I recently received this very timely question at USTaxAid.com:
“I’m curious if you have done any updates to contractor/ employees relationships. I currently am happy contracting with a company that I believe is very loose on this distinction. I have no interest in pursuing myself, but it won’t surprise me if they are eventually tested on the distinction. I’d like to be prepared if that eventuality occurs.”
The reason it’s timely is because two big changes have recently occurred.
First, your biggest issue isn’t the IRS anymore.
These days, states are your biggest concern for changing your independent contractors (IC) into employees. Some states are following California’s lead in aggressively re-characterizing who is an employee and who is an independent contractor.
In 2018, California courts made a landmark decision in a case called Dynamex Operation West. It put some real teeth in the ABC test that California uses to determine whether a worker is an IC or an employee.
Currently, Hawaii, California, Louisiana, Mississippi, Alabama, Pennsylvania, Vermont, New York, Connecticut, Idaho, Colorado, Illinois and New Jersey all have the ABC test.
The ABC test is comprised of 3 parts. All parts must be met in order to be considered an IC. Otherwise, all workers are employees.
(1) The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
(2) The worker performs work that is outside the usual course of the employer’s business.
(3) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
How about leased employee arrangements? Just to stay consistent, let’s focus on CA again. This is the law back in 2014 (so it’s been around for a while):
California’s AB1897, signed by Governor Brown on September 28, 2014, adds Section 2810.3 to the California Labor Code. The new law became effective on January 1, 2015.
Labor Code Section 2810.3 contains three new requirements:
- An employer must share with a labor contractor all civil legal responsibility and civil liability for all workers supplied by that labor contractor for:
- the payment of wages; and
- any failure to secure valid workers compensation coverage. Labor Code Section 2810.3(b).
- An employer may not shift to a labor contractor any legal duties or liabilities under the provisions of Cal/OSHA. Labor Code Section 2810.3(c).
- Upon request by a state enforcement agency or department an employer and/or labor contractor must provide to that agency or department any information at all within possession, custody or control required to verify compliance with applicable state laws. Labor Code Section 2810.3(i).
In other words, you can have leased employees as opposed to employees as long as you treat them exactly as you would employees. That means same benefits, same taxes, everything is same.
That’s the first issue. What will the state think? And it’s not a simple question either. You also need to consider nexus for your business and the worker. Which state’s laws will apply?
Secondly, you may not want to have ICs if it means you will lose out on the 20% income deduction. You only get that with employees. Leased employees are a special case. Make sure you talk to your CPA on how your leased employees will work with the new deduction.
There are a couple of things you can do to make sure you have a better case in the IC argument.
First, as much as possible, nexus shop. Use the state that has the best law. If you can hire a worker outside the US, you’ll pay less and have less tax obligations.
Secondly, require your ICs to have a business structure.
Third, make sure you have an IC agreement.
We’ve got more tips, but that’s a good start.
Our coaching class on December 18, 2019 at 5 pm Pacific is all about the NEW Independent Contractor Status, what it takes to win the argument and whether it’s something you really WANT to do in light of the Trump Tax Plan provisions.
If you are reading this before the coaching class, you can join live at 5 pm Pacific. Join coaching here https://www.ustaxaid.com/coaching-program
If it’s past 12/18/19, you can still listen to the recording and read the Home Study Course when you join coaching and log into the coaching page.
As a coaching member you’ll be able to ask me questions about this or other tax matters for your business or real estate, please join in at the next coaching class or drop me an email at Coaching@USTaxAid.com.