and many of the workers performed masonry services exclusively for the company. The workers also worked a normal eight hour day, could be fired at will, and received weekly cash payments based upon their productivity. The Tax Court held in favor of the IRS finding that under the IRS Test, the workers were employees and not independent contractors and taxes should have been withheld by the company and paid to the IRS.
When a company decides to outsource work to independent contractors, it is essential that the IRS Test is used to structure the relationship. It is also essential that the relationship be clearly defined in a written agreement and that the company issue an IRS Form 1099 for services provided by any independent contractor in the taxable year.