Do you know the difference between an employee versus independent contractor?
If you don’t, you may be a target of the IRS’s latest crackdown…
Have you tried to reduce costs by hiring independent contractors? Savings on employment taxes, benefits and payroll expenses can be tempting, but tread carefully: the IRS has targeted the misclassification of employees as independent contractors for special scrutiny and chiropractic offices are likely targets in this crackdown, too. If your practice were selected for an audit, could it bear the weight of penalties and back-taxes imposed because you failed to comply with a complex area of the law? Don’t let the new, stricter scrutiny on employee classification break the back of your practice; know and use the IRS checklist and avoid a lot of stress.
IRS Has Greater Range of Motion than You Think
As a sole practitioner or as a partner in a practice, you need to be aware that an auditor’s lengthy grasp does not necessarily stop when it reaches the last page of your business records. Take the case of a well-respected practitioner in solo practice who had entered a partner venture to operate a small clinic. The clinic was, in every respect, separate and distinct from his private practice. But when the clinic became subject to an audit, the examiner found questionable use of deductions on returns filed by the practitioner on behalf of the venture. Soon, he found himself hastening to open his professional practice’s records for the IRS, too. While the bulk of the audit was conducted at the CPA’s office, the examiner did spend a morning perusing the files at the practice, while the practitioner shuttled staff and patients around the paperwork and tried to shrug off embarrassing interruptions. Auditors may even ask for any records you keep once they begin an examination. And from there, they can even reach into your personal life.
Avoid the Pitfalls of Misclassifying Employees
While your primary concern is for your patients, the concern of the IRS is keeping the federal coffers full. That is why they are exercising such careful watch on the payment of employment taxes by practitioners just like you.
Running a practice means being responsible for employees’ Federal Unemployment Tax (FUTA), social security (FICA) and benefit plans. The IRS is taking a hard look at temporary associates, maintenance engineers, clerical assistants, and any person performing services who is designated as an independent contractor. Any of these people may have to be reclassified for purposes of collecting payroll taxes. For the IRS, the key question is: who exercises control?
First, remember that when you hire an independent contractor, you should ask for and receive his or her own business card, as well as any statement for services rendered, showing the business name, separate phone or fax number and logo, if any, even a copy of an advertisement they placed in the local phone book–anything that evidences their independent status. In addition, keep available all Letters of Agreement, contracts or receipts tending to show or back-up the independent contractor relationship. The worker designated as an independent contractor should meet the IRS criteria, a set of twenty questions the IRS uses to make their determination of employment classification.
Keep in mind the loose checklist that follows is the best means of understanding how the IRS determines employee vs. independent contractor status. However, the checklist is intended as a guideline. The IRS will consider each occupation and the context of the situation. So, use these twenty questions to help you decide who is and who isn’t an independent contractor.
Who gives the instructions?
The IRS will look at how the worker learns where, when, and the method of doing the job required. If your practice hires Wendy, a temporary worker, to handle backed-up insurance claims, providing specific instructions may be considered evidence of employee status.
Who gives the training?
As in the above example, if Wendy must be familiarized with some or all aspects of dealing with third-party payers, willingness to completely train that worker is evidence of employee status despite the limited scope of the work.
Is the service integrated into the practice?
If the worker’s services are generally separate from your business, there may be more justification for independent status. When you go on vacation, maybe you know Ted Bracer is willing to see your patients for their weekly appointments. He is not on your posted list of staff, does not answer to anyone about his hours or he arranges his own hours, and only confers with you as an appropriate. Ted is probably an independent contractor.
Who renders the actual service?
If no one else can do the job of the worker, the services must be rendered personally. That means it is more than likely the worker is an employee. This is a tricky area: Erin Kowalski, an x-ray technician, must personally work with the patients, and, while she is at your office or seeing your clients, she has access to the office x-ray equipment and your staff. While she may initially appear to have an independent contractor relationship with you, the requirement that she render services personally weighs in favor of an employee relationship. The determination will require looking at all of the criteria.
Who does the hiring, supervising and paying of assistants?
Following from the last criterion, if a provider of service may hire, fire, set hours, instruct and sign the paycheck of her own assistant, an independent contractor relationship is likely. If you hire an extra worker to assist her, the provider is likely an employee.
Does the person providing the service have an ongoing relationship with your practice?
Even if it is on an irregular or part-time basis, the overall duration of the relationship is what the IRS sees as evidence of status. For example, you may usually handle routine bookkeeping tasks or have your receptionist work on them as time permits, but when an employee goes on vacation, you may need help to keep the office running smoothly. Do you always call Ms. Snowdown to take on the work? Does your practice have an established procedure with her for providing such services?
Who determines work schedule?
Independent contractors usually may determine their own work schedule. They are concerned with fulfilling the terms of the contract, but they are in control of just how and when they do it within the specified time frame.
Does your janitorial service always come at 9 pm? Or can Bill and his crew come anytime before you re-open in the morning? Provided Bill fits the other criteria, he is likely an independent.
Is the worker full-time?
The IRS will generally determine that a full-time worker is an employee without proof of a different relationship.
Where is work conducted?
Clearly, there are times when an employee works outside the office. Follow-up calls after regular business hours, or, in the case of an associate you’ve brought in temporarily, even home visits may be a fully anticipated part of an employee’s job. Just as commonly, an independent contractor will use your office facilities for the duration of her contract period. As with full-time workers, the IRS will likely presume someone someone working within your office space is an employee unless proven otherwise, but clearly where the work is performed is not a sure indicator of the relationship.
Who sets the order of tasks?
If you decide the order in which the work is to be done, the worker is probably your employee. As with scheduling, an independent contractor generally controls the order of the tasks. Since you probably set the order of priority with Ms. Snowdown, she is more likely to be considered an employee than say, Ted Bracer, who decides whom to see first when he fills in for you.
Are reports required?
It is often the case that independent contractors make periodic reports, verbally or in writing, as to the progress of the work. Nevertheless, requiring these reports is thought by the IRS to evidence of an employee status.
How is the worker paid?
Paying an hourly rate, or providing weekly or monthly paychecks will usually be considered evidence of an employee relationship. Contractors are more often paid by the job.
Is the worker entitled to reimbursements?
Expenses are supposed to be included within the contractor’s agreement, and there is usually no provision for ordinary reimbursements. Reimbursing expenses related to the job will look like an employee relationship to the IRS.
Who provides the equipment?
If work-related equipment is provided by you, the worker is more likely an employee. Independent contractors generally provide their own equipment, so if the contractor is using your office space and x-ray machine, you must have strong evidence to show independent status if the IRS comes knocking.
Who has invested in the facility?
This question becomes complicated by the growing trend of more and more people working from their homes these days. The IRS had traditionally presumed that someone who made financial investments in work-space (such as extra phone lines, desks and computer) was not an employee, but an independent. Now, employees can use fax and phone lines to work as efficiently from homes as from a furnished desk or suite at the office.
Who stands to make a profit?
A worker who makes a profit or incurs a loss along with an associate or investor is probably an independent contractor.
Is the worker employed by multiple employers?
The IRS views working for multiple offices as evidence of independent contractor status. Bill, the maintenance man works all over town for a number of professional offices. He even advertises his services in the professional journal that comes to you each month. Bill undoubtedly has independent status with each of his employers.
Can the worker offer services to the general public?
If the provider of services is not allowed to offer his or her services to the general public, he or she is probably an employee. Clearly, this question and the last work together to show evidence of employment status.
Can you fire at will?
If the worker can be terminated at will, he or she is considered an employee in most cases. Firing an independent contractor can raise questions of legal liability unless the contract has been breached and even then, there may be serious litigation potential. Ted Bracer may have turned down profitable contract work at another office to fill-in for you. He would suffer financial damage should you terminate his services suddenly and without a cause spelled out by you in the written agreement you both signed.
Can the worker quit at will?
On the other side of the coin, if the worker can quit at will, this, too, evidences an employee relationship. An independent contractor faces the same contract liability for unjustified termination as your practice would.
If Ted refused to honor his obligations, your practice might be compromised. His refusal might have such serious ramifications that a lawsuit for breach of contract probably would be justified.
The overall amount of control that you exercise over the service provider is the most important factor in determining the appropriate employment status. You could file IRS Form SS-8 in seeking a ruling on the status of a service provider, but be warned: this form alerts the IRS to a need for a tax examination of employment status in your practice.
The IRS will collect employment taxes one way or another, and if there is inconsistency in filed returns as between your office and the worker, the IRS is more likely than not to investigate your practice. Penalties are stiff, so be sure you meet the criteria.
What happens if the IRS reclassifies?
The IRS has a wide range of penalties at its disposal. If you classified a worker as an independent contractor, you should have filed Form 1099-MISC. If the worker is reclassified, the employer must pay its portion of FICA, plus 20% of the employee’s share of FICA and 1.5% of wages as income tax withholding. These numbers double if the Form 1099-MISC was not filed. And the fine for an intentional misclassification can be as steep as a 100% penalty of the amount of taxes owed. In addition, the IRS can impose a 20% accuracy-related penalty if it determines an employer negligently reported or under-reported.
Be sure to correct any error promptly: the longer it takes, the steeper the penalty imposed. Back taxes can accrue to substantial proportions, but the addition of penalties to the actual taxes can be disastrous for any practice. Remember, if the IRS reclassifies one of your workers, you must also correct, that is, make up for any omission from all applicable employee pension and benefit plans.
Observe the Pension Laws
Abuse of 401(k) plans has made pension and profit-sharing plans an area closely watched by the IRS. Proper funding of these plans is essential and must be available to all qualified employees. If you misclassify a worker, your whole plan may be disqualified and penalties assessed if you fail to include all who should be legally be included in the plan. The IRS is constantly changing the rules that affect such plans. The consequences for noncompliance or faulty plans can be quite severe, so be sure that you are familiar with the most recent IRS rulings.
Evaluate the status of your independent contractors now
Take a look at the current roster of outside help. Work with your accountant to check the IRS guideline to see if any of your workers appears to have been misclassified. Make sure your accountant has the information necessary to field any inquiries from the IRS. Use as much care with your chiropractic practice as you do with your patients, will decrease the likelihood of an audit, but if one does come your way, preparing now will ensure that it proceeds more smoothly and with the least disruption to your practice.”
“Bill Gifford is President of the Illinois CPA Society and President of Glenn Ingram & Company Ltd., a Chicago-headquartered accounting firm specializing in service to chiropractors and other service professionals for more than 70 years. You may contact him at Glenn Ingram & Company Ltd, 150 North Wacker Drive, Chicago, Illinois 60606, phone: 312-368-0220; fax: 312-368-4998.