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We are frequently asked whether it is safe to treat a particular
service provider as an independent contractor -- and almost always
our answer is "No." Here's why.
What is an Independent Contractor?
The concept of "independent contractor" is first and foremost a
concept of tort law. Generally, a person who retains the services of
another, but who does not control how the services are performed, is
not held liable for any injuries or damages caused by that
independent service provider. For example, if your business retains
the services of an independent trucker to deliver products to your
customers, you should not be liable for any injuries or damage caused
by the trucker in the course of delivering your products because you
do not control how he carries out his duties. If, on the other hand,
you own the trucks and hire and train the drivers of those trucks,
you should be liable for their negligent acts -- you have made the
delivery of products part of your business.
Independent Contractors and the Tax Code
The concept of "independent contractor" takes on new meaning under
the Internal Revenue Code, primarily because of the payroll tax
withholding rules. Employers are responsible for payroll tax
withholding from employees, but not from independent contractors.
(An independent contractors is, by definition, a separate employer.)
The Service favors classifying a service provider as an employee
rather than an independent contractor because it improves the
likelihood of proper payroll tax withholding.
The battle with the IRS over the independent contractor/employee
issue has been fought for quite some time. Several tax court cases
have listed the factors that determine whether a person is an
independent contractor or an employee. Some of the key factors are
the amount of control exercised by the employer over the services
provided; who supplies the tools; who does the scheduling; who
provides specific instructions and training; who hires, supervises
and trains assistants; whether regular and recurring services are
provided; whether the service provider has his own separate office or
business; and whether the service provider performs more than minimal
services for others. Unfortunately, evaluation of these factors is a
subjective exer- cise, and the IRS and the employer frequently
disagree as to the conclusion that should be reached after these
factors are considered.
To stem the Service's aggressiveness in re-characterizing independent
contractors as employees, Congress enacted Section 530 of the Revenue
Act of 1978. That provision states that an employer has a right to
treat a person as an independent contractor if it has been the
practice of the industry to treat individuals performing such
services as independent contractors.
Unfortunately, where the industry practice is clearly to treat
certain individuals as independent contractors, the IRS may not
agree. In a recent controversy over the status o f emergency room
physicians, the Service rejected a study commissioned by the American
College of Emergency Physicians that dem- onstrated that the industry
practice is to treat emergency room physicians as independent
contractors, stating that the employer must prove a "local" stan-
Few taxpayers have been willing to fight for the protection offered
by Section 530 because the appeals process is costly. Ironically, as
more and more taxpayers settle with the Service, many industry
practices have effec- tively been transformed from "independent
contractor" to "employee."
The Current State of Affairs
Public comments from IRS officials suggest that the Service is
preparing to step up its attacks on independent contractors. The
Service's tough public stance and the extraordinarily high cost of
fighting the Service over this issue argue against the creation of
independent contractor relationships unless the Service has
previously ruled in a taxpayer's favor in a very similar situation.
If someone insists on contracting with you as an inde- pendent
contractor and you are concerned about these tax issues, you should
insist that the individual incorporate. It appears that contractual
relation- ships with a corporation are less likely to be challenged
than contractual relationships with individuals.
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