Avoid Irs Grief By Ensuring ‘Helpers’ Are Truly Independent

Most entrepreneurs try to stay on the good side of the Internal Revenue Service. Onerous penalties can result from even unintentional “miscommunication” with the tax man, and straightening out a tax problem can consume hours of a venturer’s valuable time. But it’s not always easy to anticipate such problems. A case in point is the flap that has emerged in recent years concerning “independent contractors.”

Q: I have a number of people working for my firm, off the payroll, as independent agents. I’ve heard that the government is forcing some employers to pay Social Security and unemployment insurance for these types of workers. How can I tell if I should be doing this?

A: In the past few years the IRS has been aggressively enforcing their regulation concerning “independent contractors,” individuals who do work for a firm but are not technically classified as employees. This kind of worker has long been a major benefit to employers, and more firms are moving in the direction of such “non-employees” since they offer big advantages, viz. a simple form 1099 with no employee related taxes, no benefit or pension obligations, and, best of all, a pool of workers with a fresh, independent perspective.

However, off-payroll people who are really employees cost the government money in the form of lost taxes - between $1.5 and $2 billion a year. So the IRS has been trying to ferret out employees miscast as “independent contractors,” get them properly classified by the retaining firm, and collect past taxes not paid plus penalties and interest.

Accordingly, it is in your best interest as an employer to make sure that your outside “helpers” are truly independent.

There are a few guidelines that can help you maintain your workers as “independents”:

Do not force them to adhere to your instructions about when, where and how to work.

Try not to have them work on your premises.

Do not require them to participate in a training program.

Make sure you can terminate them - and that they can quit - without liability or obligation.

Allow them to have the authority to hire and supervise.

Try to pay them by the job, not the hour.

Have them furnish their own tools and equipment.

Keep them from being fully integrated into your employees’ normal work and social environment.

Don’t have them do jobs that have been routinely done by employees in the past.

Your IRS office should be able to provide you with a more detailed checklist and, of course, your accountant is familiar with these standards. Given the penalties for noncompliance, it’s better to be safe than sorry.

Q: I’m in the process of starting a new business, and have formed a corporation to protect me from personal liability. I’ve just heard that something called an “LLC” would be a better alternative. Is it?

A: All of the states in the Northwest have authorized “limited liability corporations” which offer most of the benefits of a corporation, but are treated as partnerships for tax purposes. Like S corporations, these entities are allowed to pass their earnings through to their owners, who then are taxed only at their individual rates. Hence, no double taxation.

However, unlike S corporations, there are few limits on the types or numbers of owners, and more than one class of stock can be issued. However, LLC’s do have some similarities to partnerships, in that cash can be distributed tax free as long as it is less than your investment; and, you can allocate income, losses, and deductions among owners as you chose.

There are some drawbacks, however. If you are going to do business interstate, you should know what your protections are in those states. Furthermore, LLCs generally dissolve upon the death, resignation, retirement or bankruptcy of any owner, and owners cannot transfer their interest to others without the consent of fellow owners.

Also, since LLCs are new, some tax issues have not yet been tested, like how to determine which owners are active and thus subject to self employment taxes.

Finally, keep in mind that tax rates on individuals are now higher than they are on corporations, so if you are planning to grow your business with the cash it generates, you might be better off having your company retain and be taxed on its earnings. If your C corporation is already operating, it would have to be liquidated and there could be tax consequences.

Check with your lawyer and tax adviser before doing anything. A Guide to Limited Liability Companies, published by Commerce Clearing House 1-800-835-5224 can help you define the issues you need to resolve.

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