I’m an employer. In addition to paying wages, I also have to pay payroll taxes and unemployment taxes as well. I’ll be honest with you. It can be a pain in the behind.
I’m guessing that a lot of employers feel that way. Some hate dealing with payroll so much, that they don’t hire “employees” they just make everyone be “contract labor”. Here’s the thing—misclassifying your employees as contract labor is illegal.
Seriously illegal! Did you know that employers in Missouri who misclassify their employees as contract labor face penalties between $50 and $1,000 a day per worker and/or up to six months in jail per violation? In addition to that—yes, there’s more—the employer could also pay a penalty of 25% of the amount that the state was defrauded. (Yeah, they consider misclassifying employees to be a form of fraud.) If the employer has no basis for classifying the worker as contract labor, he’ll also be held liable for the employee’s unemployment contributions.
Here’s the big one though: Knowingly failing to insure workers’ compensation liability under the law is a class A misdemeanor, and is also punishable by a civil penalty of up to three times the annual premium the employer would have paid had it been insured or up to $50,000, whichever is greater. (You got an extra $50,000 lying around? I don’t.)
Do I have your attention yet? If you mess around with labeling employees as contract labor when they should be employees, you’re risking huge fines and jail. Suddenly, paying those payroll taxes doesn’t seem like such a burden after all.
So how do you know the difference between whether the person you hire should be a contract laborer or if you need to put him on the payroll as an employee?
Here’s a very over-simplified answer: control. Who has control of the employee’s work? Do you set the time and location of the person’s work? Do you provide all the tools and materials? That sounds like you have an employee. Does the worker also work for other companies doing a similar type of work? That sounds like contract labor. The quick and dirty analysis is—if you’ve got complete control over the person’s work—then that person is an employee. If the person does the same work for other people, controls pricing, etc., then they’re contract labor.
It’s not always easy to determine. Like I said, I just gave an oversimplified answer. The state of Missouri has a free booklet out that explains it pretty thoroughly. Here’s a link to get it: http://www.labor.mo.gov/DES/Forms/M-INF-310-AI.pdf .
If you have any questions about whether your contract laborer should be reclassified as an employee or not, then you need to read the whole booklet. It’s not a hard and fast “rule book” but rather guidelines of twenty areas that you can look at to see whether your worker falls into the employee or contract labor category. If you read the pamphlet and you’re still unsure about how you should classify somebody, call the Missouri Department of Labor and talk to one of their representatives. The main switchboard number is: 573-751-3215. I had to call them and they were friendly and helpful.
It’s really important to classify your employees properly. Missouri has the tools you need to make sure you do it right. If you’re still confused, they’re willing to help. There’s no excuse for messing this up.
The 1099-MISC form is what you need to give to a contract laborer if you pay them over $600 in the course of the year. There’s a whole new emphasis on reporting and so many more businesses are finding that they need to be issuing 1099s. But there’s a lot of confusion about how.
I recently was at the IRS office near my house asking if they had any of the new 2012 1099-MISC forms that I could have. “What do you want them for?” The IRS agent asked me. So I explained to her that I was teaching a class about 1099s and wanted to have the actual forms to hand out to the class.
“Oh thank God!” She said. Now, I work with the IRS a lot. I do audits and debt resolution, and although I genuinely like most of the agents I get to work with, I can assure you that “Oh, thank God,” is not a phrase used when the IRS is dealing with me. (Unless it’s used as “Oh thank God she’s gone now, but that’s about it.)
So I asked her why she was so excited that I was teaching a 1099 class and she told me about all the mistakes that they see and the problems they have with bad 1099s. “Somebody’s got to teach this stuff,” she told me. So I figured it would make for a good blog topic.
Here’s a link to see the 1099-MISC form for 2013. http://www.irs.gov/pub/irs-pdf/f1099msc.pdf If you’re the business owner, you need to issue the 1099 to the recipient by January 31, 2013. You must send the red copy to the IRS by February 29, 2013. (Electronic filers have until March 31—but if you’re reading about “how to” then you’re probably not and electronic filer for 1099s.)
My directions are just an overview; here are the official IRS directions: http://www.irs.gov/pub/irs-pdf/i1099msc.pdf. If you have questions, that’s the best place to look.
The Quick and Dirty
Generally, when you prepare a 1099-MISC you’ll put the dollar amounts in box 7 for non-employee compensation. If you’re preparing a 1099-MISC for any other reason, you should check the rules to make sure you’re using the right box. I’m talking about non-employee compensation.
Payers name, address, etc, is you. Recipient is who you paid. I recommend using EIN numbers instead of Social Security Numbers whenever that’s an option for safety.
You put the whole amount of money you paid the person into box 7. For example, let’s say I hired Brad the Painter to do some work in my offices. I paid him $600 for the labor, $75 for the paint, and $25 for his parking. If I paid that money to Brad, even though part of it was for supplies not labor, I give him a 1099 for the whole $700. Brad will write off the $75 for paint and $25 for parking as his business expenses.
Mail your 1099MISC with a transmittal form. The transmittal form is called a 1096 and here’s link to that: http://www.irs.gov/pub/irs-pdf/f1096.pdf
The filer is you (or your company.) The forms being reported is the 1099-MISC. The total amount reported on the 1096 is the total of what you paid the 1099 contract laborers. Here’s a clue—that number you put in box 5 should also go somewhere on your business tax return as a 1099 contract labor expense.
The IRS’s Biggest Complaints
- People are supposed to use the red forms. You have to use the real form; you can’t print it off the computer, even if you have a color printer. Those forms are scanned so it has to be the right paper. You can order your 1099-MISC and your 1096 transmittal from for free from the IRS. Here’s the link: http://www.irs.gov/Businesses/Online-Ordering-for-Information-Returns-and-Employer-Returns
- Don’t cut the copies. Leave all the pages whole. If you only have 1 form to issue, just leave the second one blank.
- Don’t staple the returns. Don’t fold, spindle or mutilate them in any way. They have to go through a scanner so leave them plain.
- Do not use a $ sign when typing in the amounts. It’s already on the form.
- Do use a decimal point and cents. So I didn’t pay Brad $700 I paid Brad 700.00
- Do not put 0’s in spaces, just leave them blank.
- Do not use # signs. For example, on the form 1096 where it asks for the number of forms, I would write 1, not #1.
A note about handwritten returns: Handwritten returns are more likely to have errors than other returns. Usually it’s a Taxpayer Identification Number and name mismatch. If you are using a person’s name—use their social security number. If you are using a business name, use the EIN number. That’s a common mistake. Be sure to use block print and not script. Yes, I need to say, print neatly.
If you are typing it on a typewriter, you need to use black ink and 12 point courier font.
You’re perfectly capable of doing the 1099s yourself. But if you are strapped for time or don’t feel comfortable doing this yourself, Roberg Tax Solutions will prepare 1099-MISC forms for a flat rate of $50 for up to 10 forms. After that we charge $2 for each additional 1099 issued. So if you had 14 1099-MISC contractors, we’d charge you $58 to prepare your 1099s. ($50 for the first 10 and $2 each for the additional 4 forms.) The price also includes your 1096 transmittal form as well.
The 1099-MISC reporting rules have a lot of people confused, but you don’t have to do this alone. We can help.
The biggest issue you’re going to face as a small business owner this year is whether or not the people you hire to work for you are employees or contract labor. This is such a hot topic with the IRS right now that they’re currently running a Voluntary Compliance Program—giving businesses a chance to “change their minds” about how their workers are classified. It’s called the Voluntary Classification Settlement Program (VCSP).
Basically, with the VCSP, if a business has been calling workers contract labor when they really should have been labeled as employees, you get a chance to go in and change your employee’s status before the IRS nails you instead.
So how do you know if you’ve got an employee versus a contract labor situation? That’s a really tough call sometimes and the law isn’t very clear. It’s all based on what’s known as “common law,” which means the issues have been settled in court cases instead of legislation spelling out the rules for us. The basic common law rule that defines an employee is that the service recipient (in English that’s the boss) has the right to direct and control how the service is performed.
Let me use an example: let’s say you hire me to do your taxes for you (Good idea, actually). In this case I would be contract labor to you. You will tell me what you need done, and supply me with the information to do it, but I’m going to use my software programs, my office, my stuff in general. I’m going to do it my own way, when I want to, and wear my pajamas at work if I want. That’s contract labor. (By the way, I never wear pajamas to work but I sometimes wear a St. Louis Cardinals jersey.)
But I used to be an employee at a large tax company. While I was working there, I used my boss’s software, I had certain hours that I had to be in the office, I arranged the paperwork for the files exactly as I was instructed (with the staple in the top left hand corner horizontal to the box in the big numbers in it) etc., etc.. My Cardinals jersey would have been a dress code violation and I would have been sent home. I could have even done your taxes while I was working for that company, but you weren’t really hiring me, you were hiring that company that I worked for.
You see how those two examples are different? Even though there isn’t an absolute, defining definition of what makes a person an employee, it’s sort of like Justice Potter Stewart’s famous quote about obscenity, “…I know it when I see it.”
I work with a lot of clients who are classified as 1099 contract laborers but should be labeled as employees. Most of them will never file a complaint with the IRS for fear of losing what jobs they do have, so employers have been pretty safe up until now. But the IRS isn’t stupid (Yes, I put that in writing). If I can look at a 1099 MISC and figure out that the person is really an employee instead of contract labor, the IRS is able to set up a computer screen and they’re going to be able to target suspicious 1099s as well. Did I mention, they’ve been updating their equipment? Faster, stronger, better—it’s like the $6 million man but more expensive.
So how do the people you hire stack up? If you’re paying people as employees, and properly paying your withholding taxes, then you’ve got nothing to worry about. If you’ve got employees but you’re paying them as contract labor it’s time to take a good hard look and decide if you’re doing the right thing. Using the common law test of “direct and control” are these people really contract labor or should you reclassify them as employees? If they should be called employees, you’ll want to find out more about the Voluntary Classification Settlement Program.
The VCSP has a whole list of requirements and there will be costs attached. Although that’s a little scary, it’s much better than the costs associated with an audit over your worker classification. To find more information about the VCSP, here’s a link to the IRS website: http://www.irs.gov/businesses/small/article/0,,id=246013,00.html
It’s perfectly legal to hire contract labor—it’s a very normal, regular part of business and many businesses couldn’t function without it. When you cross that line, when you’re really hiring employees but you’re just calling them contract labor to avoid paying payroll taxes– that will get you into trouble.
I was talking with a small business owner the other day and she told me this story:
I have a friend who’s really hurting. She lost her job about six months ago and she just can’t make ends meet. She’s having a hard time even putting food on the table. I wanted to help her out so I had her come help me with a project at my business and I paid her under the table. The thing is, she really did a good job and I could really use some more help but I can’t afford to pay her under the table any more.
Let me make one thing perfectly clear: Never pay anybody under the table!
First, it will come back to bite you in the behind one way or another. Trust me, I do a lot of audit work. “Under the table” doesn’t help anybody. You don’t get a deduction for paying “under the table” and the person you paid can wind up getting audited and get stuck paying tax on that money anyway. It’s a lose/lose situation.
If you really want to help someone out, but you can’t officially give them a payroll job, hire them as a contractor. Do the whole thing, have them fill out a W-9 form, and explain that you’re hiring them as contract labor. Tell them they’ll have to pay taxes on the money: 13.3% for self employment tax plus any additional income tax for their tax bracket.
Hiring someone as a contractor gives you a “triple good” effect. First, by making your friend contract labor, you can write off the money you give her as a tax deductible expense. If you’re paying 40% on your self-employment income, that $100 you pay is really only costing you $60. Plus, you’re getting a benefit out of it too because you’re getting the benefit of her labor. And third, your friend has a job. It might not be a full time job, it might not pay all the bills, but it’s something to put on the resume to show that she’s working. News reports are saying that employers won’t hire someone who has been out of work for over six months. That contract labor job gives her a better chance at finding real work. Plus, it allows her to use you as a reference. (Okay, I guess that makes it four benefits, not three. That sort of makes me the accountant who can’t count. Maybe I should hire someone to help me with that.)
But what about all the reporting requirements? With contract labor, all you have to do is prepare a 1099, which is due in January. You can get the forms free from the IRS. It’s easy. You only have to submit 1099s if you pay someone over $600 so if you’re just helping someone a little, you don’t even have to worry about that. I’ll make a how-to post in late December, so you can do it yourself. (My fiendish plan to get people to come back to my blog.)
What about all the new tax incentives for hiring that the president has proposed? So what about them? Right now, that’s all they are—proposals. Congress may or may not pass some or all of them. We have to run our businesses and our lives in the present tense. I’ve tried waiting for Congress to pass bills before—it’s bad business. Hiring someone as contract labor is a good quick fix for your staffing problems and it’s a good quick fix for someone who may need to eat.
Who knows? Maybe that contract laborer you hire will be the key to you making big profits.
I’ve done a lot of blog posts about what to do if you’re the contract labor, but the other day I had a client ask me about hiring contract labor. Here’s what you need to know if you’re doing the hiring.
First, you don’t need a “contract” with them. Contract labor is a term that’s used to mean they are working for you, but they are not on the payroll. For some things, it’s good to have a contract, but often it’s not necessary.
Second, never pay in cash—always pay by check. A check shows where you paid the money to – it’s a paper trail of how your business spent it’s money. That’s a good thing. The number one mortal sin in business accounting is making cash payments. Never take cash out of the ATM for your business; never pay bills in cash. You can use a “petty cash” account for really minor things, but there should be receipts for everything and a check should be written for “petty cash”. Cash gets you into trouble so you have to be doubly careful with it. If you remember nothing else, remember:real businesses do not pay bills with cash!
Third, although you don’t need a contract for the people who do work for you, you do need to have them fill out a form called a W-9. Here’s a link to get the form: http://www.irs.gov/pub/irs-pdf/fw9.pdf
Say for example that John Doe was doing some construction work for your business and over the course of the year you thought you might pay him over $600. You would have him complete the W-9 form for your records. (I even had my own kid do a W-9 and I didn’t expect her to make over $600. It’s just a good business habit.) I recommend having your contract labor give you the completed W-9 before you make the first payment. This keeps your behind covered in case the IRS or one of the other taxing jurisdictions decides to audit your books.
Anyway, on the form, John Doe would list his name under “name”.
For business name, he would leave it blank unless he had a business with a different name like “John’s Construction Business.”
Under the business type, he’d be an individual/sole proprietor (once again, unless he owned a regular business that was a corporation or something.)
He’d put down his address, zip code etc. He probably wouldn’t have an account number for you, but if he did, he could put it in the box. It’s not necessary.
Requester’s name is “Your Business Name.” You don’t really need to fill that out, you know who you are. If he’s completing the form right in your office, it’s okay to leave blank. If you’re mailing it to him, then you should put your business information in that box.
The TIN is John Doe’s social security number, unless he has a business EIN number. A regular business will know the EIN number and use it. If the person doesn’t know what an EIN is, then he should put his social security number. This W-9 form gives you good records and will protect you in an audit.
Make sure your contract laborer understands that if he receives over $600 from you, then you will be reporting his pay to the IRS as non-employee compensation. You need to do this or else the IRS will not allow you a deduction for the money you paid him.
You will need to prepare 1099 MISC forms in January (they’re easy to do.) Your contract laborer will receive his form by January 31st. You’ll also be sending copies to the IRS which are due at the end of February.
Hiring contract labor is much easier than putting someone on the payroll, but you do have to remember the rules: pay by check, get a W-9, and issue a 1099 MISC. These three things will help audit-proof your contract labor.
Filed under: Jobs, People, Self Employed, Tax Deductions, Uncategorized
What do you do for a living? Are you in advertising, construction, real estate? When you tell people what your job is do they seem to have a grasp of what that means? Some people’s jobs aren’t so easily defined, like Superman for example.
Actually, his name is Charlee Chartrand and he dresses as Superman for his job. This is not your every day occupation. Now I don’t know Mr. Chartrand and I don’t do his taxes, if I did, my confidentiality rules wouldn’t allow me to talk about him. I read about him in Sunday’s Post Dispatch. I did contact him and ask for his permission to use him as an example though.
The main part of Mr. Chartrand’s job is that he dresses as Superman, hangs around at Cardinals games and collects tips for posing in pictures with fans and tourists. He’s also been performing at birthday parties. If you think there’s no money in this, think again, he can earn as much as $400 in tips in a day. And that’s why he’s going to need to figure out his deductions before he files his tax return.
So what can Superman deduct? Let’s hit the obvious thing first: the costume–all of it. Cleaning, repairing, replacing, clearly this is one clothing expense that will count as a business expense. I would also include his undergarmets. You can’t dress as Superman and wear any old boxer shorts.
The hair: most of the time hair cuts and styling products, etc are not considered legitimate expenses for business, even if you are a professional actor or television personality. In Superman’s case here, I would claim his hair expenses. He has to dye his hair black to be Superman, and he uses four different products to get just the right effect–including the “S” shaped curl on his forehead. I think that goes far beyond what would be normal for Mr. Chartrand during his off duty hours.
I can’t tell from the photo if Superman is wearing make-up or not. He doesn’t look like it, but if he was, I’d allow it. (He might need to darken his eyebrows to match his hair.) A note about make-up: generally, make up is frowned upon by the IRS as a business expense. A clown wearing clown make-up would qualify for a deduction, but most women in any business would not. I once helped a dancer with her return and as we went through her expenses she claimed “a gallon of eyelash glue.” Now, I thought that was an excessive amount even for a professional dancer. “Not for eyelashes,” she said, “It’s to keep my costume on!” Evidently, during a dress rehearsal she had had a “wardrobe malfunction”. In order to keep herself looking decent, she glued her costume on to make sure she stayed covered. That clearly fit the category of “necessary” and I put it in. (Even the meanest IRS agent couldn’t argue that one.)
Let’s get back to Superman, He can probably claim either a home office deduction or rent for his work space. And, since he travels from his home office to his gigs, he can deduct his mileage as well. These are expenses that are pretty normal for many small businesses. It’s important to remember that even unusual businesses have normal types of expenses. Another normal type of expense for Superman might be advertising, if he has flyers or cards that he distributes to get new business.
Here’s another expense that I would use for Superman that might seem out of the ordinary: comic books—Mr Chartrand uses comic books to compare against his costume and maintain the authenticity of his look. I’d count it as a valid business expense.
Also, Mr. Chartrand has a goal of moving to Los Angeles. Making a permanent move to Los Angeles would count as a moving expense, as opposed to a business expense. But, if Mr. Chartrand makes a trip to Los Angeles, to test the market so to speak, he could probably write off most of that stay as a business deduction. This would give him a chance to test out the market and give himself an out to come home if he found Los Angeles wasn’t the place for him.
When claiming business deductions, the key phrase the IRS uses is “ordinary and necessary”.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
When you’ve got a one-of-a- kind type of career, it’s not always easy to figure out what ordinary means. Hopefully, Superman’s example can give you some ideas about what’s ordinary and necessary for your business.
To read more about Charlee Chartrand, aka Superman, this link will take you to the St. Louis Post-Dispatch article about him:
With the economy being in turmoil, a lot of people are turning to contract labor jobs. That’s where the company doesn’t hire you as a regular employee, even though you work for it. You won’t receive a W2 at tax time, but you will receive a form 1099MISC and you will be expected to pay tax on that.
Contract labor is good for employers who are a little gun shy over hiring. It’s also good for employees who may need to work to put food on the table, but don’t want to commit to a job that they wouldn’t ordinarily take.
If you’re thinking about accepting a contract labor type job, here’s a few things you should know. First, when you receive a form 1099MISC, the IRS treats that as self employment income. That means, at tax time you’re going to have to file a Schedule C along with your 1040 long form. You will be required to pay your own Social Security and Medicare taxes, in addition to paying what your employer would normally have withheld.
Let’s use an example: Heather and Melanie are both high school seniors looking for summer jobs. Heather gets a job at McDonald’s making $10 an hour. Melanie gets a contract labor position also making $10 an hour. They both work 20 hours a week. Since this is the only income the girls will make all year, we’re not even going to look at regular income tax (they won’t owe any) we’re just going to look at their take home pay and self employment taxes.
Since Heather works as an employee, McDonad’s is required to withhold her Social Security and Medicare taxes (FICA). Heather makes $200 a week, but she’ll only take home $184.70 because McDonald’s will hold back $15.30 to pay her FICA. What most people don’t realize is that in addition to the money McDonald’s holds out of Heather’s paycheck, McDonald’s also pays an additional $15.30 towards Heather’s FICA. At the end of 12 weeks, Heather will have $2,216.40 that she was paid by McDonald’s. She will owe no income tax at the end of the year.
Now let’s look at Melanie. As a contract laborer, Melanie has no FICA withheld from her pay. For one week, she gets a check for $200. At the end of 12 weeks, she’ll have been paid $2,400. The difference here is that Melanie will have a tax bill of $339 that she’ll owe at tax time. After paying her taxes, Melanie will only have cleared $2,061.
[Geek alert: if you checked my math, you'd say. "but 2400 times 15.3% is $367" -and yes, you're right. The first $433.13 of self employment income isn't taxed so the actual equation is income x .9235 x .153.]
In our example here, it’s better to be hired as an employee because the company pays half of your payroll taxes. But that doesn’t mean that you should not take that contract labor job. For one thing, you may be able to write off some of your job expenses, which would reduce your self-employment taxes. Or, you might negotiate a higher hourly wage rate. An increase of 7.65% would basically cover the additional tax paid by the employer. Knowledge is power. Knowing how you’ll be taxed and how much you’ll be taxed let’s you make smart decisions.