The IRS' 20 Questions for Independent Contractors
Are you really an Independent Contractor, or...?
Independent contractors who don't know about — or who ignore — the relevant aspects of current independent contractor tax law are endangering their own livelihoods. Worse, they pose a significant threat to their client companies.
The IRS routinely funds California's EDD to conduct independent contractor-related corporate tax audits. Such audits can last several months and the resources required to respond to them can bring a small or even mid-sized company to its knees. If your client company loses its fight, the interest and penalties (for failing to withhold and pay employment and income taxes, and provide you with benefits) can amount to 50 percent of the money it paid you. And if the company has hired other contractors within the past few years, it's almost a guarantee that each of those relationships will be audited as well.
If your client gets audited and ruled to have been your employer, you're likely to be audited too. At the very least, any business deductions you claimed against your supposed 'independent contractor' income from that company will be disallowed. And if you didn't accurately report your income, you can expect additional penalties such as the obligation to surrender 30 percent of future income from all sources (a privilege known as 'backup withholding'). Add to these challenges the fact that you've probably lost your client, and you'll wish you'd known better.
Read more about relevant contractor-related tax law here, then see Synergistech's solution.
Forewarned is forearmed. The IRS' rules governing who is and isn't an independent contractor are arbitrary and inconsistently applied, but knowing them — and specifically knowing the "right" answers — will help keep you and your clients safe.
The following are IRS' 20 Common Law Factors (or "20 Questions") to determine whether workers are employees. The answers most favorable to independent contractors and their clients follow in parentheses, with illustrative (but not comprehensive) comments in red.
- Are you required to comply with instructions about when, where, and how the work is to be done? (No.)
Among other things, this means you should schedule meetings collaboratively, you shouldn't use your client's equipment, tools, or office space on a regular basis, and your name shouldn't appear in the company directory much less on the wall near your ... uhh ... coffee cup.
- Does your client provide you with training to enable you to perform a job in a particular method or manner? (No.)
Your client must not provide you with more than minimal training. For products you cannot be expected to learn on your own, you must pay market price to attend training sessions that the client provides for its customers.
- Are the services you provide integrated into your client's business operation? (No.)
If you perform the same services as an existing or recently departed employee, you're an employee. To qualify as an independent contractor, you must provide only those services that the company needs occasionally and that are incidental to its central business.
- Must the services be rendered by you personally? (No.)
If you are contractually obligated to provide all services personally, or put another way you are contractually forbidden to subcontract any part of that service, you're an employee.
- Do you have the capability to hire, supervise, or pay assistants to help you in performing the services under contract? (Yes.)
You must be able unilaterally to engage one or more contract or staff workers to help you provide the contracted service. A client who forbids you to hire helpers has sealed their own fate in an independent contractor-compliance audit.
- Is the relationship between you and the person or company you perform services for a continuing relationship? (No.)
Your service must be occasional and incidental to the client company's central business. Repeat engagements are fine, but long continuous assignments are considered irrefutable proof of employment.
- Who sets the hours of work? (You do.)
If you allow your work hours to be dictated by your client, either by precedent (consistently making yourself available when the client's workers are available) or explicitly in your contract, you look a lot less independent to a contractor-compliance auditor.
- Are you required to devote your full time to the person or company you perform services for? (No.)
If your client explicitly demands all your time and forbids you from accepting other projects concurrently, you're that company's employee.
- Is the work performed at the place of business of the potential employer? (No.)
If your client demands that you perform all your services at their site or hinders your efforts to work offsite, you're that company's employee.
- Who directs the order or sequence in which the work must be done? (You do.)
If your client demands that you perform your services in a specific order, you're that company's employee.
- Are you required to provide regular written or oral reports to your client? (No.)
If your client demands regular, detailed status reports and won't settle for the explanations typically included in an invoice, an auditor is much more likely to consider you that company's employee.
- What is the method of payment — hourly, commission or by the job? (Contigency- or project milestone-based payments are ideal.)
Being paid exclusively for hours worked makes you appear to be a wage slave. Synergistech recommends defining milestones in your contract and documenting your progress toward them in each invoice. We also advise invoicing in the name of your business, not as an individual.
- Are your business and/or traveling expenses reimbursed? (No.)
Your business and travel expenses are deductible against income you earn as an independent contractor. Not incuring these costs makes you look like an employee.
- Who furnishes tools and materials used in providing services? (You do.)
If you don't incur the expense of providing your own tools, training, and other necessities for your services, you're an employee.
- Do you have a significant investment in facilities used to perform services? (Yes. The more substantial your investment, the better.)
Many otherwise compliant contractors fail to expose themselves to the risk of losing money. If you can't demonstrate investments in your own tools, training, marketing, insurance, and similar business expenses, your independence will be questioned.
- Can you realize both a profit or a loss? (Yes.)
This question is pivotal — for many auditors, exposure to the risk of losing money is the single biggest differentiator between an employee and a contractor.
- Can you work for a number of firms at the same time? (Yes.)
A true independent contractor can, and when possible should seek to, work for multiple clients concurrently. Synergistech recommends that you never stop marketing yourself and that you take seriously all opportunities, regardless of whether you're currently fully engaged.
- Do you make your services available to the general public? (Yes)
Real independent contractors have their own web site, are listed in relevant business directories, and conduct marketing campaigns to emphasize that they're in business and demonstrate that they can be found by those seeking their services.
- Are you subject to dismissal for reasons other than nonperformance of contract specifications? (No.)
If you can be terminated because your client has a layoff, or decides to hire a staff employee to fill your role, you're not all that independent. At-will termination makes you look like an employee. Unless you've violated the contract yourself, insist on at least two weeks' notice.
- Can you terminate your relationship without incurring a liability for failure to complete a job? (It depends.)
Yes, if you're working on a time-and-materials basis and invoicing hourly. No, if you're working on a project, or milestone, basis — in this case you are obligated to deliver on your commitments if you wish to be paid for your efforts.
There's no 'passing grade' for this test. Auditors assign relevance to each factor subjectively at the time of the audit. And filling out the IRS' Form SS-8 is suicide — it's a veritable admission of guilt. Essentially, the key to being judged a true independent contractor is to walk, talk, look, feel, and smell like a business.
In this context, technical communicators who do everything else "right" are often faulted for not having multiple concurrent clients and multiple personnel. For them, some argue, getting beyond being a one-person business is the most important indicator of professional independence.
As you can see, the 20 Questions are not an easy hurdle to clear. Wouldn't it be great to have the benefit of the doubt in your favor, and potentially avoid having to answer each of these questions correctly? As we explain in our discussion of relevant independent contractor tax law as well as in our explanation of how Synergistech heals companies' 1099-based Independent Contractor headaches, Synergistech's unique method of working with independent contractors and their clients gives all parties confidence, simplicity, and savings.
Incidentally, the '20 Questions' were distilled from the '50 Factors' an annotated copy of which appears here. The explanations for many of these factors are helpful in understanding how auditors arrive at their decisions.