April 15 is coming at us faster than we realize. It’s a good time to discuss one of the big bugaboos in the entertainment business: the status of the freelance worker.
The term “freelance” translates in IRS-speak to “independent contractor,” a category that has undergone significant revision and clarification over the last decade because, in an age when few people stay at one job more than a few years, the notion of self-employment has gotten fuzzy around the edges. Back in 1996, the Internal Revenue Service redefined what constitutes an independent contractor, establishing a complex set of 20 common-law factors plus interpretations of numerous tax court cases. Here’s how the IRS establishes the boundary between independent contractor and employee:
A worker is an employee if…
- An employer or an employer’s representative tells the worker where, when and how to work.
- An employer trains the worker.
- The business performance depends on the worker.
- The worker has a continuing relationship with the company.
- The worker’s services must be personally rendered by him/her.
- An employer sets the worker’s work hours.
- The worker works on the employer’s premises.
- The worker is paid by the hour, week or month.
- An employer furnishes tools and materials.
- An employer can fire the worker without violating a contract.
- The worker has a right to quit without incurring a liability.
- The worker does not offer the worker’s services to the public at large.
- The worker has no opportunity for profit or loss as a result of the worker’s service.
- The worker has no significant investment in the business.
- An employer requires the worker to submit oral or written reports.
- The worker is a corporate officer.
A useful FAQ list can be found at www.irs.gov/govt/tribes/article/0,,id=134976,00.html.
These distinctions are critical to both the worker and the employer. Independent contractor workers who perform as though they were employees put a company at risk of liability for withholding taxes on payments (which suddenly become “salaries”), half of the worker’s FICA (Social Security) responsibilities, plus any penalties and interest the IRS assesses if they rule the worker was indeed an employee. Freelancers have to keep their status clearly defined because they will file tax returns based on that and will receive notification of income in very different ways: Employees receive a W-2 at year’s end listing all salary and related income; independent contractors will get a 1099 statement listing what the contractee has paid them during the calendar year. A ruling in retrospect that changes an independent contractor to an employee or vice versa would necessitate refiling the return and paying the difference in tax plus any penalties and interest.
Some scenarios are very clear-cut: A lighting director who works for 15 different clients in a year and who does designs and layouts in his or her own home or office and goes on-site only to supervise and direct is obviously an independent contractor. But if the LD works for only a handful of clients in a year, or worse, just one, on a long-term basis, that could lead to other interpretations.
That’s why contracts between companies and freelancers have become significantly more complex, and often onerous on the freelancer, in recent years. Agreements often not only spell out the nature of the relationship, but also indemnify the employer against legal action if the IRS or a court rules that the contractor is an employee. These indemnifications are legally questionable, and it’s a basic tenet of law that contracts are implicitly construed against the author, assuming whoever writes the contract will by nature seek to craft it to his or her own advantage.
But why let it get that far? Make sure you have an agreement that clearly defines the status of each party.
The fuzziness of the issue has engendered its own mini-industry. Several companies, such as MyBizOffice.com, offer to “employ” independent contractors, listing them on their books as employees. They assert that the benefits include freeing the independent contractor from having to file quarterly tax payments and enabling them to participate at group rates for medical and other insurance coverage. MyBizOffice will issue a W-2 at the end of the year. What’s less clear is who pays the “employer’s” share of the “employee’s” Social Security responsibilities. There may be some advantage to these kinds of schemes, but caveat emptor is the watchword.
In fact, you might as well apply that to the entire employee/independent contractor scenario. Let “never assume” be rule one. Make sure that the distinction between 1099 and W-2 is clear. Employers should make sure that HR departments know the intended status of each person performing services for the company. Freelancers should always send a completed W-9 form to the client with their first invoice, and it’s not a bad idea to resend one at the beginning of each calendar year. When it comes to taxes, ambiguity equals trouble.
