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Chuck Gravett 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.


 In 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?

 These 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.

 The 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 the time.

 And, 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. 

 The 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 employee.

 An 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 contractor.


  • 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 income.
  • 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 specific circumstances.

 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




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