Contract Laborers: A Trap!

Paying out "contract laborers" is hazardous for small business. Be careful.

What is at risk?
Add up the amount you have paid "contract laborers" in a year's time. Multiply the amount by 15%. That is the amount IRS could demand that you pay. Multiply that by the last several years. Add the interest and penalty.

But I have a written agreement with the contract laborer?
I have an authentic-looking $1,000 bill with a portrait of the the Statue of Liberty. It has the words "legal tender for all debts, public and private." It is still worthless.

  1. I, John Smythe, understand and agree that I am not an employee of Deserk St Exxon.
  2. I understand that taxes will not be withheld from my compensation because I am an independent contractor.
  3. I further agree that I will be fully responsible for my own taxes.

This does not work. The IRS says that a person either is or is not an independent contractor. If you can control the hours, supervise or train the employee, and provide the tools to do the work, that person is clearly an employee. If you are not certain, IRS expects you to ask them using Form SS-8. You can fill-in this form online then print it out.

If you must have a written "agreement," instead use this STATEMENT TO INDEPENDENT CONTRACTOR instead. It is a statement, not an agreement.

This could happen, but does it ever happen?

Here's how it happens.

  1. You have a firm written agreement with a contract laborer.
  2. At the end of the year, you give him his Form 1099 showing $20,000.
  3. He goes to H&R Block, Hewitt-Jackson, Econotax, or other tax preparation service.
  4. The tax return preparer tells him he owes $4,000. He becomes enraged and makes a scene.
  5. To shift the blame to someone else, the preparer blames you for not holding out taxes.
  6. The preparer tells him about Form SS-8.
  7. "You might be able to get IRS to collect the tax from your employer," he explains.
  8. They file Form SS-8.
  9. There is about a 50:50 chance that IRS will take up the issue against you.
  10. You show the IRS agent the written agreement.
  11. The agent asks to keep the agreement as evidence that you deliberately avoided holding out taxes.

What do I do if I have this situation?
These are my suggestions:

  1. Ask me to write you a letter telling you that you cannot continue to do this.
  2. Fill out Form SS-8 with or without the employee's knowledge. The IRS will tell you in writing whether the person is an employee.
  3. Be done with it and give him a choice of being paid as an employee or being fired.