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Death, Taxes and 1099

February 16, 2015 | By Neil Ducoff | 9 Comments

death-taxesThere was a “lively” thread on Strategies Idea Exchange forum on Facebook. A group member posted, “I just spoke to an owner who files a 1099 for her staff, but doesn’t call it ‘rental’. She lets stylists make their own schedules, she provides products and all services are booked through the receptionist. She pays commission. Does this make sense? I’ve never heard of classifying someone as an “Independent Contractor” while paying commission.” The thread quickly grew to over 65 comments, became quite heated … and one poster that resorted to profanity got booted and blocked from Strategies Idea Exchange.

I have been involved in the independent contractor versus employee debate for what seems like forever. The debate is about two diametrically opposed business models – Employee Based or Independent Contractor (classified as 1099). One business model employs individuals to do the work. The other model leases, or rents space to individuals to do their own work. Seems pretty easy, doesn’t it? Well, it’s not. The IRS has very clear and specific guidelines to classify workers as independent contractors or employees.

Simply put, too many business owners don’t have a clue what those guidelines are and essentially make up their own rules based on assumptions that are not compliant with IRS tax law. Specifically, a business cannot direct or exercise any control over the worker’s performance and behavior and classify that employee as 1099 independent contractor.

The IRS.gov website offers these guidelines:

Facts that provide evidence of the degree of control and independence fall into three categories:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • 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.)
  • 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 that 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 your business leases/rents space, or classifies workers as 1099, I highly advise you to review IRS Form SS-8 for determining worker status. Here is the link: www.irs.gov/pub/irs-pdf/fss8.pdf

The death and taxes factor:

The true point of contention is not what constitutes an employee/employer relationship … it is which party, the independent contractor or the business, is responsible for withholding, reporting and paying Federal, State and Local income tax. A business cannot simply classify “employees” as 1099 Independent Contractors (or renters) and wipe its hands of withholding, reporting and paying income tax. If it was that easy, every business would classify employees as 1099, compensate them “Gross Pay” for their work … and push the entire tax reporting burden onto employees. Legally, it is not that easy, which means many businesses that classify “employees” as 1099, or renters, are fully exposed and liable for employment taxes, penalties and interest.

Here’s what the IRS says about treating an employee as an independent contractor: If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.

Here are my no-compromise thoughts on death, taxes and 1099:

  • It’s about what you’re building: If you want to build a company and a brand that grows in value, in most cases, you will need to build an employee-based company. FACT: A business cannot function, perform effectively, assure quality, provide growth opportunities, offer benefits … and build a viable brand … if it does not have the ability to direct and control employee performance and behavior. If you don’t want to deal with employees and taxes … and all the stuff that leading, managing, coaching, inspiring, training and disciplining that an employee-based business model demands … go 1099 or lease/rent space.
  • Know the rules: I don’t know how else to say this other than, “Know and understand the rules of business and the requirements of being an employer.” If you make up your own rules … be prepared to suffer the consequences. If you don’t like the rules, you can argue your case with IRS where your chance of winning is slim to zero.
  • Accountants: It still boggles my mind that we regularly hear owners tell us that their accountant told them to do 1099 without any explanation or guidance on what they can and cannot do in a 1099 business model. To me, that is irresponsible and potentially damaging advice to give any business owner. If this describes your situation where you were told to “just do 1099” when in fact, you run an employee-based business – fire your accountant.
  • It’s about a level playing field: It is totally unfair that many employee-based businesses play according to IRS guidelines and comply with tax laws … while others, knowingly or unknowingly, run lease/rental and/or 1099 businesses that are actually employee-based businesses that avoid and push the employment tax burden onto their “employees.” For the owners of those businesses, I wish for nothing but the full extent of the consequences for misrepresenting worker status and failure to report, withhold and pay employment taxes like the rest of us.

If you don’t like anything that you read here, your beef is with the Internal Revenue Service. They make the rules that individuals and businesses must comply with.

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Please share your thoughts with me about today’s Monday Morning Wake-Up. Click below to comment.

Pass this e-mail on to your business colleagues, managers and friends. They will appreciate it.

Categories: Business Builders , Compensation , Financial Literacy , Leadership , Monday Morning Wake-Up , No-Compromise Leadership

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Comments

  1. Neil,
    Thanks for sharing this info!
    There is so much argument and confusion on this topic. I had an accountant initially tell me to 1099 my staff as well. It made it difficult to grow the business when you have a group of independents who want to do things their way. I fired her several years ago.
    Our industry has a broken system where people want to ride the fence and take the easiest path.
    True business doesn’t last that way.
    Thank you for bringing change and encouraging professionalism!

  2. Thank you for this post. I think you’ll find clarity here on whether or not your business is an independent one or an actual employee/employer situation. Both models have merit and challenges but you cannot “morph” them into your own model. It is not just our industry that has to comply with the IRS regulations. I have business owner friends that have been challenged by these rules in court reporting and others. Rule of thumb-follow the rules because the IRS wins a lot.

  3. Right On! Right On! I have been sharing this debate with service providers and clients for the entire 10 years I have been paying my employees above board with a W2. The system needs to be fixed. What can we do? I tell everyone I know “whether you come to my business or not at least make sure where you go is classifying their employees properly otherwise you are supporting fraudulent businesses.” Thanks for the great article.

  4. This practice is not legal in New Jersey… I think every hairdresser nail tech ,person in this business should always think of their clientele as a personal business that they own!!

  5. Well said Neil. The IRS neither having the time, money or motivation to go after salons that are improperly setup to avoid taxes has fostered a culture of acceptance in the salon industry. It has led to one of the main reasons the general public does not see salons as a real business and hairstyling as a career choice for their son or daughter. It sure does make it hard for the salon owner who wants to do the right thing and obey the law.

  6. You are right on the money Neill, as usual. It is really amazing how many people don’t bother looking up the rules for doing business. On the other hand, most 1099 salons think it is ok because the IRS don’t ever audit these salons. It has almost become ‘ legalized tax evasion’. I know it’s a oxymoron. I too wish there was something there could be done about this, In order to level the playing field. Sometimes it really gets old to play by the rules, when all the others seem to get away with cheating and the government looks the other way.

  7. Amen! Too many businesses, besides salons are doing this also. I was actually audited by the State of Illinois because of the 1099 issue – it sent a red flag. Not only the IRS is watching, but so are the state governments. Not paying unemployment taxes is a big no-no as well. All it takes is one disgruntled worker to file unemployment and, BOOM!, it’s over. Luckily, I had Strategies in my corner to make the transition from being out of legal limits to being compliant. My audit went well because I had documentation and we had gone to hourly in the nick of time. I can sleep better at night knowing that even if the IRS or State of Illinois are looking over my shoulder, I am confident that I am abiding by the employment laws and providing a more stable income and benefits for my staff. Who wants to feel like you are running to hide? Not me. I would rather focus on growing my business and giving my staff a livable wage than trying to lure someone as an employee with the enticement of “50% commission”. Once you explain it to future hires, they can see that you are the best game in town!

  8. It would be in everyone’s best interest to google irs and booth rental or 1099
    This topic has been on there books for 3 years now and if you don’t enter into an agreement with them (IRS) that you will classify your workers as employees you WILL be paying back taxes for the last 3 years! Yep!!! That’s right 3 years on every booth renter .
    Get with it people the gig is up!!
    If you want to be the BOSS take all the responsibility or get out of business and go “work” for a REAL BOSS.
    That’s all I have to say about that !!!
    Goooooo W2 or go home……

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