Employees or Independent Contractors.
Defining and understanding the IRS regulations for contract labor in a detail shop.

Considering that so many detail operators hire people as "contractor labor" to avoid taxes, Workers Compensation Insurance, etc. it is critical that they know what the IRS says about this issue.

Many detail shops simply designate their detailers as independent contractors, believing that so long as they do not deduct taxes from the detailers' earnings and issue a 1099 at the end of the year, they are insulated from the liabilities that typically go hand-in-hand with an employment relationship. The use of independent contractors permits companies to avoid paying federal and state tax withholding, unemployment and disability insurance premiums, and the company's share of Social Security and Medicare taxes (FICA).

Failing to properly classify workers costs the government billions of dollars each year in the form of unpaid taxes, and business expenses deducted by individuals who are not true independent contractors. The government's response to this problem has been increased enforcement and auditing.

These audits can have costly consequences for detail shops who fail to do their homework before designating workers as independent contractors. Fines, penalties and interest under the Internal Revenue Code can be quite substantial, particularly if the failure to properly classify a worker is deemed intentional.

If your business does not have the funds to pay, the fine, etc., the IRS may seek to hold its officers, partners, accountant and/or bookkeeper personally liable. To make matters worse, the IRS will typically notify the state taxing authorities when violations are found, causing the State authority to conduct its own audit, causing you "double trouble." The company can then expect to be hit with other assessments for unpaid unemployment insurance taxes, state/city/county withholding taxes, penalties and interest.

Unfortunately, and despite the high stakes involved, there is no uniform standard for determining whether a detailer is an independent contractor or an employee. There is, however, a set of guidelines issued by the IRS which can help you determine whether your detailers are properly classified under IRS rules.

Historically, when the IRS evaluates whether a person was an employee in the detail business, it applies what is commonly known as the 20-point common law test. Application of this generic multi-factor test to the detail industry, however, can lead to an inconsistent or inaccurate determination.

In order for a detailer to be properly considered an independent contractor, he must satisfy two "Critical Factors" and at least one of three "Significant Factors."

If the presence of the two Critical Factors is established, the IRS will then look to see if one or more Significant Factors is present.

Two Critical Factors combined with one Significant Factor will usually, but not always, lead to a finding that the detailer is an independent contractor. But while the IRS usually follows the findings of the aforementioned test, it is not required to do so:

Does the Detailer Meet the Two Critical Factors?

The two Critical Factors are categorized as a significant investment, and risk of profit and loss.

Significant Investment: According to IRS guidelines, an investment by a person in equipment and the incurring of expenses (such as for - detail equipment, tools, supplies and chemicals) used to perform services for another are considered to be factors which tend to establish an independent contractor relationship. Do your detailers bring their own equipment, tools, supplies and chemicals when they work for your shop?

Typically, where the detailer provides all these things they would be considered to have made a significant investment could be held to be an independent contractor.

Risk of Profit and Loss: Employees are typically paid for their services on a time basis and, as such, have no risk for loss or to gain profit.

In comparison, according to IRS, the profitability of an independent contractor's business generally depends upon variables they control. Examples of variables which the detailer controls and which impinge upon the profitability of an independent contractor's business include insurance, repairs and maintenance of equipment; chemical and supply inventory.

If a detailer is found to have a significant investment in their business and to run the risk of profit and loss, they will typically be regarded as an independent contractor if they meet at least one of the three Significant Factors discussed below.

Has the Detailer Met the 'Significant Factor'?

The Significant Factors look to which party (the detailer or the company) has the right to control the detailer. These three factors are whether the detailer must personally perform the work, whether they can service their own clients, and whether the instructions under which they work leave them discretion.

Who Performs Work: Detailers who must perform the work themselves are usually employees; detailers who can hire qualified assistants or sub- contract with qualified third parties are usually independent contractors.

Discretion to Serve the Public: Detailers restricted to servicing only your customers are usually employees; detailers who can have their own clients are usually independent contractors.

n Instructions: The manner in which you instruct your detailers can make or break the independent contractor status. The IRS guidelines note that when the company issues instructions as to how the detailer must perform the work, the detailer is usually deemed an employee. Where the instructions are merely what should be done, independent contractor status is usually not compromised.

Independent Contractor Instructions

There are several instructions that the IRS deems are consistent with independent contractor status:

• What, How and When of the detail work

• Reasonable parameters for dress and grooming are OK.

• A requirement that the company logo be displayed on their uniform or that they wear a uniform in your shop.

• Requirements regarding communications protocols

• Requirements regarding processing of work orders and accounting to the detail shop for revenues that are to be divided between the detailer and the company.

• Dispatching protocols, such as allocation of jobs and availability of the detailer.

Likewise, there are several instructions that the IRS deems are inconsistent with independent contractor status:

• Requirements prescribing what time to arrive to work; what vehicles to work on and how the work is to be performed.

• Requirements fixing work hours, prescribing a minimum number of work hours, daily or weekly number of jobs, or otherwise fixing the detailer's work schedule.

• A requirement that detailers accept all jobs offered to them by the company.

• A requirement that detailers refrain from doing any outside detail work.

• A requirement that detailers use certain vendors for chemicals and supplies.

• A requirement that detailers perform all services personally and not substitute other detailers.

• A requirement that detailers provide specific chemicals and supplies.

• Requirements regarding how the detailers should greet customers.

It is important to keep in mind that merely labeling a detailer as an independent contractor does not make them one in the eyes of the IRS. Likewise, simply identifying a detailer's status in a employee contract as an "independent contractor" does not make them one in the eyes of the IRS.

Courts look straight past such labels and examine whether the facts and circumstances indicate an employment relationship or an independent contractor relationship.

Accordingly, detail companies which wish to use independent contractors to perform their work should attempt to adhere to the IRS Guidelines as closely as possible.

Workers Compensation Insurance

And, if the IRS issues were not enough to give you concern if one of your "independent contractors" get injured on the job and makes a Workers Compensation claim, look out, you are really in trouble.

If you have any questions on this subject I advise you get professional help.