A couple of years ago, California’s Employment Development Department (EDD) came into the wine country and swept through the spa industry with worker classification audits. Masseuses, working as independent contractors for several spas as well as for themselves, were reclassified as employees. The state taxing agency hit the spas hard with bills for employment taxes, along with penalties and interest. Some spas suffered such huge liabilities they were forced out of business.
EDD followed established guidelines to determine that these workers should be classified as employees. But many spa owners, unaware of the rules, genuinely believed that if the masseuses were “on call” and expected to be treated as independent contractors then it was fine to do so.
The IRS and state taxing agencies take a different approach, ruling mutual consent is not a criterion in making this decision. After all, they want those employment taxes, and do not look kindly on employers who try to shrug their way out of it.
How do you make the determination of how to classify workers? Well, it all boils down to degree of control and independence. According to the IRS, the employer must consider the following:
- Behavioral: Does the company control--or have the right to control—what the worker does, and how the work gets done?
- 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?
If you answer yes to all of the above, then you have an employee, not an independent contractor. 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.
In the case of the spas, most masseuses were assigned a window of time to be present at the spa to accommodate their clients as well as walk-ins. During down time, they were required to do laundry, answer phones, and perform other duties. Therefore, it was the spa that had the control over the workers, and they were easily and rightfully reclassified as employees. Other criteria considered in this case are that the workers performed the same service as the company offers to their clients, and in almost all cases, the masseuses used supplies provided by the spa. All of these factors indicate an employer-employee relationship.
If you realize that you have been misclassifying your workers, there is a special program for you. The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
Also check with your state taxing agency about their rules and regulations governing classification. They may have a different or expanded set of rules than what the IRS has.
This month, when completing Forms 1099 (due to recipients by Jan. 31), remember that if you paid by debit or credit card or any method other than cash or check, you should exclude the amounts from the reporting. These amounts will be included on third party payment processors such as credit card companies, PayPal etc. on forms 1099-K, which are new this year.
It continues to get more complicated
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.