Employee vs. independent contractor saga.

Employee vs. independent contractor saga

The classification of an individual as an employee or an independent contractor is an age-old problem that seemingly cannot be completely resolved. If an individual is treated as an employee, the employer is obligated to withhold social security and income taxes and pay all applicable employee benefits (health insurance, workmen's compensation insurance, retirement plans, etc.). If an individual is an independent contractor, the only obligation is to pay the agreed-upon compensation. The controversy that has developed over the years concerns the employer's obvious motivation to liberally classify individuals as independent contractors.

An employee (according to the income tax regulations) is an individual who performs services subject to control by an employer, both as to what services shall be performed and as to how they should be performed. An employer has the right to control and direct the individual performing the service, not only as to the result to be accomplished, but also as to the details and means by which that result is accomplished. An employer-employee relationship exists even if it is called something else by the parties involved.

An independent contractor is one who is subject to the control and direction of another only as regards the result of the work, and not as regards the means. Typically, an independent contractor offers his services to the public and is not under the direction and control of the recipient of the services.

The Internal Revenue Service and many of the states (especially New York) have recently increased the number of audits in this area. These "payroll tax audits" have the potential of creating devastating consequences to an unsuspecting employer who could find himself owing several years' payroll taxes, as well as, possibly, the income taxes that should have been withheld. The amounts that could be charged include 15.3 percent of compensation for employer and employee social security taxes, at least 15 percent for federal income tax withholding, approximately 6 percent for state income tax withholding, and approximately 4 percent for unemployment insurance. This amounts to over 40 percent of the renumeration paid, before the likely imposition of interest and penalties.

The most recent I.R.S. pronouncement in this area provided a listing of the criteria to be used in distinguishing between employees and independent contractors. The criteria consist of twenty specific questions regarding various aspects of the relationship between the service provider and the recipient. While no single question is by itself conclusive, a pattern will typically develop which leads to a determination.

In the real estate industry, the employee status issue arises frequently with respect to contractors and consultants. The "employer" should take as many steps as possible to avoid the recharacterization of an independent contractor as an "employee."

Some recommendations would be that:

*The employer avoid paying a periodic fixed and recurring amount

*The employer base compensation on a method other than by hour, week, etc.

*The service provider incorporate or form his own business

*The service provider work for more than one "employer"

*The service provider have a place of business apart from the employer's premises (other than his residence)

*The service provider be listed in the telephone book.

As was described, the savings that can be achieved by sustaining the independent contractor classification are enormous. The efforts needed, in terms of properly documented arrangements, are well worth the time, effort and cost involved.

Jeffrey Stavin specializes in the tax and accounting aspects of real estate ownership, operation and development. He has served on real estate and tax committees of the New York State Society of Certified Public Accountants.