Employee vs contractor for a very small business?

jeannie · #1 (**permalink**) 10-12-2004, 12:27 PM

Hi,

I currently run a small "one person" on-line shopping business out of my home. Business was slow in the beginning, last few month business has picked up a bit. Maybe now too busy to handle myself - especially for the upcoming Christmas season.

My question is: Can I Hire someone to work for me as a (1099) contractor instead of an employee?

I don't even have a EIN number. My understanding is that it's much easier to hire and pay a contractor (1099) than an employee and having to file Payroll taxes.

Any advice would be appreciated.

OldJack · #2 (**permalink**) 10-12-2004, 01:14 PM

Of course it would be easier to hire an independent contractor and not have to deal with the employee payroll taxes, but that is why the IRS says that you can't do it. Here is the IRS 20 factors to determine if the worker is an employee subject to payroll and employment taxes:

Quote:

Originally Posted by IRS

The traditional tests to determine whether a worker is an employee or independent contractor involve the concept of control: Are the services of the worker subject to the Taxpayer's will and control over what must be done and how it must be done? In Revenue Ruling 87-41, 1987-1 CB 296, the IRS developed 20 factors used to determine whether a worker is an independent contractor under the common law. Remember: the burden of proof is on the taxpayer; therefore, in general, at least 11 of these factors must show independent contractor status under the common law tests.

For the following questions, a "yes" answer means the worker is an employee.

1. Does the principal provide instructions to the worker about when, where, and how he or she is to perform the work?
2. Does the principal provide training to the worker?
3. Are the services provided by the worker integrated into the principal's business operations?
4. Must the services be rendered personally by the worker?
5. Does the principal hire, supervise and pay assistants to the worker?
6. Is there a continuing relationship between the principal and the worker?
7. Does the principal set the work hours and schedule?
8. Does the worker devote substantially full time to the business of the principal?
9. Is the work performed on the principal's premises?
10. Is the worker required to perform the services in an order or sequence set by the principal?
11. Is the worker required to submit oral or written reports to the principal?
12. Is the worker paid by the hour, week, or month?
13. Does the principal have the right to discharge the worker at will?
14. Can the worker terminate his or her relationship with the principal any time he or she wishes without incurringliability to the principal?
15. Does the principal pay the business or traveling expenses of the worker?

For the following questions, a "yes" answer means the worker is an independent contractor.

16. Does the worker furnish significant tools, materials and equipment?
17. Does the worker have a significant investment in facilities?
18. Can the worker realize a profit or loss as a result of his or her services?
19. Does the worker provide services for more than one firm at a time?
20. Does the worker make his or her services available to the general public?

If you determine that the person can be an independent contractor, you must report (1099Misc) the amount paid if you pay $600 or more for the year. If you are going to pay $600 or more as a contractor, I would suggest that you have a written agreement signed by the contractor that spells out that they agree that you are not their employer and not withholding or responsible for any taxes.

The truth is that you can probably get by treating them as independent contractors if:

1. If the worker is temporary and not going to claim unemployment and agrees to not be an employee and
2. You are only talking about a small amount of money relative to other business deduction on your tax return and
3. You file the IRS forms 1096 (transmittal) and 1099misc (nonemployee compensation) forms for all payments even those under $600.

my 2? ??

MONOLITH · #3 (**permalink**) 10-12-2004, 04:45 PM

OldJack,

If I answered yes to 11 of the first set of questions, but also a yes to one or more of the second set;

Does the second set override the first and make me an independent contractor?

OldJack · #4 (**permalink**) 10-12-2004, 06:27 PM

You have to have at least 11 of all the questions in favor of independent contractor status. In other words if you said "no" (contractor) to 11 of the first groop of 15 and "no" (employee) to the last 5 you would probably be save to claim independent contractor status. Or you might say "yes" to the last five and you would still need 6 more as "no" in the 1-15 group. Needless to say the answers are stacked in favor of the IRS and status of being an employee.

MONOLITH · #5 (**permalink**) 10-12-2004, 06:58 PM

Ah, got it.

Recently, I was in the situation where I was performing a service for a company, and they want to claim me as an independent contractor, and 1099 me.

Specifically, I am an electrician, and there is an Electrical Contractor who provides service calls via an add in the yellow pages. 'The company' receives the call, but they send me to the person's home to make the repair. They get the majority of the service call fee, and I get a portion. It is their license, their company, and their advertisement. The homeowner knows nothing of my status except that they assume I am an 'employee' of the company they called.

Now, I would answer the above questions this way:

1. yes
2. no
3. not sure how this applies in my case
4. yes
5. yes
6. yes
7. yes
8. yes
9. no
10. yes
11. yes
12. no
13. yes
14. yes
15. no

16. yes
17. not sure of the meaning, but I think 'no'.
18. yes
19. no
20. no

So that appears to be at least 12 in favor of being an 'employee'.

My questions are:

First, based on your explanation of the test, it appears I could argue that I am an employee, and not an independent contractor, right?

Second, would it be more beneficial financially for me to be an employee, or an independent contractor (assuming I have no deductions to claim as a contractor)? I am assuming I would save more tax dollars being an employee, by avoidng the 13% self employment tax?

Thanks.

OldJack · #6 (**permalink**) 10-12-2004, 07:23 PM

There is a "safe haven" rule that if it fits you don't have to use the 20 factor test. The safe haven rule "in plain language" is if the type worker is a long-standing recognized practice to treated as independent contractor within a "significant segment" of your industry, and you follow all the reporting requirements of filing 1099's consistantly then you may treat the worker as an independent contractor.

The test is what the IRS uses, not what a lot of companies do. The company wants an independent contractor to do the work and you either work that way or they will get someone else. The company is at risk for penalties and taxes regarding payroll taxes not withheld even if you pay your 1040 and self-employment tax. In other words the IRS can claim tax from both although they usually don't.

OldJack · #7 (**permalink**) 10-12-2004, 07:37 PM

A more detail description on the safe haven is summarized by the IRS pamplet:

http://www.irs.gov/pub/irs-pdf/p1976.pdf

MONOLITH · #8 (**permalink**) 10-12-2004, 08:48 PM

Thanks.

Based on the Safe Haven deal, they most likely can claim me as an independent contractor because;

a. All of their other 'workers' are also handled this way.

and

b. They have a history of this format going back several years.

OldJack · #9 (**permalink**) 10-12-2004, 09:59 PM

Well... their history and actions are not the real question as much as is it common and a long-standing practice in their industry.

Evan · #10 (**permalink**) 10-17-2004, 11:47 AM

I'm running into the same situation, I run a very small business, and I even consider it a hobby with a business name to make it more professional. It's a website development company, and I do many things myself, but I have a friend help me with a certain aspect, so I do pay him, generally weekly (assuming we have work to do), if he sends me a time sheet of all the times he worked. I classify him as an independent contractor, and I don't see him as an employee because he doesn't really work for me, and I can't 'fire' him.

Now if I have to file the 1099misc at the end of the year, how can I go about getting these forms sent to me to print? Can the IRS provide them, or do you have to purchase them?

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