Misclassify Your Workers II

Monday and Tuesday this week, I attended a corporate tax update class in Ocean City, Maryland. While I was out of the office, my beloved Jen Aniston stopped by. On Facebook, I posted a picture that proves she was actually there. She signed her picture and even wrote “I miss you, XOXO.” For those of you, who only understand English, “XOXO” means hugs and kisses. We are a really affectionate couple. Silly me – I forgot to tell her I would be in Ocean City. She could have joined me there. Paul would have had to give up the back bedroom in his condo, where we slept during the conference. Paul slept in the back bedroom and I got the pull out sofa. We didn't sleep together in the back bedroom to be perfectly clear. More correctly, I should say we slept AT the conference.

If someone invites you to a corporate tax update conference, punch him in the face. Sitting through a corporate tax update class is like learning about new methods of waterboarding – minus the celebrity appearance by Dick Cheney.

In my first installment of “Misclassify Your Workers” I covered the basics of determining whether your workers are truly independent contractors or employees. I also showed an example of a clearly misclassified worker and wrote about an IRS program administered in cooperation with state unemployment tax offices. If you missed part I, please read it first. In this installment, I will write about one of our clients, who did everything perfectly and had a great audit outcome. I will also explain exactly what they did correctly and why it worked so well. Finally, I will tell you about an IRS amnesty program if you have been misclassifying your workers.

In part I, I wrote about how I found out about the joint IRS / unemployment tax office audit program. The client, who was audited, requested that I attend the audit, and it was my pleasure. They were as absolutely well prepared as they could possibly be. Before the audit, I told them they were probably not being audited by the state unemployment tax office to see if they had incorrectly completed their quarterly unemployment tax forms. They were being audited to determine if they were misclassifying employees as independent contractors. Instead of spending a lot of time reviewing their payroll records, I asked them to prepare a file for each independent contractor for whom they had issued 1099-MISC forms. They used a payroll service. So I was certain the unemployment tax forms were in order.

In the file, I asked them to assemble a number of documents for each independent contractor. First, they retrieved copies of the W-9 forms they had required of each contractor. A W-9 form is given by a company to its independent contractors. The contractor completes the form, giving his / her federal tax ID number, business name, and type of entity.

Next, in each file they placed a copy of the contractor's proof of liability insurance. Yes, my client requires contractors to have liability insurance policies. Why? A contractors liability insurance is a level of assurance that my client won't suffer losses if the contractor destroys a customer's property. But that isn't the reason for the purposes of our audit. A liability insurance policy supports the concept that the contractor is really in business – not an employee. Do your employees have liability insurance? Of course not. A workers compensation policy is even better. However, in most states, very small companies aren't required to have them.

Third, my client put copies of invoices submitted by each contractor in the files. Yes, the contractors invoice them to get paid. Do employees submit invoices to get paid? Of course not. As you can see, we are building a strong case that each contractor is a separate business.

When the auditor visited, all of the files were in order and presented to him. The audit result was perfect. No contractors were reclassified as employees. My client had prepared perfectly. This audit was won before the auditor set foot in the office. There are some other items I think would be great to further convince an auditor that your contractors are properly classified.

First, to be separate legitimate businesses, your contractors should really have business licenses. In Virginia, business licenses are issued by the counties. If I were an auditor, I would place great weight on this. In my experience, however, they place next to no emphasis on business licenses. They place far more emphasis on another factor, probably unintentionally.

Independent contractors should have fictional names. In my bedpan cleaning example from part I, the employer might have entirely escaped scrutiny if the 1099 form had been issued in a name like “Bedpan Technologies, LLC” instead of “Frank Stitely.” The 1099 issued to the LLC would have a federal employer identification number on it. One issued directly to a person normally has a Social Security number on it. Auditors look at Social Security numbers on 1099 forms the way the Army's predator drones look at terrorists. Find and destroy.

I would suggest going one step further with your contractors. Help them organize their limited liability companies. I don't mean paying the $100 fee (in Virginia). Just forcefully suggest it as a requirement for having you as a customer.

As you can see, surviving an independent contractor audit can be easy if you gather the proper documentation. However, what can you do if you suspect there is no way you could survive an audit? The IRS is offering an amnesty program. There are a number of requirements to participate. In short, you can't already be in the process of an audit. That's too late. If you agree to fess up and become a fine upstanding employer in the future, you can get away with paying just 10% of the payroll taxes for which you would be liable on audit. And you only have to pay for one year. You also have to agree to treat all of the workers in question, and similar workers in the future, as employees. This is a great deal. If your business is grossly non-compliant with the independent contractor classification rules, run to your nearest IRS office and confess. Confession is not only good for the soul, it might save you a lot of money in an audit.

As always, if you want non-snarky tax and accounting advice, please visit www.skcpas.com. Thanks for reading!!

Frank

Misclassify Your Workers

This past weekend Laura and I visited my oldest daughter at James Madison University. We went to watch a football game on Saturday afternoon and just catch up with Meg. Early on Saturday afternoon, Meg and her roommates held a pregame cookout. At the cookout, I met Meg's BFFRN. For those of you not fluent in text speak, that means boyfriend for right now. I liked him a lot. He is a Capitals fan, so liking him was easy. After a couple of beers and a little sports conversation, I unloaded my pistol and put it away.

The next morning I called Meg from our hotel to tell her we were leaving to pick her up for a late breakfast. We weren't out the door yet. So that gave her about half an hour to get ready. When we pulled up to her apartment, we saw her BFFRN walking out of the apartment. In my younger days, half an hour was plenty of warning to vacate my girlfriend's apartment when her parents were on the way. Fifteen minutes warning was even enough for me to get a shower first. He had a sheepish look on his face when we greeted him. We told him that we were young once. We weren't going to hassle him. I did reload the pistol, however. I hope his life insurance is paid.

I apologize in advance for this being a two part piece, but this is an urgent topic for business owners. Please indulge me this time. In this first part, I will tell you about a new audit program the IRS is using to catch employers, who are misclassifying employees as independent contractors. I will talk a little about rules for classifying workers as employees or independent contractors. Then I will show where a company has gone horribly wrong in their policy. In the second installment, I will show you how to avoid problems in an independent contractor audit and talk about a client who survived an audit by doing everything right.

Two months ago, I got a message from a client telling me that the state unemployment tax people had scheduled an audit of their payroll. This type of audit is usually to determine if you have paid all of the unemployment tax payments that you owe. I have helped clients through a lot of these over the years. The client wanted me to attend the audit and I agreed.

During the course of the audit, I struck up a conversation with the auditor. I usually try to develop a friendly relationship with auditors. If I can get an auditor to view my client and me as good people, we may be able to get the benefit of the doubt if an issue arises. During the course of the conversation, he told me that this audit was part of a IRS program to identify employees misclassified as independent contractors. To make this clear, this was a state unemployment tax audit that was part of a joint program sponsored by the IRS. At this point, I knew the auditor didn't really care about auditing payroll. He was interested in auditing my client's 1099 forms. He was looking to reclassify independent contractors as employees. Since that first audit, I have had a couple more clients audited under this program. The first audit was in Maryland, but the subsequent ones were in Virginia. This is a national program.

To determine if you have misclassified an worker as an independent contractor, the IRS considers three factors: degree of behavioral control, degree of financial control, and relationship. In short, if you exercise significant control over a worker, that worker will likely be considered an employee by the IRS. If you have classified that worker as an independent contractor, the IRS will assess the taxes that you should have paid if you had treated the worker as an employee – plus interest and penalties. Rather than go into a long discussion of the three factors, I will show an example of a misclassified worker.

Let's say you own a nursing home, and you need to hire someone to clean bedpans. You hire some miscreant, named Frank Stitely, just to throw out a name. You don't really want to pay the employer share of Social Security, Medicare, and unemployment taxes for him. So you give Frank a contract that explicitly states that he will be treated as an independent contractor, not an employee. In addition, you hand him a W-9 form to complete. Frank dutifully signs the contract and completes the W-9 form using his Social Security number as his taxpayer identification number. Some days cleaning bedpans seems preferable to preparing tax returns.

In the contract, you agree to pay Frank twenty dollars per hour. You tell him that the going rate for bedpan duty is $15 per hour, but you are paying him more since he is an independent contractor to cover his taxes. To perform his duties, Frank has to come to your facility from 8:30 A.M. To 5 P.M. just like your other employees. He will use your bedpans, and you agree to pay him every two weeks just like everybody else. He also has to submit the same timesheet everyone else uses.

Frank is happy processing poo until he goes to S&K to get his income tax returns prepared. There, a very knowledgeable tax preparer tells him that he is paying way more in taxes than he would if you had treated him as an employee. The tax preparer goes further and has Frank complete an SS-8 form. An SS-8 form is a form that can be submitted to the IRS to ask them to determine if a worker should be classified as an employee or an independent contractor. Frank is no longer a happy little bedpan jockey. He mails the form to the IRS, and a few months later you get a cryptic letter from the IRS telling you that a nice man in a boring blue suit will be visiting your facility to determine if you are misclassifying employees as independent contractors.

How do you think you will fare in this audit? Let's evaluate Frank's situation against the three factors the IRS uses to determine the correct status. First, what is the degree of behavioral control you exercise over Frank? He works in your facility, using your tools (bedpans), and is required to follow all of the procedures your employees follow. Strike one.

What is the degree of financial control you exercise over Frank? He gets paid by the hour just like your other employees. He has no risk of financial loss. In other words, he incurs no business expenses. You pay for all of those. Strike two.

What is your relationship with Frank? You had him sign a contract that stated that he understood that he would be treated as an independent contractor. You also had him complete a W-9 form and issued a 1099-MISC form to him after end of the year. All of that is in your favor. However, Frank does not have a business license and does not carry a liability insurance policy. He only works for you and isn't really in business for himself. Strike three and you are out. Taxes,penalties, and interest are in your future.

Unfortunately, I see a lot of situations like Frank's. The more a worker looks like an employee, the more likely he is to be reclassified as one by the IRS. In the next installment, I will show you some ways to make certain you can survive an independent contractor audit.

For more informative tax and accounting information, please visit the main S&K web site, www.skcpas.com. Thanks for reading and go Redskins! Beat those dog hating Eagles.

I Almost had a Positive Experience with the IRS

I am a victim of domestic abuse. No, Laura isn’t beating the crap out of me. Maybe she should, but she is a gentle and affectionate person. No, Jennifer Aniston’s bodyguards didn’t beat the crap out of me. I’m a stealthy stalker. The twelve year old bitch from my last blog is terrorizing me. Apparently, she wants something in return for a good licking. Last Thursday, she pinned me down against the couch with her front paws and demanded some heavy petting. No means no – even to Jack Russell terriers. When she was done abusing me, she left a ten inch deep gash across my chest. Actually it was a two inch scratch, but this is a blog. So I get to exaggerate.

Most people feel a similar sense of abuse after dealing with the IRS. There is even a sense of shame that maybe they aren’t being good citizens and deserve some abuse from the IRS for owing back taxes. Since I get paid to deal with the IRS, I don’t feel shame, except as a US citizen that they represent our country. I normally feel exasperation. While on hold with the IRS, you will frequently find me on Facebook lamenting my life as a tax preparer. I used to work on other tasks while on hold, but I found that I wasn’t being productive. When I call the IRS, I normally have a stack of paperwork related to why I am calling on my desk. As soon as an IRS representative picks up the line, I want to be ready to launch into the facts of my client’s situation. If I am working on something else, I have to put that quickly away and retrieve the paperwork for the call. That takes time, and I found I wasn’t immediately effective and organized in presenting my case. Like rabid dogs (and Jack Russell terriers), IRS agents smell fear and uncertainty.

Last Wednesday, I almost had a positive experience with the IRS. In a ritual I have performed a dozen times this summer, I called the IRS to arrange for a payment agreement for a client. He owed a mid five figure amount for a couple years and needed some time to pay off the balances. I had his paperwork spread out on my desk and was listening to the on-hold IRS music. The music doesn’t have lyrics, but I imagine if they did, they would go something like, “You suck, deadbeat. Wait ‘til we get a hold of you.” The refrain would be, “Now we’re gonna levy your bank account, ha ha ha.” Imagine this sung by Yoko Ono. That’s how much pleasure I get from their on-hold music.

After an interminable forty minutes on hold, an IRS agent picked up. “My name is Ms. Satan, badge number 666. How may I assist you?” This translates as, “I am looking to bleed you dry as soon as you give me a little information, you filthy deadbeat.” However, I am used to the attitude and jumped into my spiel about getting a payment arrangement for my client. I know that if you propose a monthly payment amount that gets the tax liability paid in three years or less, you have a good chance at success. Nonetheless, I then had to listen to her rehearsed spiel. We were dancing together with her in the lead. She made me prove I had a power of attorney for the client. I had faxed it two months earlier, but it still wasn’t in the IRS records. So I had to run to our fax machine and fax it to her directly. This is why I need everything quickly accessible on my desk. Then she let me lead as I proposed a monthly payment amount that my client had agreed to present as affordable.

She took the lead again and asked me if I had a completed form 433-F. That form is a collection information statement that lists a taxpayer’s financial information so that the IRS can determine the maximum payment that a delinquent taxpayer can afford before emptying the bank accounts. I knew that form didn’t apply, since my client was self-employed. The more complicated forms 433-A and 433-B applied, and I had them prepared and ready to fax to her. However, she insisted that form 433-F was the correct form and proceeded to start asking me the questions from that form. This was fine with me, since I had all of the information required by that form and much more – information that I was happy not sharing. I called up a copy of a blank 433-F form on my computer screen so that I could anticipate the questions she would ask and have answers available immediately. Very rarely, will an IRS agent take the time to delve this deeply into a situation in the hopes of reaching an immediate deal.

She then asked me what we were proposing as a monthly payment. She knew as well as I did that my proposed payment amount would get the liability paid in three years or less. She told me she thought the amount would work and that she needed to put me on hold to reference some information on my client that wasn’t directly available on her computer terminal. Five minutes later, she returned.

“We have a problem,” Ms. Satan said. “I see that we have received your client’s 2009 tax return, but it isn’t processed yet. So I can’t determine the actual balance due.”

We had mailed the 2009 tax return at the very beginning of the summer. There were maybe a hundred numbers to keypunch from the return. That should take maybe an hour – if you type with one finger. I’m thinking middle finger here. After three months, the IRS hadn’t been able to process this. The really funny, or actually sad thing, about having to wait more than three months to process a tax return is that IRS employees, including their top executives, don’t see anything wrong. If you talk to them, they give you a funny look like, “What the hell planet are you on where they process work in less than three months?” That planet would be earth, i.e. the real world, someplace they never visit.

I had a similar problem this past winter with the tax returns for an elderly lady, who had not filed returns for three years. When you don’t file your returns, eventually the IRS makes up a return for you based on information they have in their computer records. It is never a good idea to accept their return. So we filed all of the back returns. Meanwhile, over a period of six months, they began to send ever more urgent threats to empty her bank accounts. Finally, in July, they processed the returns and stopped the collection actions. They harassed an old woman for most of a year. That makes for happy public relations.

My call with Ms. Satan wasn’t destined to have a totally happy ending, but it wasn’t a total disaster either. She agreed to place a six week hold on collections activity to allow some time to get the 2009 tax return processed. Of course, she expects me to monitor the six weeks and check back in with them again. That’s my responsibility?? When we are behind in our company’s work, I walk down the hall and tell somebody to start hauling ass. But again, I live in the real world.

I was informed a few minutes ago that my future wife, Jen Aniston, was in Washington DC this week. Surprisingly she never looked me up. She knows I’m a busy guy, but I would move some things around and make time for a lunch date with her. She shows no appreciation for all I have done for her career.

As always, if you are looking for useful (it hurts when I write that) tax and accounting information, go to our S&K web site http://www.skcpas.com.

Thanks for reading!! Frank