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Avoiding the Independent Contractor vs. Employee Quagmire

Introduction   When an employer-employee relationship exists, the tax consequences can be staggering to the employer. In an attempt to ease the tax burden, many companies seek to hire independent contractors in lieu of employees, however, the regulations governing these classifications are complex and not easily deciphered. Also, California workers' compensation laws relating to employee versus contractor status are different from the laws applied to this status question by other state and federal agencies. Tests have been devised to ascertain the difference in status but the answer to any single test is not the determining factor.



Dealing with an Entity Rather Than an Individual   Another approach which may avoid the question of classification altogether is the imposition of an entity between a company and a worker, such that the company contracts directly with the entity, thereby skirting the issue of worker classification entirely. The entity replaces the worker as the contracting vehicle, but - the worker owns the entity.

In most cases, if the company contracts with an entity which, in turn, enters into an employment agreement with an individual worker and, pursuant to the company-entity contract, the worker performs services for the company, there is no employer-employee relationship between the worker and the company



IRS Position   IRS, in its training course for determining employee vs. independent contractor relationships, concedes that if a company contracts directly with a corporation which, in turn, hires a worker to perform services for the company on behalf of the corporation, the relationship will be respected and the worker will not be an employee of the company. Rather, the worker will be an employee of the worker's corporation that entered into the contract with the company.

NOTE: The balance of this article has been incorporated into the Tax Prophet's Action Guide entitled, "Employee Stock Options - A Primer" described below:

This Action Guide is the product of the author's extensive experience in negotiating stock options as part of the compensation package paid to employees and contractors. In addition, the author represents several taxpayers who confronting huge tax bills stemming from the exercise of employee options and the subsequent crash of the stock market.

This Action Guide defines the key terms and concepts involving both incentive stock options (ISO's) and non-qualified stock options, identifies the tax-triggering events and discusses strategies to minimize the tax impact. The guide discusses the alternative minimum tax as applied to ISOs as well as sophisticated tax-planning concepts. This guide is a must read for employee or company that receives stock options as part of their compensation.




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All contents copyright © 2007 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet(TM) is a trademark of Robert L. Sommers.