I’m neck-deep right now in emails from owners and staff seeking advice regarding either initiating misclassification suits or defending them. You know why? It’s the most wonderful time of the year–tax season.
What makes tax season so “special,” you ask?
It’s the time of year that independent contractors realize exactly what it means to be an independent contractor–specifically, how much it costs and how much freedom they’re owed because of that higher employment tax they’re paying.
So, in this brief post, I’ll provide some broad advice to those of you that might be looking at the identifying factors for an independent contractor and going, “What the hell?! I’m not really independent!” and some advice for salon owners that are looking at their audit notifications and saying, “What do they mean they weren’t really independent?!”
1.) Compile your research.
If you believe you were misclassified, gather information and specifically list your reasons why you believe so. Make copies of any employment contracts, employee handbooks, schedules, and pay stubs you have. Click this link to see the 20 factor evaluation the IRS uses to determine employee classification and notate the circumstances that involve your particular situation.
2.) Speak to your boss.
In a private, one-on-one meeting, show your boss your data and inform the owner that you believe that their classification was inappropriate and therefore, illegal. Explain that the situation needs to be rectified immediately with a change in status and that you need to be reimbursed for the owner’s portion of your employment tax. If they refuse to do so, let them know that your next step will be to contact the IRS and the Department of Labor.
3.) Follow through.
Click this link to file an SS-8. Search Google to find your state’s labor department contact information (most of the time, this will be the Attorney General’s office since they often handle these disputes).
4.) File your taxes with Form 8919.
Form 8919 allows you to pay only your portion of the employment taxes if you believe you have been wrongly classified. File this with your SS-8. Use Reason Code G on the form.
1.) Analyze the strength of your legal position.
You have two options here: you can fight the dispute, or you can admit fault due to ignorance and pay the taxes you rightfully owe. My advice, as always, is to be honest. If you know you made a mistake, admit to it. The consequences will be far less severe than if you lie and are proven to have lied.
2.) Know the Criteria to Satisfy Act (Sec. 530)
This bullet point deserves its own full-length article, which I’ll get around to eventually. For now, this brief overview will have to suffice.
Section 530 is a safe harbor provision. This means that the IRS can’t retroactively reclassify “independent contractors” as employees and subject the principal to federal employment taxes, penalties and interest for such misclassification. In order to qualify for section 530 relief, you must
a.) consistently treated the workers and similarly situated workers) as independent contractors (Substantiative Consistency):
This requires consideration of the relationship between the taxpayer and those individuals.
b.) complied with the Form 1099 reporting requirements with respect to the compensation paid the workers for the tax years at issue (Reporting Consistency);
You must have timely filed Form 1099 with respect to the worker for the tax period at issue. Failure to timely file in a tax period will not prevent section 530 relief in periods where returns were timely filed. If there is no obligation to file a Form 1099 (as is the case with booth renters and independent contractors paid under the yearly threshold), section 530 relief will not be denied. Also, if you file the wrong kind of Form 1099 in good faith, you do not lose eligibility for section 530.
c.) had a reasonable basis for treating the workers as independent contractors (Reasonable Basis).
“Reasonable basis” is intentionally broadly defined in favor of the taxpayer. Reasonable basis can include court decisions or published IRS rulings (even if they don’t directly relate to the beauty industry specifically), correspondence from the IRS (private letter rulings, technical advice, or determination letters), a past IRS audit that determined there was no assessment attributable to the treatment of workers holding positions substantially similar to those of the workers whose status is currently at issue, or reliance on the advice of an attorney or accountant.
Please understand that relying on the advice of an attorney or accountant may not be considered “reasonable basis” depending on your particular circumstance. This is the age of information. Statutes are widely available online. This defense may not serve you since the IRS Revenue Manual specifically states “…the taxpayer should establish at a minimum, that it reasonably believed the attorney or accountant to be familiar with taxpayer’s tax issues and that the advice was based on sufficient relevant facts furnished by the taxpayer to the adviser.”
This means that you don’t necessarily need to seek out someone who specifies in employment law, but if you took the word of legal counsel that clearly isn’t qualified to give relevant advice (like a divorce attorney, personal injury lawyer, or other professional that has no reason to understand the intricacies of employment law) and/or if you weren’t furnishing all of the facts necessary to the attorney to make the correct determination for you, this defense will not be acceptable.
Reliance and misinterpretation of the 20 factor common law test for determining employment status may also be used as well, but in our industry this defense almost never works since if the majority of you were to actually compare your employment situation to the 20 factor test, you would clearly see that the classification is blatantly and obviously inappropriate.
Another reasonable basis defense is “industry custom.” I disagree with this defense vehemently. The basis of this defense is that “everyone else does it this way, so why can’t I?” So…if at least 25% of the owners in this industry do things wrong, it’s okay to do things wrong yourself? This reason is absolute bullshit. You are a grown adult and a business owner. It is your responsibility to inform yourself. Whether you do the research yourself or hire an attorney or accountant to advise you, you have absolutely NO excuse not to know better.
Sigh. That being said…a lot of well-intentioned owners get audited because they were doing things “the way they’ve always been done.” They didn’t think it was illegal because every salon they ever worked at operated that way. One one hand, I hate you people for being too lazy to do your research. I hate you for exploiting your staff (even if it was unintentional). I hate you for not attempting to be better than those that came before you. I hate you for being ignorant and then trying to use that ignorance as an excuse. On the other hand, mistakes happen. A lot of people accept the words and actions of those in a position of authority without question. What reason would you have for questioning your superiors? A lot of you truly believe they know what they’re doing and why wouldn’t you when so many other salon owners make the same mistakes?
Whether or not this defense will help you at all is questionable at best. I’ve been noticing that the IRS has been taking the “ignorance of the law is no excuse” position these days, so you may not be able to skate away from those charges, even if you truly did make there error on accident.
3.) In any case, if you are facing an audit or an IRS investigation, it is imperative that you immediately hire an attorney that specializes in tax and/or employment law.
These cases are no joke. The DOL jumps on board, state labor officials jump on board, and before you know it, your ship is going down fast. The sooner you get legal counsel, the better.
4.) Be civil.
You cannot “curse out” an IRS representative or kick them out of your salon. You can’t scream at them, “Come back when you have a warrant!” (A salon owner who is now a friend of mine did this in a moment of panic. I laughed so hard when I heard that, I cried.) The IRS auditors are just doing their jobs. Do not tout your experience as if it matters…because it does not. An IRS representative does not give a single crap that you’ve “been in this business for 35 years!” All that’s going to do is lead them to investigate all 35 years of your history in the business. I can’t even believe I have to give this its own bullet point on this post, but it needs to be said apparently because some of you for some reason thought that mouthing off to your auditor was a good idea. (Spoiler alert: it wasn’t.) I know you’re scared. I know you’re overwhelmed. I know that some auditors aren’t the nicest people in the world, but getting aggressive will not help you at all. Calling the police on the auditor won’t help you either. Do yourself a huge favor and hire an attorney. Assist the IRS as much as possible. Cooperate, be civil, and show a genuine interest in helping them resolve the issue. It will all go much more smoothly for you if you do.