Independent Contractors: Classify Carefully

Many businesses use independent contractors to help keep their costs down and provide flexibility for short-term needs. But the question of whether a worker is an employee or an independent contractor is complex. Be careful that your independent contractors are properly classified for federal tax and employment tax purposes, because if the IRS reclassifies them as employees, it can be an expensive mistake.

Differing Obligations

If a worker is an employee, your company must withhold federal income tax and the employee’s share of Social Security and Medicare taxes, pay the employer’s share of Social Security and Medicare taxes, and pay federal unemployment tax. State tax obligations may also apply. A business generally must also provide that worker with fringe benefits if it makes them available to other employees.

However, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more). The contractor is responsible for paying self-employment tax and, generally, making estimated tax payments for income tax purposes in relation to the amount paid.

Key Factors

Who’s an “employee?” Unfortunately, there’s no one definition of the term. The IRS and courts have generally ruled that one of the key factors that determines the difference between an employee and a contractor is the right to control and direct the person in the jobs they’re performing, even if that control isn’t exercised. The issue of control is evaluated by asking several questions, including:

• Who sets the worker’s schedule?
• Are the worker’s activities subject to supervision?
• Is the work technical in nature?
• Is the worker free to work for others?

Another important factor is whether the worker has the opportunity for profit or loss based on his or her managerial skills. That is, can the worker apply independent judgment and business acumen to affect the success or failure of the work being performed? If there’s a lack of such opportunity, that’s one indication of employee status.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors. Be aware, Section 530 doesn’t apply to certain types of workers.

Think Carefully Before Asking the IRS

You can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, you should also be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

So, before you file Form SS-8, contact the office for a consultation. Filing this form may alert the IRS that your business has worker classification issues, and it may unintentionally trigger an employment tax audit. It may be better to properly set up a relationship with workers to treat them as independent contractors so that your business complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Dissatisfied workers you’ve treated as independent contractors may do so because they feel entitled to employee benefits and want to eliminate their self-employment tax liabilities. If a worker files Form SS-8, the IRS will notify the business with a letter that identifies the worker and includes a blank Form SS-8. The business will be asked to complete and return the form to the IRS, which will render a classification decision.

Need More Help?

Worker classification is complex. In addition to what’s been discussed here, there are differing rules that apply for labor law purposes, which can impact minimum wage and overtime pay requirements. If you have questions, contact the office to assist you in ensuring that your workers are properly classified.

5 Strategies for Improving Collections

Businesses that operate in the retail or restaurant spheres have it relatively easy when it comes to collections. They generally take payments right at a point-of-sale terminal and customers go on their merry way. For other types of companies, it’s not so easy. Collections can be particularly difficult for business-to-business operations, which often find themselves in complex relationships with key customers. In these businesses, it’s often not as simple as “pay up or hit the road.”

If your company is dealing with slow-paying customers, which isn’t uncommon in today’s economic environment where everyone is trying to preserve cash flow, it helps to review the basics. Here are five tried-and-true strategies for increasing your chances of getting paid:

1. Request payment up front. For new customers or those with a documented history of collection issues, consider asking for a deposit on each order. This would generally be a small but noticeable percentage of the contract or order price. You could also explore the concept of asking for a service retainer fee, similar to how law firms typically operate.

2. Charge fees. Most customers are likely familiar with the concept of late-payment fees from dealing with their credit card companies. Consider implementing fees or finance charges on past due accounts. Place extremely delinquent accounts on credit hold or adjust their payment terms to cash on delivery.

3. Reward timely payments. An effective collection strategy isn’t only about “penalizing” slow-paying customers. It’s also about incentivizing those who pay on time or who represent a potentially lucrative long-term relationship. Crunch the numbers to determine the feasibility of giving discounts to customers with strong payment histories or to those who have improved the timeliness of payments over a given period.

4. Communicate proactively. Set up regular e-mail reminders and place live phone calls to customers who haven’t settled their accounts. If the employees who work directly with the delinquent customers can’t resolve payment issues, elevate the matter to a manager or even to you, the business owner. If necessary, consider executing a promissory note to prevent the customer from disputing the charges in the future.

5. Get external help. If, after repeated tries, your collection efforts appear unsuccessful, it might be time to get outside help. This typically means engaging either an attorney who specializes in debt collection or a collections agency. View this as a last resort, however, because third-party fees may consume much of the collected amount and you’re unlikely to continue doing business with the customer.

One last important point about collections: If an outstanding debt is uncollectible, you may be able to write it off on your tax return. Be sure to document each customer’s promises to pay, details of your collection efforts and why you believe the debt is worthless.

Contact the office if you have questions about tax deductions and other collection activity. Or call for help improving your overall accounts receivable processes.

Renting to Family Members

As rents continue to rise in many areas, you may decide to help your financially challenged family members by renting a property to them at a discount. But this can lead to the loss of significant tax deductions. Here's a look at the tax treatment that applies when you rent to unrelated parties and how the rules change when you rent to relatives.

Business vs. Personal

If you use real estate strictly for business purposes, that is, as a rental property, you must report the income and can deduct mortgage interest, property taxes, utilities, depreciation, maintenance and other expenses. You may claim a loss (subject to limitations) if your expenses exceed your rental income.

Suppose you use a property as a personal residence (such as your primary residence or a vacation home) and rent it out for fewer than 15 days per year. In that case, you don't need to report the rental income, but you can't deduct related expenses. If you itemize, you can still claim personal deductions, to the extent allowable, for mortgage interest and property taxes.

Suppose instead that you rent out the residence for 15 or more days per year. In that case, it's treated as a mixed-use property. You must report the rental income and allocate your expenses between the property's personal and business uses. You generally can claim the personal use portion as itemized deductions. The business use portion of these and other expenses are deductible as rental expenses, but they can't create a loss. Disallowed deductions may be carried forward to future years.

Family Matters

Renting property to family members means you risk losing the ability to deduct rental expenses. That's because use by family members is considered personal use, even if your relative pays rent, unless two requirements are met. The family member:

1. Uses the property as a principal residence, and
2. Pays fair market rent (not discounted).

If these requirements aren't met, then you must report the rental income (if you rented the property for 15 days or more per year). But related expenses won't be deductible.

If you want to avoid losing valuable tax benefits, set the rent at or above fair market value and document fair market rent with comparable local rental rates. If you give family members financial gifts to help with the rent, the IRS will likely view this as discounted rent.

Know What You're Getting Into

Helping family members with housing expenses is a nice thing to do. But be aware of the tax consequences of renting to relatives. Contact the office for assistance with these decisions.

HSAs Can Be Powerful Retirement Saving Tools

Health Savings Accounts (HSAs) are tax-advantaged savings vehicles for funding health care expenses not covered by insurance. And for those in relatively good health, they also may serve as attractive retirement savings vehicles.

To be eligible to contribute, an individual must be covered by a high-deductible health plan (HDHP). In 2024, an HDHP must have a deductible of at least $1,600 for individual coverage or $3,200 for family coverage. For 2024, you can contribute up to $4,150 to an HSA, $8,300 if you have family coverage (plus an additional $1,000 if you'll be 55 or older this year). Contributions are tax-deductible and withdrawals used to pay for qualified unreimbursed medical expenses are tax-free.

Any funds you don't need for medical expenses will continue to grow on a tax-deferred basis, providing a valuable supplement to your other retirement accounts. In general, once you reach age 65, you can use your HSA funds to pay for anything. Amounts spent that aren’t for qualified medical expenses will be subject to state and federal taxes, but not subject to a penalty. Contact the office with questions about adding an HSA to your plans for retirement.

Handle Your 401(k) Rollover With Care

Leaving a job? You may want to roll over funds in your former employer’s 401(k) plan to an IRA. But there’s a tax trap for the unwary. If you receive a 401(k) plan check that’s payable to you personally or if you have a distribution put into a personal account electronically, 20% of the taxable amount of the payout will be withheld for federal tax.

If that happens, you have 60 days to come up with the missing 20% and get it (along with the amount distributed to you) into your IRA. If by that deadline you transfer to your IRA only the amount distributed to you, you’ll owe income tax on the 20% withheld amount plus a 10% early withdrawal penalty if you’re under 59½.You can dodge this tax trap by arranging for a direct trustee-to-trustee transfer from the 401(k) plan to your IRA.

Valuable Tax Credit Available for Energy-Efficient Homes

Under the Inflation Reduction Act, construction contractors who build or rehab energy-efficient homes may be eligible for a federal tax credit of up to $5,000 per project. To claim the credit, builders are required to construct or substantially rehab a qualified home and own it during the construction process.

To be qualified, a home must be a U.S. single-family dwelling that’s purchased or rented for use as a residence. It also must be certified to meet energy-saving requirements before it’s sold or leased.

The credit value is based on whether the contractor acquired the home before or after 2023, and the certification and standards the home meets following construction. Contact the office for more information.

Upcoming Tax Due Dates

July 15

Employers: Deposit Social Security, Medicare and withheld income tax for June if the monthly deposit rule applies.

Employers: Deposit nonpayroll withhold income tax for June if the monthly deposit rule applies.

July 31

Employers: Report Social Security and Medicare taxes and income tax withholding for the second quarter of 2024 (Form 941) and pay any tax due if all of the associated taxes due weren’t deposited on time and in full.

Employer: File a 2023 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

August 12

Individuals: Report July tip income of $20 or more to employers (Form 4070).

Employers: Report Social Security and Medicare taxes and income tax withholding for second quarter of 2024 (Form 941) if all associated taxes due were deposited on time and in full.

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