Dear Rita in HR: I am executive director of a very small nonprofit. Recently, I had to fire an employee for the first time. In retrospect, I probably made a bad hiring decision, but it was a real nightmare to go through. I would like to just hire independent contractors from now on. As I understand it, with contractors I just pay them a flat amount every month and at the end of the year they get a 1099 instead of a W-2. Sounds like a great solution to me! Are you going to rain on my parade?
Signed,
Found the Magic Wand


Dear Magic Wand: Get out your umbrella, my friend. Payroll and other taxes can account for up to 30 percent of an employee's cost, so I understand how hiring an independent contractor instead of an employee can sound like a good solution for nonprofits on a tight budget. Unfortunately, the federal government and many states are cracking down on that practice, called "worker misclassification," and with good reason. Some employers have abused the independent contractor classification as a way to avoid paying minimum wage and payroll taxes or to duck requirements for meal and rest breaks. In 2010, the Massachusetts Attorney General settled a case with FedEx Ground alleging misclassification of its drivers as independent contractors. That settlement was worth $3.5 million. New York has a special task force devoted just to pursuing misclassification issues. California imposes stiff fines on employers for misclassification, above and beyond the other penalties that otherwise exist.
Don't think that your nonprofit will be immune because of your small size or 501(c)3 status. I have seen several nonprofits get caught in the misclassification trap after they terminated the "contract" and the worker subsequently filed for unemployment benefits, for which contractors are not normally eligible. Increased cooperation between governmental agencies means that information gets shared between all the different government entities that get a piece of those payroll taxes. So while it may start with an unemployment claim, it can lead to a full-scale audit of your organization by state and federal tax authorities.
So what is the legal definition of an independent contractor so you can avoid the misclassification trap? Ah, if only it were that simple. You see, different tests are used to determine whether a worker is properly classified depending on the agency reviewing the classification. The IRS has its own rules, but state workers' compensation, unemployment and labor boards also have their own regulations for classifying workers as independent contractors or employees.
Whether a worker is properly classified as an independent contractor or an employee is not something that an employer can just decide to do one way or another. The classification depends on the nature of the relationship. In general, your relationship with an independent contractor is going to be more like one you have with a separate business that is providing a service or product for a set price with little direction in how the work gets done. Not surprisingly, the more "independent" the worker, the more likely they are to be appropriately classified as a contractor.
The following chart explains the types of tests typically used by governmental agencies to determine whether someone is an independent contractor or an employee:
Type of Test
Common-law
Economic Realities
Hybrid

Description
Degree of control and degree of independence in three categories: 1) behavioral control; 2) financial control; and 3) the type of relationship. The origin of this test is in the twenty-factor IRS test (see links at the end of the article).
Often used where there may be multiple employers, this test focuses on whether the individual worker is economically dependent on the business.
The broadest test will look at both the economic realities and the common-law factors, particularly the right to control the "means and manner" of how the work is performed.

Agencies and Laws That Use This Test
Federal Insurance Contributions Act


Federal
Unemployment Tax Act


Income tax withholding


Employee Retirement and
Income Security Act


National Labor Relations Act


Immigration Reform and Control Act
Title VII of the Civil Rights Act


Age Discrimination in Employment Act


Americans with Disabilities Act


Fair Labor Standards Act


Family and Medical Leave Act (likely to apply)
Title VII of the Civil Rights Act


Age Discrimination in Employment Act


Americans with Disabilities Act


Courts in different areas of the country have applied the tests differently, and as you can see from the chart, some laws have been analyzed using more than one test. Now that we've gotten through the legal jargon, let's look at the problem from a more practical perspective.
Best Practices for Classifying Workers
Although every situation will be a little different, there are some common characteristics of a contractor relationship. For example, a contractor will typically:

• Have a significant degree of control over how the work is performed (minimal direction by the employer)
• Provide their own equipment for the work
• Have multiple clients
• Set their own hours
• May hire and fire their own workers
• Operate as a "business" including a bank account separate from their personal account, have a federal tax ID number, and their own insurance.

You should always have a written agreement with an independent contractor. This agreement should specifically state that they are not an employee and that they are responsible for their own payroll taxes. I strongly recommend that you require the contractor have his or her own insurance.
You should also avoid treating the contractor like an employee. For example, independent contractors should not receive the types of benefits that employees often receive, such as paid time off or health insurance. While employees may require job training, independent contractors should come to the job already having the necessary skills and training. Contractors should not be using your nonprofit's business cards, and if you give them an email address, consider using the word "contractor" in the address or specifying that the individual is a contractor in their signature line. Mike McVay, Accountant 850-725-5696

By Alison Bennett, Aaron E. Lorenzo and Kaustuv Basu
July 1 — Thousands of U.S. businesses and taxpayers are raising their voices to support the Treasury Department's controversial rules to stop companies from stripping income out of the U.S., in sharp contrast to the growing pressure from multinational corporations to drop the rules.
Just days ahead of a July 6 meeting between Treasury officials and lawmakers and a July 7 comment deadline, the Main Street Alliance and Americans for Tax Fairness are urging the government not only to keep the rules as proposed, but to expand their reach.
Even more action is needed to preserve critical tax dollars and help small businesses and other U.S.-based companies compete, the two organizations said.
Rare SupportTheir voices come as rare support for the rules (REG-108060-15), which have drawn vigorous attacks as causing harm to multinational companies across a wide range of industries, including manufacturing and technology. Proposed in April under tax code Section 385, the rules are designed to keep these companies from shifting income out of the U.S. through loans to subsidiaries (65 DTR GG-1, 4/5/16).
The rules would give the IRS the ability to recast entire loans as equity instead of tax-favored debt, causing deductions on loan interest payments to vanish and potentially saddling companies with hefty withholding taxes. They also allow IRS examiners to bifurcate loans so part would be considered equity and part debt.
Treasury has resisted intense pressure to extend the July 7 comment deadline, with a July 14 IRS hearing to follow. The outcry against the rules has reached Capitol Hill, where key Treasury officials are expected to meet with lawmakers July 6 to discuss the guidance.
Leveling Playing FieldThe Main Street Alliance said in June 29 comments that the proposed earnings-stripping rules would “help level the playing field for job-producing, tax-paying small businesses.” The rules are needed, the group said, because “the U.S. Congress has failed to act to stem the tide of inversions.”
In submitting nearly 30,000 letters to the IRS in support of the rules, Americans for Tax Fairness Executive Director Frank Clemente said the rules would eliminate an array of “manipulative financial arrangements multinational companies use to dodge paying their fair share of U.S. taxes, such as earnings stripping.”
He was joined in submitting the letters by Chris Bowers, executive campaign director for the Daily Kos, a liberal political blog that garnered support from its members to press the government to expand the rules before they are finalized.
Criticism From S&P GlobalAs an example of pressure from big companies, S&P Global, a major company in New York that provides credit ratings and other financial data to corporations all over the world, told Treasury in recent comments that the rules raise the specter of double taxation and big administrative burdens.
The clash of opinions on the rules is only expected to increase as the deadline for comments draws near, with Treasury remaining firm on the date comments are due.
Capitol Hill ScrutinyRepublican tax writers, including Sen. Rob Portman (R-Ohio), say they favor minutely reexamining the Section 385 regulations.
Portman said he was disappointed by Treasury’s decision not to push back the comment deadline. “I’m disappointed they are not moving the date. I think the more we learn about it, the more concerns are being expressed,” Portman said. “I’m hearing from companies that had no idea they were going to be affected because they are not companies involved with inversions.”
“What we want is for people to repatriate their earnings so that we can invest more in jobs and plants and equipment here. What companies are telling me is this would actually lead them to keep more money overseas because this recharacterizes equity,” Portman said.
Measured Approach in SenateStill, Portman and his colleagues in the Senate Finance Committee have taken a more measured approach to the regulations than their House colleagues, who have been more vociferous in their opposition. Ways and Means Republicans and Democrats have fired off letters to Treasury with their concerns.