David Huffman brought up a point that slipped my mind altogether and
that's the subcontractor status.
I have pasted below info form the company that helped me incorporate
years ago about this.
John already said he will make more money using my book so he
needn't get into the findings of cost, material, markup that David
mentions. Good way, yes. But John using my book said he'd make more
money. Why complicate life.
If the person BEING the subcontractor doesn't pay their own taxes on
a timely basis (a real problem for small guys) the STORE OWNER COULD
BE LIABLE FOR THEM.
Here's the article, the 2 or 3 paragraphs really tell the story as
it might apply to John.
2/1/04 from nvinc.com Are You Using the IRS's most Recent 3 Factor
Test vs the older 20 Factor Test?
Will your Independent Contractors Meet the Tests? When you hire a
person in your business, understanding if the worker will be
considered an employee or independent contractor for IRS purposes is
critical. Many would rather not have the worker be viewed as an
employee because your company must pay half the Social Security and
Medicare taxes. If the worked is classified as an independent
contractor, you have no withholdings or benefit costs.
If you are wrong and classify a worker as an independent contractor,
the IRS will impose substantial assessments, penalties and fines. One
potentially big problem is when you terminate an independent
contractor and they apply for unemployment benefits because they felt
they where an employee. The Old 20 Common-Law Factor Test
To help determine whether an individual is an employee under the
common-law rules, the IRS has identified 20 common-law factors (Rev.
Rul. 87-41). These factors-sometimes called the 20 factor
test-indicate whether sufficient control exists to result in employee
classification. The IRS developed these 20 factors based an
examination of earlier cases and rulings considering worker
a. The 20 factors outlined in Rev. Rul. 87-41 attempt to identify to
the extent of a business's legal right to control how the worker
performs the job.
b. Rev. Rul. 87-41 was intended to clarity the treatment of certain
brokered technical service workers following changes made by the Tax
Reform Act of 1986 to Section 530 of the Revenue Act of 1978.
- The IRS Training Guide for agents and the Internal Revenue
Manual, Employment Tax Handbook, Chapter 5 (IRM 4.23.5) sets forth
guidelines for making worker classification determinations. The guide
and the IRM reshuffle the 20 common-law factors into three categories
of evidence (behavioral, financial, and relationship of the parties)
and identify certain factors as no longer relevant to worker
The New Three Categories of Evidence Test
I. Behavior Control: Facts that show whether the business has a right
to direct and control how the worler does the task for which for
which the worker is hired, including the type and degree of: a)
Instructions the business provides the worker, and b) Training the
business gives the worker.
II. Financial Control: Facts that show whether the business has the
right to control the business aspects of the worker's job. These
a. Reimbursement of business expenses
b. Extent of worker's investment
c. Extent to which worker makes services are available to the
d. How the business pays the worker
e. The extent to which the worker can realize a profit or loss (An
independent contractor can make a profit or loss. An employee
III. Type of Relationship: Factors that show "type of relationship"
(as provided by the IRS in Publication 15A):
a. Written Contracts describing relationship parties intend to
b. Whether the business provides the worker with employee-type
benefits, such as insurance, a pension plan, vacation pay or sick
c. The expectation of permanency of the relationship - is the worker
hired with the expectation that the relationship will continue
indefinitely rather than for a specific project or period? If so,
such expectation indicates an employer-employee relationship rather
than independent contractor relationship.
d. The extent to which services performed by the worker are
considered a key aspect of the company's regular business. The more
important they are to company business, the more likely the business
will have right to direct and control worker's activities, thus
indicating an employer-employee relationship.
Here is a structured approach for applying the common-law control
A. Statutory employees.
- In addition to treating common-law employees as employees for
FICA purposes, IRC Sec. 3121(d) lists specific types of workers who
are also treated as employees (i.e., statutory employees). The
distinction between common-law employee and statutory employee is
important for payroll tax purposes.
a. Although statutory employees are subject to social security and
Medicare (FICA) tax withholding ( and employer matching), they may be
independent contractors under the common law control rules.
b. In those situations, they are exempt from federal income tax
- Statutory employees include corporate officers and individuals
performing services included under an agreement pursuant to section
218 of the Social Security Act (i.e.. certain nonfederal governmental
workers) are normally considered statutory employees. In addition,
the following types of workers are considered statutory employees
when the agreement between the worker and the employer contemplates
that substantially all services to be performed will be personally
performed by the worker.
a. Food, beverage (other than milk), and laundry or dry cleaning
b. Full-time life insurance salesmen who work primarily for one life
c. Home workers who perform work according to their employers
specifications and use the employer's materials.
d. Traveling or city salesmen in specified industries.
- Despite fitting within the definition or one of these four
enumerated types of statutory employees, a worker with a substantial
investment in facilities used in connection with the performance of
the services (other than transportation facilities), or who performs
the services as a single transaction rather than as part of a
continuing relationship with the person for whom they are performed,
is not a statutory employee [IRC Sec. 3121(d)(3)]
Example 1 Officers not considered to be employees. John Smith is an
officer of ABC Corporation. He performs only minor services and does
not receive any compensation from the corporation. Is John
considered to be a statutory employee of the corporation? Although
corporate officers are included in the list of statutory employees
under IRC Sec 3121(d), an exception exists for officers with limited
duties in the corporation. If John performs no services or only minor
services for the corporation and neither receives nor is entitled to
receive any compensation, he will not be considered an employee of
the corporation [Reg. 31.3121(d)-1(b)].
B. Statutory Independent contractors.
Certain workers (qualified, licensed real estate agents and
direct sellers) have bean statutorily excluded from being classified
as employees. Example 2 Proper tax status of real estate agents. Bob
Ping is a full-time real estate agent who sells exclusively for
Nationwide Realtors. Nationwide pays Bob a commission for each sale.
The company provides Bob with a desk, a computer, and a telephone and
requires him to attend weekly sales meetings. Bob will be treated
statutorily as an independent contractor if [RC Sec. 3508(b)(1)]:
he possesses a valid real estate license;
his compensation is based on sales output such as a commission
based on sales price (not in the form of fixed, periodic compensation
paid for services rendered); and
a written contract exists between Bob and Nationwide Realtors
stating that Bob will not be treated as an employee for federal
income tax purposes. C. Filing Form SS-8.
If a taxpayer wants to eliminate uncertainty as to an
individual's status as an employee or independent contractor, the IRS
provides a means to accomplish this objective. By filing Form SS-8
(Determination of Employee Work Status for Purposes of Federal
Employment Taxes and Income Tax Withholding), the taxpayer can
receive a ruling as to the individual's status. However, it appears
that a high percentage of the requests for rulings usually result in
the individual being classified as an employee. Furthermore, the
filing of a Form SS-8 may greatly increase the chances for an IRS
employment tax examination.
In the past, the design of Form SS-8 reflected the 20-factor
common-law test for worker status. The 20-factor test has been
largely replaced by the IRS's new categories of evidence analysis,
which groups evidence into three categories (behavioral control,
financial control, and relationship of the parties) and identifies
certain factors as no longer relevant to worker classification.
Accordingly, the IRS redesigned Form SS-8a in early 2001 to follow
the new guidelines.
It is important to speak to a tax professional or attorney if you
have questions in this area. You do not want your independent
contracts to be reclassified as a employees. It is best to know from
the start as this can be a very costly issue. Plus you will have the
proper agreements in place for the new employee or independent
contractor. Contact NCP at 1-888-627-7007 after you speak to your
CPA to determine if forming a corporation will help you to avoid this
problem as an employer. There are certain rules that allow a
percentage of employees to help solve this issue (see two paragraphs
Incorporation Test: Under this test, an individual will be treated
as an independent contractor if he or she conducts business through a
corporation or a limited liability company. In addition, the
independent contractor must be responsible for his or her own
benefits, instead of receiving benefits from the service recipient.
The independent contractor must also have a written contract with the
service provider stating that the independent contractor will not be
treated as an employee and is responsible for his or her own taxes.
To prevent the incorporation test from being abused, the bill limits
the number of former employees that a service recipient may engage as
independent contractors under this test. The limitation is based on
the number of people employed by the service recipient in the
preceding year and is equal to the greater of 3% of the service
recipient's employees in the preceding year or 10 persons, as
follows: Example: Business X has 500 employees in 2000. In 2001, up
to 15 employees (the greater of 3% of Business X's 500 employees in
the year 2000 or 10 individuals) could incorporate their own
businesses and still have Business X as one of their initial clients.
This limitation would not affect the number of incorporated
independent contractors who were not former employees of the service
recipient or independent contractors meeting the general test.
This is intended to provide accurate and authoritative
with regard to the subject matter covered. It is offered
with the understanding that NCP, Inc. is not engaged in rendering
legal, accounting or other professional service. If legal advice or
other expert assistance is required, the service of a competent
professional person should be retained.