I often deal with Chicago small business owner taxes, and the one thing that I see often is a big mistake being made with independent contractors. Do you hire 1099 contractors? Are they really 1099 contractors? If so, have you done the one thing you need to do to protect their 1099 status so you don’t get hit with payroll taxes and penalties?
If you failed this one thing, the IRS can reclassify your 1099 contractors as W-2 employees even when you have a good case for their 1099 contractor status. This should scare you. Let’s review the Kurek tax court case (UNITED STATES TAX COURT MIECZYSLAW KUREK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE)to see why.
Mieczyslaw Kurek operated a construction business that made improvements to the interiors of homes, including kitchens, bathrooms, and floors, where he and his workers installed tile, sheetrock, doors, and windows and did carpentry and painting. During the year before the court, Mr. Kurek had 29 contractors, of which only seven did some work in all four quarters of the calendar year.
Relationship with Workers
Mr. Kurek had the following relationships with the workers:
- He told the workers what work needed to be done and set deadlines for the jobs.
- The workers worked on projects. No one worked full time for Mr. Kurek.
- Mr. Kurek negotiated a flat fee and timeline with each worker for the work to be done on the project.
- He paid each worker every week according to the percentage of the work the worker completed.
- He paid the workers by checks made out to them personally.
How the Work Was Done
- The workers set their own hours and work schedules.
- Mr. Kurek came to the worksite every day or two.
- Mr. Kurek did not tell the workers how to do their jobs, but he replaced workers who missed deadlines.
- If he thought a worker was doing the work improperly, he would order the worker to repair the problem or redo the work.
- Mr. Kurek allowed the workers to work simultaneously on other projects with him or with other independent construction groups.
- The workers brought their own sets of small tools to the work-sites, worth around $1,000.
- Mr. Kurek bought or rented the larger tools and he left them at the work sites for use by the workers.
No Office or Benefits
Mr. Kurek did not provide an office or any other facility for the workers. He did not:
- Train the workers.
- Offer them any employee benefits such as sick or vacation pay, medical insurance, or pension plans.
- Carry unemployment insurance, severance pay, or workers’ compensation insurance on the workers.
- Require the workers to have any type of insurance or license.
Based on what you know from what you have read above, are the workers 1099 independent contractors or W-2 employees?
What Did You Pick: Employee or Contractor?
Interestingly, you could be right with either choice. Because Mr. Kurek failed the one test that could have saved independent contractor status for his workers, the court used the seven common-law factors to evaluate employee status and it ruled that the workers were W-2 employees.
The IRS has a 20-factor test to determine if a worker is a 1099 independent contractor or a W-2 employee. But if Mr. Kurek does this one thing, he does not have to face the 20 factors, just as he doesn’t have to suffer the court’s seven-factor test.
IRS Publication 1976, Do You Qualify for Relief under Section 530, says that Mr. Kurek could have treated his workers as 1099 independent contractors if he had:
- A reasonable basis for treating the workers as independent contractors, such as showing that a significant segment of home improvement businesses treated their workers as independent contractors or relying on the advice of a lawyer or accountant who knew the facts about his business.
- Consistently treated the workers and all similar workers as independent contractors.
- Filed the 1099s for those independent contractor workers to whom he had paid $600 or more.
Mr. Kurek failed to file the 1099s. With this failure, he simply said
- Hello IRS,
- Goodbye Section 530 statutory relief,
- Goodbye 1099 worker status, and
- Hello payroll taxes and penalties.
Because Mr. Kurek failed to file the required 1099s, the court could not grant relief under Section 530 and had no choice but to examine the seven common-law factors. Sadly, the court’s application of the seven factors to Mr. Kurek’s workers caused the court to reclassify the workers from independent contractor status to W-2 employees.
What You Need to Do
Make your life easy. Avoid the big hurdles of the tax court’s seven-factor common-law tests or the IRS’s 20-factor common-law tests. You want to qualify for Section 530 relief. To ensure that relief: File the 1099s—period.
Although we’ve given you the basics, this is not an all-inclusive article. Should you have tax debt help questions, need Chicago business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office toll free at 1-855-743-5765 or locally in Chicago or Indiana at 1-708-529-6604. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
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Fact check me: T.C. Memo. 2013-64 UNITED STATES TAX COURT MIECZYSLAW KUREK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 5459-11. Filed February 28, 2013.
Section 530 Tax Relief: IRS publication 1976 Section 530.