Collabrusâ„¢ Expert Compliance Blog

If you read my last article for ICs you can probably guess. There are a whole bunch of reports and taxes coming up that must be filed and paid.

What are some examples?

You probably thought of the Form 1040, U.S. Individual Income Tax Return that everyone must submit by April 15^th (unless you request an extension), but here are a few more for those who are in business and have employees and IC’s.

Form 940 Employer’s Annual Federal Tax Return

This form is required to report (and pay) your annual Federal Unemployment Tax Act (FUTA) taxes. This tax is administered in conjunction with state unemployment (UI) taxes. You get a credit for amounts you pay to a state against your (federal) FUTA tax. So if for any reason, you did not pay your state unemployment taxes in a timely fashion, you will pay higher federal UI taxes on the Form 940.

The FUTA tax applies to the first $7,000 you pay to each employee during a calendar year.

Due Date: By February 2, 2009. However, if you deposited all your FUTA tax when it was due, you may file Form 940 by February 10, 2009.

TIP: You no longer need to include your state UI number on the Form 940. Why? Because the government has a much better database than they had in the past-they know…

You probably will also need to file a Form 940-V

The Form 940-V is a transmittal form for your check or money order. If you have a balance due of $500 or less on your 2008 Form 940, fill out Form 940-V and send it with your check or money order. If you owe more than $500 you’ll probably be making quarterly deposits next year.

Form 941 Employer’s Quarterly Federal Tax Return

You should have been filing the 941 every quarter to report and pay over the employer’s share of Social Security Medicare tax.

TIP: Do not withhold (or pay the employer’s share) after an employee reaches $102,000. Note- there is no limit on the amount of wages subject to Medicare tax.

Due Date:

• For January, February, & March by April 30^th
• For April, May, & June  by July 31^st
• For July, August, & September by October 31^st
• For October, November, & December by January 31^st

(There are exceptions if these dates fall on holidays or a Sunday).

Form 1099 MISC

If you are a business and pay an Independent Contractor $600 or more during the year then you must report the payments made to them on the 1099 MISC.

Due Date:  In California you must file paper 1099s by March 2, 2009. If you report over 250 IC’s you must file electronically, but have until March 31, 2009 to do so.

Form W-2 and W3

You must provide every employee you had during the year with a W2, so they can report wages earned and pay their share of taxes. The Form W-3 is the transmittal form.

Due Date: These forms must be filed by March 2, 2009, unless you are filing electronically, then the due date is March 31, 2009.

TIP: You can request an extension for an additional 30 days to file; however, you are still required to furnish Form W-2 to your employees by February 2, 2009.

The State of California…

Follows similar deadlines for year end forms and returns, including the 540, which is California’s version of the federal Form 1040 with the same April 15^th deadline (unless you request an extension).

There are also a few other reports the State of California requires.

Annual Reconciliation Statement (DE 7)

The DE 7 reconciles all the DE 6’s and taxes you needed to file and pay (see below) if you had employees.  If you owe money at this time you will need to include a DE 88 (see below).

Due Date: The DE 7 must be filed (post marked) by January 31, 2009, except this year it will be accepted as timely if post marked by February 2, 2009 (because the 31^st falls on a Saturday).

Quarterly Wage and Withholding Report (DE 6)

This is the quarterly tax return where you report your employees’ wages and withholdings throughout the year. The dues dates are the same as for the Form 941 above. You will need to also most likely pay taxes at this time, so include a DE 88 (see below).

Report of New Employee(s) (DE 34)

California state law requires that new employee hires be reported to the state within 20 days of hiring. They are reported on the DE 34. This is to help track down parents who are not paying child support payments. The information is shared nationwide.

Report of Independent Contractor(s) (DE 542)

California state law requires that if you pay an IC $600 or more, or upon signing a contract that anticipates paying the contractor $600 or more, you must report certain information to the state.  This report is due anytime during the year you meet the requirement. The form DE 542 is used to help track down parents who are not paying child support payments. The information is shared nationwide.

Payroll Tax Deposit (DE 88)

All tax payments made to EDD for payroll taxes must be submitted with a completed DE 88, unless the payments are made by electronic funds transfer.

There’s more…

I probably left out a couple hundred, less common forms, but I think you can see why government tax administrators get cheered up this time of year.

It’s Tax Season!

This article is for the IC Consultant.

One of the biggest advantages to being an IC over an employee is the tax breaks.  A small business gets to deduct expenses employees do not.  However, there are also responsibilities attached to the benefits.

Here are a few items to think about:

Business Deductions: If you are an IC then you are entitled to the same deductions larger businesses can take on all ordinary and necessary business expenses.  These expenses are deducted from your revenue to reduce your taxable income.

A few examples are:

• Business travel
• Cost of equipment
• Cost of supplies
• Cost of rent for office space
• Advertising
• Client or prospective client entertainment to gain new business
• If you have employees their wages are an expense against your income.
• The costs of fringe benefits for your employees such as health insurance.
• The taxes you pay on your employee’s wages such as:
  • The employer’s share of FICA and Medicare taxes.
  • Federal and state unemployment taxes.

A bonafide business is subject to the risk of loss.  It is possible you could actually lose money during the year.  These losses can be deducted against your income to reduce taxes. If the losses exceed income for the year, some of the year’s losses may be carried over to the next year.

Responsibilities

The self employed are required to file and pay quarterly estimated tax deposits. This is an area that many small businesses, sole proprietorships and corporations fail to do-at least initially, until the IRS catches up with them.  Failure to pay quarterly estimated taxes can add penalties and expose you to hard collection procedures by the IRS.  Some people consider this a complicated area of tax because they are not familiar with the requirements.  The rules are really fairly simple.

• A business generally should pay quarterly estimated taxes if the total tax bill at the end of the year will exceed $500.
• In addition by the end of the year, you should have made deposits of either
  • 90 percent of the tax that will be owed for the year, or
  • 100 percent of last year’s tax.

(There are formulas that are best left up to your CPA or account to compute estimated income tax deposits).

• If you had employees you were responsible to withhold the employee’s share of FICA, Medicare and personal income taxes (and Disability Insurance in California) from their wages and pay it to the government during the year.
• Do you need a special license to perform your profession? If so, is it up-to-date?
• Do you have liability insurance?
• If you are only providing a service you don’t need to be concerned about sales taxes-at least not at this time (there have been discussions in the state legislature about this possibility but the concept has not yet found life).

The list of advantages and responsibilities of having your own business is much more than what was covered here.  The point is being an employee is relatively simple.  Show up-do the job-get paid.  The IC, on the other hand, must be aware of, and follow, many other legal requirements.

You may need an expert to help you meet these requirements.

In a recent article I briefly covered some points about the IRS Safe Harbor provision under Section 530 IRC.  Coincidently, the Sixth Circuit Court of appeals issued a decision that may add a ray of hope for all businesses using Independent Contractors.  That is, if you meet the requirements.

In Peno Trucking, Inc. v. Commissioner (6th Cir. Oct. 3, 2008), the United States Court of Appeals for the Sixth Circuit reversed a United States Tax Court’s determination.  The Sixth Circuit held that the company was entitled to the protections of Section 530, despite having misclassified its drivers as independent contractors.

Here is a simplified synopsis.

The trucking company had a contract with each driver under an agreement that expressly stated they were independent contractors. It issued the drivers a 1099 MISC.  The company also had two separate rulings from the State of Ohio.  One from the Industrial Commission (OIC) and another from the Bureau of Workers’ Compensation (BWC); both ruling the drivers were independent contractors.

However, The Internal Revenue Service (IRS) reclassified the drivers as employees anyway and issued an assessment, which the company appealed to the Tax Court. The company argued that the drivers were properly classified, but even if they were not, the company met the requirements for Section 530 relief.  The Tax Court ruled in favor of the IRS on the worker common law status, finding that:

• The drivers did not have a substantial investment in the tractor-trailers,
• The drivers’ services were continuous in nature,
• The driver’s services were essential to the company’s business,
• The drivers could not realize a profit or loss,
• The company controlled the driver’s responsibilities, work hours and loads hauled.

On appeal, the Sixth Circuit affirmed the determination that the drivers were common law employees and not Independent Contractors.

However, the company also argued they were relived under Section 530 tax relief.  To refresh your memory, from my previous article, to qualify for Section 530 relief you must have:

1.       Exercised Substantive Consistency in the treatment of these individuals.  If at any time in the past you treated this (or similar) workers as employees you fail this test.

2.       Exercised Reporting Consistency by properly filing all required federal tax returns (including information returns such as 1099 MISC) consistent with your belief they were IC’s.

3.       Have a Reasonable Basis for not treating a worker as an employee by having at least one of these:

1. 1. • A previous audit (after 1996) holding the individual or class of workers as IC’s.
      • There must be a ruling, such as a federal court decision (the IRS thinks…read on) holding them as IC’s that meets legal standards of application.
      • Show the industry substantially does it this way (this gets problematic in actual application).
      • Show you were following reliable legal advice (again-problematic).

The Sixth Circuit decided the company established a prima facie case that it met all three criteria.  The court found that the criteria of Section 530 were met because:

1.       The company had always treated the truckers in question as independent contractors.

2.       The company had always filed its tax returns in a manner consistent with this treatment.

3.       Then the Sixth Circuit found that the law applied by the state of Ohio appeared to be virtually identical to the federal common law 20-factor test; therefore, the determinations of the OIC and BWC were reasonable judicial precedents upon which the company could rely and satisfied the reasonable basis requirement.

At that point, in legal maneuvering and tactics, the burden shifted to the IRS to prove otherwise.  To cut this short, the IRS failed to do so and the company won!  Therefore, the Sixth Circuit held that the company was entitled to Section 530 tax relief.  In other words, they were forgiven the federal payroll taxes, penalty and interest and will be allowed to continue treating the drivers as ICs for federal tax purposes.

Keep in mind that won’t give them a Get Out of Jail Free pass for civil lawsuits should one pop up in the future.

I just thought you’d like some good news before the holidays.

If so, are you treading on thin ice?

What is Safe Harbor?

Some think Section 530 of the IRC is a “Get Out of Jail Free Card.”  They think a business that qualifies for Safe Harbor may treat a worker as an Independent Contractor for federal employment tax purposes, (see Thin Ice Warning below) regardless of the worker’s individual status under common or statutory law.

Is it really that easy?

I believe for a while even IRS auditors thought they were barred from assessing anyone who had misclassified a worker as an IC.  However, in recent years the IRS has retrained their auditors and tightened up the application of Section 530.  Here are the high level rules the IRS uses in applying Safe Harbor during a tax audit.

How does a business qualify for Safe Harbor?

It gets a little complicated…To qualify you must meet all three of the following requirements:

1. 1. You have a Reasonable Basis for not treating a worker as an employee by having at least one of these:
      • A previous audit (after 1996) holding the individual or class of workers as IC’s.
      • There must be a ruling, such as a federal court decision, holding them as IC’s that meets legal standards of application.
      • Show the industry substantially does it this way (this gets problematic in actual application).
      • Show you were following reliable legal advice (again-problematic).
   2. You exercised Substantive Consistency in the treatment of these individuals.  If at any time in the past you treated this (or similar) workers as employees you fail this test.
   3. You exercised Reporting Consistency by properly filing all required federal tax returns (including information returns such as 1099 MISC) consistent with your belief they were IC’s.

As usual, the devil is in the application.  It’s surprising how easy it is for the IRS to find where you fail just one of these tests, which throws you out of the Safe Harbor and into the Tax Storm.  (Remember the recent articles about Fed Ex and the $300 million tax assessment for only one year?  Do you think their attorneys didn’t make a run on Safe Harbor?)

Thin Ice Warning:  Your risk could be much more than federal employment taxes.

Even if you can take refuge in Safe Harbor for federal employment tax purposes, doing so does not protect you from legal challenges by other federal or state enforcement agencies (such as, U.S. Department of Labor, State of California Department of Industrial Relations, etc).

For example, The State of California’s Employment Development Department (EDD) is not legally bound by the IRS Safe Harbor law and will not honor an IRS Safe Harbor ruling.  Therefore, for tax purposes, it is possible to treat an individual as an IC for the IRS and still be required to report and pay taxes to the State of California as an employee.

Maybe more important are co-employment and labor law issues.

Safe Harbor does not apply to labor laws or to civil lawsuits by workers who claim they are common law employees and want the benefits.  Therefore you can not use Safe Harbor to defend yourself in the labor law enforcement and civil cases that follow.

SACRAMENTO-In November, Governor Schwarzenegger called back the lame duck lawmakers to fix the budget crisis for California.  As you may have guessed, nothing was accomplished, so now he has called a special session of the new legislators to work on the problem.  What’s on the table?

Governor Schwarzenegger said, “Without immediate action our state is headed for a fiscal disaster and that is why with more than two dozen new legislators sworn in today I am wasting no time in calling a fiscal emergency special session.  We must act now to address the current year revenue shortfall of $11.2 billion and we must implement an economic stimulus package to help retain and create jobs, keep Californians in their homes and fix the state’s Unemployment Insurance Fund.”

Specifically, the governor includes the following labor law and tax points in his plan:

• Provide overtime exemptions and allow more flexible work schedules to increase productivity to keep jobs in California.
• Clarify meal and rest periods to save businesses in litigation costs and create less confusion from meal break violations.
• An increase in contributions into the Unemployment Insurance Fund, combined with a small reduction in UI benefits in order to maintain the fund’s solvency.
• A bipartisan “Commission on the 21st Century Economy” to re-examine and modernize California’s revenue laws.

It’s always alert-time when politicians want to “re-examine and modernize” revenue laws during a time of government budget shortfalls.  The Republicans are still resisting tax increases, favoring instead a cutback in government services.  However, the Democrats now have three more seats in the State Assembly than the last session, so their solution to the budget of raising taxes may have a better chance to pass.

I’ll keep an eye on this and report any changes in the future.

The November election resulting in President-Elect Obama and a strong Democratic majority in Congress will create a wind of change like we have not seen in…well…ever.  One big winner of this wind of change will be organized labor. For example, the new congress and President-Elect Obama are expected to enact the Employee Free Choice Act (EFCA).

Why do I say that?  Because Obama was a co-sponsor of the bill while a senator.  In a speech before the SEIU prior to the election, Obama vowed to pass the EFCA, stating: “We will pass the Employee Free Choice Act. We may have to wait for the next president to sign it, but we will get this thing done.”

EFCA would result in the most sweeping changes to the National Labor Relations Act since the 1935 Wagner Act.

A few of the provisions are:

• Require the National Labor Relations Board (NLRB) to certify a labor union as the exclusive bargaining representative by the use of authorization cards signed by employees and without the supervision and oversight of the government, (instead of the current practice of secret ballot with oversight);
• Require binding arbitration if an employer and a newly certified union are unable to reach a first contract in a timely fashion;
• Give the NLRB more powers in stopping employer unfair labor practices during union-organizing campaigns and during the initial bargaining process. This element also gives the NLRB the authority to impose penalties.

Employees can be unionized-Independent Contractors can not.

But before you reclassify all your workers to IC’s be sure that you do it right. I recommend you engage the services of a true expert.  Even the largest companies, with in-house attorneys, have made the mistake of thinking they can migrate their workforce from employee to Independent Contractor by just making a few adjustments in title and tasks.  A true expert will be able to advise you if your model will hold up under fire from the IRS, other enforcement agencies, or from civil lawsuits.  If not, an expert will be able to provide you with options to save money and misclassification risks.

WASHINGTON-In June 2008, I reported that the Department of Homeland Security (DHS) and the Social Security Administration (SSA) had joined forces to require private companies doing business with the federal government to ensure their employees are working here legally.  At that time, the federal government was also considering making this a requirement for all employers across the nation.  In August the DHS backed down on requiring all private companies use E Verify and said it was studying other options.

This requirement is aimed at cracking down on hiring of illegal immigrants. However, people who overstayed visas or came to the country legally but do not have permission to work, such as some students or those awaiting work permits, also could be snagged.

The latest on E Verify:

This week the Bush Administration announced that, “Federal contracts awarded and solicitations issued after Jan. 15, 2009 will include a clause committing government contractors to use E-Verify.  The same clause will also be required in subcontracts over $3,000 for services or construction…Companies awarded a contract with the federal government will be required to enroll in E-Verify within 30 days of the contract award date…”

What is E-Verify?

The Eligibility Verification Program is an online system operated jointly by the Department of Homeland Security and the Social Security Administration. Participating employers can check the work status of new hires online by comparing information from an employee’s I-9 form against SSA and DHS databases.

Today using E Verify is voluntary for most employers

The DHS originally planned to require all employers to use E Verify, but backed down in August 2008, as a result of overwhelming opposition.  At this time, using E Verify is voluntary for most employers, but on their website DHS is encouraging every employer to use this system.  It’s possible the Obama Administration, or the new federal legislature, will take another look at this process next year.

I’ll keep an eye on this and report any changes in the future.

WASHINGTON-According to study conducted by Dr. William Fishbein, a cognitive neuroscientist at the City University of New York, not getting seven to eight hours of sleep each night disrupts the brain’s ability to regenerate memory function.

Dr. Fishbein also reports that taking a nap during the day enhances your brain’s ability to better see the big picture and produce creative ideas…

So do you want to do a better job and live a better life?

The answer is get more sleep.

Are you losing sleep?

Some managers lose sleep because they worry about the IRS or EDD knocking on their door to conduct a tax audit of their poorly done IC classifications or because of labor lawsuits.

If this contributes to your loss of sleep, let Collabrus protect you from misclassification errors.  We also can manage your contingent workforce more cost effectively than you, or any of our competitors.

Why does providing a computer, email, telephone, supplies, materials, tools, software applications, workspace, or other material assistance tend to make someone an employee?

The short answer: Because those are the normal items and expenses that an independent contractor (or business) traditionally pays for.  Employees expect to receive this apparatus as part of the employment relationship.  Independent Contractors should not.

There are actually two primary legal and logical explanations why.

1. Two important characteristics of an Independent Contractor (or business) are the Financial Investment and the Risk of Loss.  IC’s, and other independent businesses, have a monetary investment in their business (time spent working doesn’t count for this factor).  If things don’t go well they can actually spend more money than they make.  An employee doesn’t typically have this risk of loss or investment in assets.
2. When someone provides the material, supplies, work space and other tools (such as proprietary hardware or software) to perform a job, they have an implied right to control how those assets are utilized in doing the job.  That, in turn, implies they have the right to direct and control the way the job is done, which is another trait of an employment relationship-the Right to Direct and Control the Work.

Therefore, the more supplies, materials, tools and workspace, etc. someone is provided to perform the work, the more they look like an employee.

Please remember, no single factor alone will decide the status of a working relationship, and factors can be weighted differently depending on the profession and the circumstances of the project.  That’s why it takes a true expert to make these calls with the confidence of being correct.

I have another question for you:

If you realize your IC is misclassified what are your remedies for fixing the problem?

When a company realizes they have misclassified workers they often aren’t sure how to remedy the problem. Actually there are several paths to properly correcting the relationship.

Here are three options to consider.

Option 1:  Reclassify the misclassified consultant to an employee.

This is a guaranteed way to avoid future liabilities and co-employment conflicts. If this is your preferred option, you should do it as soon as possible. I don’t recommend this action as a wholesale changeover for every IC performing services in the company. Sometimes, the best option is to reclassify the consultant to an employee because they are that valuable to you, the way they operate today. A change in the working relationship just won’t work.

Changing an IC to an employee should involve a thoughtful, case-by-case evaluation of your consultants with the assistance of a true IC compliance expert.

But if we reclassify an IC to an employee won’t that flag us for an IRS or EDD audit?

It may, or may not. However, if you know you have a misclassified worker it is best to correct the situation as soon as possible. The statute of limitations for taxes is generally three years. The sooner you fix it the sooner the statutes drop off on the backend and you become squeaky clean.

Be sure to consultant with a true IC compliance expert before making a change.

A true expert in common law classifications will tell you that not every consultant requires reclassifying. They may be able to recommend several different legitimate options to mitigate your risks without reclassification. Keep reading for several below.

Option 2:  Consider a bonafide restructure of the working relationship.

You need a true expert to do this correctly or you can end up in real trouble. However, sometimes all it takes to change a misclassified worker into a genuine Independent Contractor is to change a few key factors in the working relationship.

For example, look at the chart below to see one limited example.

One column describes an IC the other an employee.  (This is a very simplified example and you should not rely on it to construct an IC model for your business).

Don’t want to give up all that control?  If you get the same end result what do you care?  However, it’s your business and your decision.

The point is a true IC compliance expert will be able to help you decide if you can make a bonafide change that will protect you.

Option 3:  Partner with a contingent workforce management company.

What we are talking about is risk mitigation, but a good contingent workforce management company, like Collabrus, will give you much more.

For example, Collabrus services include:

1.      Risk management Services-Independent Contractor validation (including oversight of other venders  and payroll services you may use), online contract tracking and reporting, and end of engagement processing.

2.       Program Management Services-the hiring and onboarding administrative process, contract management and monitoring, employee and IC contractor support, project oversight, and budget control.

3.       Pay and Benefit Services-a benefits program for contingent employees and voluntary programs available to IC’s, consolidated online invoicing and billing system for time, deliverables, expenses and other payments, employee withholding and reporting, and insurance benefits.

The use of a responsible contingent workforce management company is a practical and viable alternative that allows your IC’s to provide services to the company, yet minimizes your exposure to liability under tax, employee benefits and labor laws.

With this option you may get to have your cake and eat it too.  This alternative can protect you and save money in the long term.