INDEPENDENT CONTRACTORS UNDER FEDERAL LAW
An installer or mechanic can be hired as (i) an employee or (ii) an independent contractor. Hiring installers as independent contractors is fairly common in the home improvement and remodeling industry because it allows you to avoid paying and collecting employment taxes for the installers that work for you. However, without taking protective steps, you are at real risk of having your 1099-based installer being reclassified as a W-2 employee in a state or Federal audit, as well as in a civil lawsuit brought by a disgruntled ex-installer.
CAUTION: INTERNAL REVENUE CODE §3508 ONLY APPLIES TO SALES REPRESENTATIVES. YOU CANNOT HIRE AN INSTALLER AS A DIRECT SELLER UNDER §3508.
Under Federal law, an employee-employer relationship is straightforward. The employer pays the employee a wage and/or a commission rate and the employer withholds income taxes, withholds and pays Social Security and Medicare taxes, and pays unemployment tax to the state on behalf of the employee. Because employee’s wages and taxes are reported to the Internal Revenue Service on a Form W-2, you will often hear employees referred to as “W-2”.
Independent Contractor Relationship
Under federal law, an independent contractor relationship avoids the above taxes – at least as to the employer. Instead, the independent contractor must make his own income tax payments to the Internal Revenue Service and pay the entire portion of Social Security and Medicare taxes. Independent contractors are not eligible for unemployment compensation. Because independent contractor wages are reported to the Internal Revenue Service on a Form 1099, you will often hear independent contractors referred to as “1099”.
Who Is an Independent Contractor?
The general rule in structuring an independent contractor relationship is that the contractor can control what they want done by the worker, but not how it is done. In other words, you tell the worker what to do, not how to do it.
Common examples from everyday life may be helpful:
- You hire a gardener to cut your grass. You tell the gardener what to do (cut the grass), not how to do it.
- You hire a lawyer to defend you. You tell the lawyer what to do (defend your rights), not how to do it.
Of course, when it comes to the remodeling industry, the issue is much less clear. Federal agencies will probe your independent contractor relationships to determine if they you truly are only telling the independent contractor what to do, not how to do it.
Determining an Independent Contractor Relationship
Unfortunately, despite the ever-increasing number of audits and lawsuits involving independent contractors, no single standard to distinguish between an employee and an independent contractor has emerged at the federal level. However, depending on the federal court or the federal agency involved, one of the following tests will apply (click blue title to view):
COMMON LAW TEST
Under the common law test, a worker is an employee if the company that retained the services of the worker has the right to direct or control the worker, both as to the final results and as to the details of when, where, and how the work is to be done. Control need not actually be exercised; rather, if the company that retained the services of the worker has the right to control the worker, employment may be shown.
The IRS-created so-called “20-Factor Test” also assesses the degree of control the company exercises over the way the work is performed by the worker. If the company exercises too much control, the worker is deemed to be an employee. The difference between the 20-Factor Test and the Common Law Test is minimal.
IRS 3 CATEGORY TEST
Ironically, the IRS has recently consolidated its 20 factors from the “20-Factor Test” into 11 main tests, and organized them into three main groups: (i) behavioral control, (ii) financial control, and (iii) the type of relationship between the two parties. Under the IRS “3 Category Test”, when performing an audit, IRS revenue agents are advised to gain a general understanding of the way a company operates, examine what the company does, how the business gets done, and the relationship between the company and its customers.
ECONOMIC REALITIES TEST
The economic realities test is arguably the most difficult federal test to pass because, in addition to considering the degree of control the company exercises, it takes into account the degree to which the workers are economically dependent on the business.
CAUTION: THE PLETHORA OF TESTS DEFINING INDEPENDENT CONTRACTOR STATUS APPLIED ACROSS FEDERAL LAWS MAKES IT POSSIBLE FOR A WORKER TO BE CLASSIFIED AS AN INDEPENDENT CONTRACTOR UNDER ONE LAW, BUT AS AN EMPLOYEE UNDER ANOTHER.
How Do I Defend My Independent Contractor Installer Relationships?
While it is possible to hire an installer as an independent contractor, it is often very difficult to defend this treatment during a focused audit. Why? The company usually does not take enough proactive steps to fully support the independent contractor relationship against an auditor determined (unfortunately) to find an employee relationship. Every debatable fact about your company and its independent contractor relationships will be used against you to support an employee-employer relationship.
To give yourself the strongest likelihood of surviving a federal audit or examination or winning a lawsuit filed by an independent contractor, you should have all of your independent contractor installers sign NAPAC’s 1099-BASED INSTALLER AGREEMENT and you should adopt the defensive business protocols discussed in NAPAC’s state-specific 1099 INSTALLER PROTOCOLS GUIDES.
Having a written agreement with your independent contractor installers is absolutely necessary; however, the importance of a written agreement will be greatly diminished if you also fail to maintain supportive evidence of the independent contractor relationship. NAPAC’s 1099 Installer Protocols Guide shows you the step-by-step way to create the strongest defensive wall to defend yourself against an audit or examination or a lawsuit filed by an independent contractor.
What Else Can I Do?
If you want to make it nearly impossible for your independent contractor installer relationships to be successfully challenged, NAPAC strongly recommends that you use the following documents (click blue title to purchase):
ACKNOWLEDGEMENT OF 1099 RELATIONSHIP
Installers gladly call themselves independent contractors at the beginning, but once they want health benefits or an unemployment check, etc., many are quick to claim that they are really employees. Having an acknowledgment of the independent contractor relationship document shows that both parties made an informed decision to create an independent contractor relationship. This acknowledgement is incredibly powerful evidence when a dispute occurs.
1099 HIRING SCRIPT
How do you interview and hire an independent contractor installer? Do not leave it to chance. NAPAC’s 1099 Hiring Script gives you a written script that you can use to conduct and record your interviews and hiring decisions.
SUBCONTRACTOR INDEPENDENCE ACKNOWLEDGEMENT
A one-page “sub-sub” form designed to reduce the potential of an installer’s workers coming back after you for claims of statutory employment (such as workers compensation). NAPAC suggests that this waiver be required to be submitted for any worker an installer intends to utilize on a company job. It is not necessarily legally binding as a waiver of a worker’s right to claim against you through the installer, but in a legal proceeding, it shows the clear understanding and good faith intent of the parties and may reduce or eliminate damages.
1099 PRODUCT MEETING ACKNOWLEDGEMENT
While you may not train your independent contractor installers, you may want to acclimate them to your products and installation methods. The problem is that in an audit or a lawsuit, any meetings will be deemed to be company training – putting your independent contractor relationships at risk. NAPAC’s 1099 Product Meeting Acknowledgment shows that you do not train your independent contractor installers, but do allow them to voluntarily attend seminars to better learn about your products and installation methods.
1099 PERSONAL GUARANTY
Imagine that you hire an independent contractor relationship installer who does business as a separate business entity. The relationship falls apart. Your disgruntled installer abandons his separate business entity, forms a different one, and ignores all of the restrictions imposed on him under his written installer agreement. NAPAC’s 1099 Personal Guaranty makes the individual installer personally liable for the performance under the written installer agreement.
1099 COMPANY BRANDING MEMO + VEHICLE BRANDING AGREEMENT
Many will say that independent contractor installers cannot wear company-branded shirts or place decals on their cars. Wrong! In most cases, independent contractor installers can wear company-branded shirts or place decals on their cars. However, you must explain why your independent contractor installers are wearing company-branded shirts or placing decals on their cars. NAPAC’s 1099 Company Branding Memo does exactly that. In addition, if your independent contractor installers are placing decals on their vehicles, an agreement in writing between the parties can reduce the risk of it being seen as exercising control over your installers. NAPAC’s Vehicle Branding Agreement does this.
10 MOST COMMON ERRORS TO AVOID WITH INSTALLERS
Want to know the most common errors you may be making with you installers, whether they are 1099-based or employees? Want to correct these mistakes and gain an advantage of your competitors? This memo addresses the most common errors with installers and what you should be doing about them.