Start-Up Law Talk 1 Corporate Law Carter Mackley Mackley & Mackley, PLLC (206) Tax Law Deniz Kiral Turquoise Financial Advisory (425) Immigration Law Tahmina Watson Watson Immigration Law Seattle, WA, (206) Intellectual Property Law Ashley K. Long Ember Intellectual Property Law Group, PLLC (617)

INDEPENDENT CONTRATOR OR EMPLOYEE? StartupLawTalk Deniz Kiral Turquoise Financial Advisory

3 Current State Overview

Current State of the IRS’s Focus NEW IRS tax gap numbers highlight future audit areas $450 billion dollar tax gap in 2006, with 40% of the GAP, $179 Million focused on Small Businesses. 17% of the tax cap can be attributed to underpayment of employment taxes. 86% of employment tax audits result in an adjustment. IRS National Research Project on Employment Taxes from employers are being audit in extensive review of employment tax returns Audit focuses on Employees being misclassified as independent contractors Will lead to the conclusion that this issue is costing billions in tax revenues. Eight Small Business IRS Audit Areas to Watch in Proper Worker Classification – CPA Practice Advisory September, 2012

EXAMPLES OF CRIMINAL PENALTIES FOR EMPLOYMENT TAX INVESTIGATIONS TitleCompanyLocationTax Liability Jail/Fine PresidentConnection Newspapers VirginiaNA6 Months 647,000 OwnerEmployment Agency Oklahoma370 K24 Months / $1 mil. OwnerTemp AgencyMinneapolis400 K12 Months / OwnerConstructionMiamiNA60 Months / 1.2 Mil. OwnerHealth SystemsOhio1 Mil.25 Months OwnerWRG ElectricSeattle377 K6 Months / $377 k OwnerHealth CareRhode Island 1.3 Mil.30 Months /1.21 M OwnerContractorFlorida504 K18 Months / 504 K OwnerHealth CareNorth Carolia 1.3 Mil.24 Months / $1.3 Mil. OwnerConstructionNew York460 K12 Months / 460 K

TAX INCENTIVES TO MISCLASSIFY EMPLOYEES: Company not subject to withholding taxes FICA FUTA State and local income and unemployment taxes Health and welfare benefits Pensions Workers compensation Unemployment benefits

7 Classification

DISTINGUISING EMPLOYEES FROM INDEPENDENT CONTRACTOR 8 MOST IMPORTANT CONSIDERATION: WHO CONTROLS THE PROVISION OF THE SERVICES? – COMPANY CONTROL: Employee – INDIVIDUAL CONTROL: Independent Contractor The mere right to direct or control the work of the service provider triggers the application of Code Sec. 3121(d)(2); whether or not the service provider actually exercises the right is irrelevant.

the IRS grouped the 20 factors into three broad categories: 9 Behavioral control factors - relate to the right of the service recipient to direct or control the work of the service provider. Financial control factors - involve the service recipient’s risk of loss. Relationship control factors - Relationship control factors focus on any agreements, particularly written

20 FACTOR TEST (REVENUE RULING 87-41) : 10 Instruction Training Integration into company’s operations Services required to be performed by specific individual Hiring supervision and payment of assistants Continuing relationship Set hours of work Fulltime commitment required Work performed at company’s facilities Company determines order of performance Oral or written reports required

20 FACTOR TEST (REVENUE RULING 87-41) : 11 Payment by hour, week, month (vs. lump sum or percentage completion payments) Payment of business expenses Furnishing tools and materials Significant investment by individuals Potential for profit or loss Working for more than one firm Services available to public Right to discharge Worker’s right to terminate

7 FACTOR TEST USED BY TAX COURT: 12 Degree of control exercised by the principal (company) Which party owns the work facilities? The opportunity for loss as well as profit The right to discharge the individual Determining if work is part of the principal’s normal business Permanency of the relationship Intent of the parties in creating the relationship

Safe Harbor

SECTION 530 SAFEHARBOR 14 Independent contractors will not be reclassified as employees if: a) The employer is not treating the worker, or anyone in a similar position, as an employee at any time b) The employer filed all required information returns (Forms 1099); and c) The employer had a reasonable basis for treating the worker as an independent contractor

SECTION 530 SAFEHARBOR 15 Reasonable Basis – Employer prospectively relied on any of the 4 criteria  Court decisions, IRS rulings, laws,  Past IRS audit decisions,  Industry Practices, or  Reliance on a qualified tax professional (attorney, cpa) Act Sec. 530 relief, while an option for the service recipient, is not an option for the worker.

UNDER SECTION 1760, 530 RELIEF DOES NOT APPLY TO: 16 Technical workers who are subject to a three-party arrangement (i.e., the company, an engineering firm and the worker)  Engineer  Designer  Drafter  Computer programmer  Systems analyst  Other similarly skilled worker engaged in a similar line of work.

17 Settlement

Classification Settlement Program (CSP) 18 Filed 1099, but no Reasonable Basis - 100% Employment Tax Penalty Filed 1099, but not a convincing basis - 25% of Employment Tax Penalty + Future Years Employee Classification VCSP = Voluntary Program a good idea for blatant disregard.

CSP Analysis Chart 19 Are the Workers Employees? Were Forms 1099 Timely Filed? Is Taxpayer Entitled to 530 Relief Type of CSP Offer YesNo None Yes No1 Year Tax + CSP Yes Maybe25% Tax + CSP

Code Section 3509(a) Example No 1099 Company’s Share of FICA7.65% Employee’s share of FICA (0.2/0.4) 1.13%2.26% Total FICA8.878%9.91% Income Tax Withholding1.50%3.0% Total Code Sec. 3509(a)10.28%12.91%

CONSEQUENCES OF IMPROPER CLASSIFICATION OF EMPLOYEES 21 TAX CONSEQUENCES OF MISCLASSIFYING EMPLOYEES Employer liable for a percentage of the withholding taxes Employer liable for employer’s share of FICA (Social Security) taxes Employer liable for a portion of the employee’s FICA taxes Interest and penalties Reclassified Employees May Qualify For Various Benefits – Health insurance and other benefits – Pension plan – Workers compensation – Unemployment compensation Reclassification Could Affect Status of Pension Plans – May cause violations of discrimination provisions under ERISA

OTHER CONSEQUENCES OF MISCLASSIFYING EMPLOYEES 22 Workers have been suing employers in a number of states to be reclassified as employees. FedEx Cases: – Federal Express has been sued in multiple state and federal courts by its drivers, challenging their status as independent contractors

Disclaimer 23 This presentation is a summary and is not intended as tax or legal advice. You should consult with your tax advisor to obtain specific advice with respect to your fact pattern. Based on the most recent "best practice" standards for tax advisors issued by the Treasury Department, commonly referred to as Circular 230, we wish to advise you that this presentation has not been prepared to be used, and cannot be used, to provide assurance that penalties which may be assessed by the IRS or other taxing authority (including specifically section 6662 understatement penalties) will not be upheld.

Start-Up Law Talk 24 Corporate Law Carter Mackley Mackley & Mackley, PLLC (206) Tax Law Deniz Kiral Turquoise Tax Advisory (425) Immigration Law Tahmina Watson Watson Immigration Law Seattle, WA, (206) Intellectual Property Law Ashley K. Long Ember Intellectual Property Law Group, PLLC (617)