Know Your Status: Are You An Independent Contractor or An Employee?

It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.Costly penalties may be incurred by the business if it is later determined that you have misclassified an employee as an independent contractor or vice-verse.

As a rule of thumb, generally you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. To aide you in deciding, select the scenario that applies to you:

• I am an independent contractor or in business for myself
  If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. For more information on your tax obligations if you are self-employed (an independent contractor), see our Self-Employed Tax Center.
• I hire or contract with individuals to provide services to my business
  If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or independent contractors.

Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be can be defined in these four categories -

1.  An independent contractor

 People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.

If you are an independent contractor, you are self-employed. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.

If an employer-employee relationship exists (regardless of what the
relationship is called), you are not an independent contractor and your earnings are generally not subject to Medicare and Social Security Taxes for Self-Employed..

2.  An employee (common-law employee)

Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

3.  A statutory employee

If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet the three conditions described under Social Security and Medicare taxes, below.

• A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission.
• A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.
• An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.
• A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson's principal business activity.

4.  A statutory non-employee

There are generally two categories of statutory non-employees: direct sellers and licensed real estate agents. They are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:

• Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and
• Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.

In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. Here are the three categories that the IRS considers to be “Common Law Rules” for determining the degree of control and independence for one’s employment:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. If a business owner is still unclear, there is a form to remit (SS-8)  and the IRS will make the determination for you. The down side of this is that of course, it is timely and may take up to 6 months to get a response.  But, as with any tax or business accounting question always feel free to Contact us at Envision Tax & Accounting of Florida for further clarification or assistance with your small business or non profit organization’s needs.

Enjoy your day~

Business Tip of the Week! Thinking of Starting A Non Profit?

Great article from Steve Mariotti offering very relevant pointers on starting a Non Profit Organization:

There are huge markets where people have needs -- for food, shelter, education and more -- but can't afford to pay money out of their own pockets to have their needs met.
In the United States, the government created the 501 (c) (3) nonprofit corporation to help address this situation. Technically speaking, a 501(c)(3) is a tax-exempt legal structure that can receive charitable donations from individuals, businesses, government agencies, and philanthropic foundations. Examples of well-known not-for-profits include: the Boys and Girls Clubs, the YMCA and the Sierra Club. People who donate money to these charitable organizations benefit by deducting the contributions from their taxable income.

In the United States, over one million organizations qualified for 501(c)(3) status in 2009 compared to 600,000 in 1993. Charitable donations have declined: in 2008, $315.08 billion were invested in the not-for-profit sector, compared to $303.75 billion in 2009. Competition for resources has increased, making it more difficult for nonprofits to grow or even exist.
Like any business, a not-for-profit needs to generate revenue to cover its expenses. It needs to identify a target market and figure out how it will deliver its products and services to that market. Some key differences and considerations exist, however, and you should be aware of them before you choose this legal structure:

1. No one can own a not-for-profit organization: A nonprofit cannot be bought and sold like for-profit businesses. If you decided to dissolve such an organization, you would not be able to sell it for your own financial gain. Nor can you issue stock in the corporation to raise money for the organization. Employees of not-for-profits typically earn money by drawing salary as a fixed cost of the organization. Not-for-profits are great vehicles for improving society; they are less effective as a tools for creating wealth and sharing that wealth with others.
2. Not-for-profits are mission driven: Before you can go into business as a not-for-profit, you will need to be crystal clear about your organization's mission. What problem(s) are you trying to solve? Is there a market of donors who will contribute money to your cause?
3. Not-for-profits have a different perspective on their EOU: Like any business, not-for-profit organizations need to conduct an Economics of One Unit (EOU) analysis. Your EOU will reveal how the business defines a typical "unit of sale," the amount you plan to charge per unit, and how much it costs the business to deliver this unit to an average customer. For-profit businesses pay close attention to their gross profit per unit because their dollar amount sheds light on the potential to become profitable. Not-for-profit organizations must also assess their EOU, but here the focus is a bit different since not-for-profits do not exist to generate a financial gain. The difference between the organization's cost per unit and its selling price per unit should be modest. Remember that not-for-profits receive charitable contributions from donors who want to make sure that their money is being invested directly into the organization's programs and services -- not their savings accounts. Not-for-profits must strike a delicate balance between charging donors "at cost" and ensuring that they have enough money to pay their overhead and stay afloat. If your donors and the general public suspect that your organization is mismanaging its funds, your reputation will be badly damaged. Many not-for-profits have gone out of business for this reason.
   
4. Analyze Your Social Return on Investment (SROI): With a for-profit business, the return on investment is calculated by looking at the corporation's financial returns. Not-for-profit entrepreneurs need to think about their ROI a little bit differently. Not-for-profits don't exist to make money, so the ultimate measure of success won't be financial in nature. Your SROI will be based upon how much it costs your organization to provide its services. This must be analyzed in relationship to the value of the level of change that was brought about as a result of this investment.
5. Define Your Unit of Change: As a not-for-profit entrepreneur you will need to set goals regarding the changes you intend to cause in society. How many homeless people will you feed? How many students will graduate as a result of your dropout prevention program? These goals must tie back to your costs and your EOU. What constitutes a unit of service? Is it based on one person, one classroom, or one square mile of the rainforest? How much does it cost you to provide services on a unit-by-unit basis? Given these costs, how many units of change did your organization produce? How can you prove that your not-for-profit caused these changes?
6. You Can Still Be Your Own Boss -- But with a Twist: Even though the not-for-profit entrepreneurs do not own their own organizations, they still get to be their own bosses. They also benefit from the satisfaction of having started something from scratch that improves society in unique and innovative ways. However, unlike a business owner who runs a privately held company, a not-for-profit entrepreneur must answer to its Board of Directors. This scenario mirrors what happens when a private sector decides to "go public" and sells shares to the public. Here, the company must establish a Corporate Board that will oversee the interests of the company's shareholders. Similarly, a not-for-profit organization's Board of Directors manages the entrepreneurs and oversees the organization's finances and operations. All nonprofits are, in a sense, "publicly held" because they cannot, by definition, be privately owned.
7. Analyze Your Financing Strategy: Not-for-profit corporations can tap into a large revenue stream that other business structures cannot access. Not-for-profits generate revenue through grants, gifts and earned income.

Here is a format for a nonprofit strategic and tactical plan you should follow:

1. What is the name of your nonprofit organization?
2. What problem(s) are you trying to solve?
3. Describe your organization's mission.
4. Describe the programs and services you plan to create.
5. How will your organization achieve its mission?
6. What is the "unit of change" (per person, animal, house, etc.)?
7. How will you measure these changes?
8. Who are your competitors?
9. How much will it cost you to deliver a unit of service?
10. Which foundations support your organization's mission? What are their funding guidelines? Make a list of five to ten possible grants for which you could apply.
11. Which individuals will you approach to raise money for your enterprise? How much will you request? Make a list of five to ten prospective donors.
12. Will you have any sources of earned income? What products or services do you plan to sell directly to the public to generate income? List the possible sources of earned income and how much money you expect from each source.

 It is always enlightening to us as Accountants to see factual articles that hit the target! For help creating your 501c(3) or other Non Profit Accounting needs give us a call at (407) 951-1492 or visit us on the web: www.EnvisionTaxandAccounting.com