is a principal in Gravett & Frater, LLP, located in Napa Valley. With
clients in Napa and surrounding counties, Chuck specializes in
representing the interests of entrepreneurial companies, start-ups,
small to mid-sized companies, wineries and family-owned businesses.
His firm's work includes business, bankruptcy, tax problems, personal
injury, defamation, real estate, workers’ compensation, and
white-collar criminal matters. Through high-quality, expert legal
services, he works hard to help his clients avoid unnecessary risk and
control legal expenses. The article below is a part of an occasional
series for Napa Valley business owners and independent contractors
which focuses on how to avoid problems in contract labor.
this day of home workers, home based businesses, contractors, consultants, and
individual entrepreneurs; questions concerning independent contractors arise
frequently. What actually is an independent contractor? Who are they? What
exactly do they do? How do you set one up? And most importantly : How do you
keep the tax collector off your back and out of your pocketbook?
questions are important because all those IRS agents who were out investigating
those tax shelters with windmills, hog farms, and record albums are now trying
to turn your independent contractors into your employees. With all the payroll
taxes that implies.
IRS has sophisticated computer matching programs, so if you receive a single
source 1099 for most of your income there is a pretty good chance you will be
audited. And who wants that? Even if you win, its time consuming, expensive,
and produces a ton of anxiety. The State of California is also very aggressive
in this area. In about 90% of the audits, the tax folks determine that
independent contractors are employees. In other words, they beat you most of
why is that? Well, the IRS prefers people to be employees instead of
independent contractors because they collect more tax dollars. Employers pay
social security tax on the entire payroll. Plus all that withholding makes sure
that the employee/contractor does not escape paying their share of taxes. That
adds up to more tax revenue than independent contractor’s pay on their money
after they deduct their expenses. Employees are generally easier to find and
collect from than independent contractors.
tax folks collect a bundle too. From the employee, if they can find them, they
collect the employee’s share of social security and the income tax. From the
employer, they collect the employer’s share of social security taxes, plus any
money that they cannot collect from the employee, because the employee is broke,
or gone, or whatever. They collect interest and penalties from everybody. And
typically, that employer is a lot easier to find and collect from than the
independent contractor is a person who works for someone else, but is not an
employee. A principal is a person who engages an independent contractor. Here
are some ways to make sure you are a principal and your worker is an independent
- Make sure the contractor
is really independent, not solely dependent on the principal. Best if the
contractor does not rely on the particular business as their sole source of
- If the contractor needs
a license, like building contractors, make sure they have it.
- Have an actual, written
down agreement between the principal and the contractor.
- The independent
contractor is an independent business person, so act like it. Have business
cards, letterhead, phone listing, and invoices.
- The principal does not
have the power to “fire” the independent contractor. The contractor can only
be terminated for nonperformance of the agreement.
- Try not to have an
hourly basis of payment. Use a per job method if possible, with progress
payments if needed.
The IRS does not require a
principal to send a 1099 to a corporation. The single best thing you may be
able to do to insulate yourself from an audit in this area, is to have all your
independents be corporations for this very reason. This can be a cheap form of
insurance. Many of the computer companies require their consulting hardware and
software engineers to be a corporation.
Every principal and
independent contractor needs a contract. That contract should be in writing,
and, at a minimum, set forth exactly what the job is, when it is to be
completed, how much money will be paid, and when. Also state what constitutes
adequate job performance. The contract should contain a clause which states
that the contractor is not an employee, has their own insurance, is not
covered by the principal’s unemployment insurance or workers compensation, and
must pay their own taxes. Many principals use a standard contract for each
contractor, and use attachments to describe the scope of work, pay, and other
While tax has been the
primary focus, the issue also often comes up in workers comp, unemployment
compensation, licensing, and other areas, as well. This area of tax and law is
highly specialized and frequently dependent upon the facts and circumstances of
your situation. If you have a question in this area, talk to your qualified tax
or legal advisor.
Author: Chuck Gravett
© 2007 GRAVETT & FRATER, LLP,
Napa, CA 94559