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Contractor Versus EmployeeJuly 1, 2007 By: Mark E. Battersby Home-Based Travel Agent
What you need to know to keep Uncle Sam at bay
Why do many travel agents covet the label "independent contractor?" At its most basic, the long-running employee-independent contractor controversy boils down to the argument that by labeling a worker as an independent contractor, an employer can avoid the voluminous paperwork and payroll tax burden.
A home-based travel agent who is an independent contractor can exclude certain types of compensation from income or deduct work-related expenses. It is also no secret that both those who are self-employed and independent contractors contribute greatly to the ever-increasing tax gap—the difference between taxes owed and taxes paid.
In addition to the IRS' worries about the timely payment of income taxes when an employer is not in the picture, the U.S. Department of Labor (DOL) frets about misclassified employees unfairly excluded from coverage under key laws designed to protect workers.
The Legal Difference in Status
There are many facts to be considered when trying to decide whether a worker is an independent contractor or an employee. Indeed, the tax regulations contain a 20-factor test for determining just who is and who is not one. These factors boil to three main categories: behavioral control, financial control and relationship of the parties.
Is the home-based travel agent subject to the control of an agency or other service recipient not only as to the nature of the work performed, but the circumstances under which it is performed? An employer-employee relationship usually exists, according to the courts, if the person contracting for services has the right to control not only the result of the services, but also the means by which that result is accomplished.
Generally, individuals who follow an independent trade, business or profession in which they offer services to the public are not employees. It is up to those travel agencies, travel-related operations and other businesses that wish to use independent contractors to create a situation in which they do not control how the individual performs a particular task for them.
Some Benefits of Being an Independent Contractor
From an employer's standpoint, the benefits of working with independent contractors are largely economic. On the other hand, the benefits of a home-based travel agent working as an independent contractor include:
1. You are your own boss, complete with all of the risks and rewards. As master of their own fate, independent contractors know that the amount of money they make is directly related to the quantity and quality of their work.
2. You may earn more. According to a Wall Street Journal survey from a few years ago, independent contractors are usually paid at least 20 percent to 40 percent more per hour than employees performing the same work. The employer can afford the independent contractor's high rates because they are not required to pay half of the independent contractor's Social Security taxes or unemployment compensation taxes, nor provide workers' compensation coverage or employee benefits.
3. Your tax bill will be lower. Being an independent contractor means no federal or state taxes are withheld from paychecks as they are for employees. Although independent contractors must generally make periodical estimated tax payments directly to the IRS, they can hold onto their hard-earned money longer before turning it over to the IRS.
Even more importantly, an independent contractor can take advantage of many business-related tax deductions that are largely denied to employees. All business expenses, so long as they are ordinary, necessary and reasonable, qualify as tax write offs. Even commuting expenses, denied to employees, are often legitimate tax deductions for independent contractors.
Negatives of Being an Independent Contractor
On the downside of being an independent contractor, there are also a number of factors: including:
1. No job security. Admittedly, an independent contractor is his or her own boss, but that is often a mixed blessing. Employees are usually paid even if business is slow or there is no work.
2. No employer-provided benefits. Travel agencies and other businesses often provide benefits such as health insurance, paid vacations and paid sick time. Employers that are more generous may also provide retirement benefits, bonuses and even employee profit sharing. Many independent contractors get no benefits.
3. No unemployment income benefits. That's right, no safety net. Home-based travel agents labeled as independent contractors cannot collect unemployment when the work for an employer ends.
4. No employer-paid workers' comp. If a work-related injury is the fault of the independent contractor, there is little or no recourse against the employer.
Ensuring Classification as an Independent Contractor
Should home-based travel agents be reclassified as employees because of an IRS audit, there are consequences. The travel agency or hiring firm may for example decide not to use their services anymore because it does not want to pay the additional expenses of treating them as employees. Reclassification as employees creates an additional tax burden on home-based travel agents if they are required to forego—or pay back—some of the deductions they were formerly permitted.
How can you as a home-based travel agent ensure that the IRS and other government agencies classify you as an independent contractor? First and foremost, retain control of your work.
The most fundamental difference between employees and independent contractors is that employers have the right to tell their employees what to do and how to do it. It is acceptable for an employer to give detailed guidelines for achieving the results expected. No home-based travel agents, however, should ask for or accept instruction or orders about how to do their jobs.
If a travel agent runs absolutely no risk of loss, he or she is not really an independent contractor. This can be as simple as charging a set fee for a job or project. If the expenses incurred earning a fee or commission are less than the amounts received, an independent contractor will profit; if too little is earned, a loss will result.
It is also a smart move to look like an independent business. Do not accept employment benefits; instead, charge enough that health insurance, paid vacations or pension benefits are affordable. Independent contractors often find it is a good idea to maintain a separate bank account.
Most importantly, an independent contractor should make his or her services available to more than one person or company. Hanging out a shingle, advertising your services or joining a professional organization are all strong indications of independent contractor status.
Employers' Escape Clauses
Should the ever-vigilant IRS discover that an employer has incorrectly labeled a travel agent as an independent contractor, unpaid employment taxes for those workers can be avoided if the employer meets all three of the relief requirements of the tax law's Section 530:
1. Reasonable basis. A reasonable basis for classifying a worker as an independent contractor exists if the employer relied on a court case, IRS ruling or if an earlier IRS audit failed to challenge the status of similar workers. Reasonable basis can also encompass similar treatment by a significant segment of the industry or if the business' owner or manager relied on the advice of a business lawyer or accountant who was familiar with the operation.
2. Substantive consistency. An em-ployer must have treated the individual, as well as any similar workers, as independent contractors. This provision is not available to any employer that treated similar workers as employees.
3. Reporting consistency. To take advantage of the Section 530 relief requirements, an employer must have filed a Form 1099-MISC for each worker labeled as an independent contractor. If the employer did not file a Form 1099-MISC or filed it for some but not all workers in similar jobs, relief is not available for those for whom the forms were filed.
Keeping It Legitimate
Despite lawmakers' reluctance to clarify or create a definitive definition of who is and who is not an independent contractor, the U.S. government, specifically the IRS and the DOL, frequently battle misclassification. The IRS periodically reminds travel agencies that use independent contractors or outside sales reps to revisit written contracts to make sure they are in compliance with the tax law.
The IRS is under Congressional pressure to address the problem of employee misclassification and the underreporting of income by self-employed individuals.
The American Society of Travel Agents (ASTA), recently released a report, "Protecting Your Travel Business: Legal Issues Regarding The Use of Independent Contractors (ICs), that addresses the regulations and legal ramifications surrounding the use of ICs, something ASTA estimates 63 percent of agencies do.
"Agency managers know that there are definitions that make ICs different from regular employees," according to Cheryl Hudak, CTC, ASTA president and CEO, "but it's a complex matter. We advise all agency members to consult their legal counsel."
— Mark E. Battersby