Tax Prophet: FAQ December 15, 1996

Frequently Asked Tax Questions - December 15, 1996

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, Sunday December 15, 1996

Independent contractors: Comparison between federal and state law; How long may a foreign person stay in the U.S. without becoming a resident?

ROBERT L. SOMMERS

Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

Questions

Question: I have a small consulting business that occasionally hires professionals. How do I ensure that these workers are treated as independent contractors?
[Answer]
Question: As a foreign citizen and resident how long can I spend in the U.S. each year at my vacation house in San Francisco without paying U.S. taxes?
[Answer]

Answer to Question #1:
Unfortunately, the IRS and California apply different criteria for treating workers as independent contractors - an unending source of frustration for small businesses. The IRS has become more reasonable and flexible, but California remains anachronistic and paternalistic is its insistence that these people are employees (subject to payroll taxes and tax withholding) despite the intent of both the workers and companies.

Federal law prevents the IRS from reclassifying a worker as an employee as long as the company has "any reasonable basis" for treating the worker as an independent contractor. This rule is subject to two requirements: the company must have filed all required tax returns and must have consistently treated its workers doing the same type of work as independent contractors.

Recent federal law allows both new and old industries to meet the any reasonable basis standard if more than 25% of workers in similar positions with other companies within that industry are treated as independent contractors. A credible industry survey on worker classification is persuasive evidence of an industry standard.

California does not use the any reasonable basis standard. Rather, it practically requires that a worker operate as an independent business to qualify as an independent contractor. Therefore, if workers and companies want their independent contractor relationship respected by California, workers should function as an independent business. For the protection of both the company and the worker, the following steps should be taken:

(1) Workers should use company names, such as "John Smith and Associates" or "John Smith Consulting," rather than merely "John Smith." Workers should obtain a company employer identification number (EIN), rather than using a social security number. The IRS information return, reporting gross earnings by an independent contractor (usually Form 1099) should be issued under the worker's company's name and EIN.

(2) The worker's company should obtain a business license and have a listing or advertisement in the telephone directory under the company name.

(3) The worker's company should have printed stationery and business cards. Resumes and promotional materials should use the worker's company's name. If its a home-based business, the answering machine and greetings should reflect the worker's company's name.

(4) Invoices should be on the worker's company stationary and for services rendered. Avoid statements that look like time sheets. When possible, the worker's company should bill on a flat rate per project, rather than hourly rate.

(5) The parties should have a written contract stating that the worker's company is responsible for completing the job, may hire sub-contractors or have employees work on the project, and is liable for contract damages for negligence in the performance of the contract.

In addition, the hiring company should have provisions requiring the worker to cooperate with the company in any employment tax audit, including the presentation of the worker's Schedule C or other tax forms showing that the income was reported as an independent business.

[Return]
Answer to Question #2:
As a foreign citizen, if you reside in the U.S. an average of 121 days or fewer per calendar year, you are not considered a U.S. resident for tax purposes by virtue of your physical presence ("the substantial presence" test). Even if you exceed this time, if you are in the U.S. fewer than 183 days in a calendar year and you can show you have a closer connection to another country, you will not be considered a resident for U.S. tax purposes. Note: for U.S. estate tax purposes, consider purchasing U.S. real estate through a foreign corporation.

The substantial presence test involves actually counting the days a person is physically present in the U.S. Generally, if a foreign citizen was physically present in the U.S. for at least 31 days during the present year, and a combined total of 183 or more days for the current year and previous two years (to determine the total days, count the full number of days in the present year, 1/3 the days in the previous year and 1/6 days in the earliest year), he may be considered a U.S. resident. For example, a person present in the U.S. 60 days in 1996, 240 days in 1995 and 240 days in 1994 is not a resident for 1996 since he is considered present only 180 days [60 days in 1995, 80 days in 1994 (1/3 of 240) and 40 days in 1994 (1/6 of 240)]. A foreign citizen may spend an average of 121 days per year in the U.S. without becoming a resident for tax purposes.

There are exceptions for diplomats, foreign government-related individuals (A and G visa holders), students, teachers, trainees, commuters from Canada or Mexico, individuals in transit between two foreign countries, professional athletes, and persons here for medical treatment for a condition that arose while he or she was in the U.S. Often, the person's family gets the same exclusions.

Further, if you meet the substantial presence test, you may not be considered a resident if you maintain a closer connection with another country. This option is available only if you were not present in the U.S. for 183 days or more during the years in question. The "closer connection" test evaluates such subjective factors as your business, professional and social contacts (including the location of your home, family, automobiles, business, church, social clubs, and where you vote) with the foreign country as compared with the U.S.

[Return]

**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**