An Important Answer to Know
Is that Worker an Employee or Contractor?
BY Charles Gentry

For a brief period it appeared that businesses across this country were going to be buried in more paperwork beginning next year. With the passage of the Health Care Bill in 2010 came an additional burdensome requirement (buried among the 2,409-page document) forcing businesses across the country to file 1099 forms for every individual corporation from which they buy more than $600 in goods or services in a tax year. Thankfully, the folks in Washington, D.C., woke up and took out the change in the law. Therefore, companies only need to file 1099 forms for independent contractors they hire that perform more than $600 in services. OK, great. But how do we know whether a worker is an independent contractor or an employee? The line may not be as bright as business owners would hope.

When to File 1099s
I recently received a call from Taxed Window Co., a door and window manufacturer. The president, Mr. Fearful, had just read an article about the role 1099 forms play in his company’s paperwork, when an IRS agent knocked on the door wanting to know why Taxed Window Co. had not filed 1099 forms for several workers. Mr. Fearful exclaimed, “I need your help, I haven’t slept in weeks.”

After listening to several minutes of stressful venting from him, I determined that he was losing sleep over
the blurry line between employees and independent contractors.

“Do you currently file 1099 forms?” I asked.

“Yes, for independent contractors providing services for us in excess of $600,” explained Mr. Fearful.

“Good! Do you know the difference between an employee and an independent contractor/1099 worker?”

“Yes,” Mr. Fearful said. “If I pay them from an invoice rather than through payroll, they are independent.”

“Well, that is one of many factors you must take into consideration” I explained. “Unfortunately, there are many factors you must consider and there are traps you must avoid.”

Look to the IRS
The IRS has a guide that assists businesses in defining 1099 workers by establishing criteria that must be considered:

1. Behavioral control. How much control and direction does the hiring business provide?

2. Instructions the business provides the worker. Is the worker free to choose when and where to work, what tools to use, where to purchase supplies, where to purchase related services, whether work must be performed by a specified worker, whether subcontractors are permitted, etc.?

3. Training provided to the worker. Typically, 1099 workers use their own methods to carry out their work;

4. Financial control. Typically, 1099 workers have unreimbursed expenses; they invest in their infrastructure and tools, invoice for their work and face a profit or a loss from the project; and

5. Relationship type. Typically, independent contractors have written contracts, no benefits, non-permanent relationships, non-core functions and the freedom to work with whom they chose.

Consider the Pitfalls
“Unfortunately,” I conceded to Mr. Fearful, “it can never be as simple as it seems; the majority of confusion stems from distinguishing an independent contractor from an employee.”

I added, “The factors serve only as a guide. In order to avoid common pitfalls and sleep easier, it is extremely important to keep in mind the characteristics and circumstances of the entire relationship between you and the workers providing services.”

Mr. Fearful asked, “What do you mean? What pitfalls?”

“Well, consider the following circumstance. There is no written contract, laborers come and go as they please, are paid so much per ton of coal stored and delivered, are able to refuse a task after accepting the assignment, own their own tools and are under no obligation to return un-owned tools.”

I asked Mr. Fearful, “Would you think the laborers are independent contractors?”

“Definitely! The hiring company gave them no instructions or training!” he exclaimed.

“Surprisingly, the laborers would be defined as employees,” I told him. “Under those circumstances there would likely be sufficient behavioral control implicit in the relationship to tip the balance toward defining them as independent contractors. It is likely that the laborers would only be paid after certain conditions were met, for instance, returning a receipt to the hiring company after a sale.”

A determined Mr. Fearful then said, “Let me try again! That one was a curveball.”

“OK, try this: the workers are able to work whenever they wish, come and go as they please, refuse to
do tasks, and they provide their own supplies and tools. The hiring company provides a place to work and instructs workers not to return if their work is
substandard.”

Confidently, Mr. Fearful stated, “Well considering the hiring company exercises very little financial control, provides bare minimum instructions and hardly any training, this surely is an example of an independent contractor!”

“Wrong again,” I told him. “The workers would be deemed to be employees. The type of relationship and behavioral control are just as important as the others.”

“I have to get one right!” Mr. Fearful pleaded.

“Okay,” I said, “I think you understand it now. How about this: Boat captains staff their own boats with crewmen, determine the duration of work, manage the overall operation of the fishing excursions and daily expenses are borne by captains and crew. The hiring company, that buys and sells fish, requires the fishing operation be exclusively for snapper, yet provides no training whatsoever and bears larger expenses such as insurance as well as boat repairs/maintenance costs.”

“Well, it is a permanent type relationship, and definitely a core function of the hiring company,” he pondered. “I bet the captains and crew are employees.”

“Correct!” I exclaimed.”

“OK, thank you so much!” Mr. Fearful stated. “As long as I keep track of the overall relationship and circumstances, I can finally sleep at night.”

Charles Gentry, attorney at Carson and Coil LLC in Jefferson City, Mo., specializes in helping the door and window industry avoid litigation.

DWM
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