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Mistakenly classifying an employee as an independent contractor can result in significant fines and penalties!

The IRS uses 20 factors to determine whether or not an employer has enough control over a worker for that individual to be classified as an employee.

Designed only as a guideline, this checklist can help determine whether you possess enough control to demonstrate an employer-employee relationship.

Default: Under PA Unemployment Compensation law, which is presumed o apply for tax purposes, every person who performs services for which he or she is paid is an EMPLOYEE of the payor.

To not fall under the category of an “employee,” the worker must qualify as an Independent Contractor, which has TWO prongs:

  1. Free from control or direction over performance of services BOTH under contract and in fact

                  They DO:

  1. Provide services that are not so unique to the client’s business that they may only be integrated into that client’s business
  2. Set their own work hours
  3. Offer their services to the general public
  4. Make the termination of their employment subject to contractual agreement.

  • General Rule: Deductibility of losses is limited by the Hobby Loss rules only when the activity does not qualify as an activity engaged in for profit. A taxpayer must use Schedule C to report income and expenses from an activity qualifying as a business. An activity is a business when
    • The primary purpose is to gain income or profit and
    • The taxpayer is involved in the activity with continuity and regularity.
  • While the Regulations do not require a reasonable expectation of profit, the facts and circumstances must indicate that the taxpayer entered into the activity or continued the activity with the objective of making a profit it to be a “for-profit” business. This is objectively determined by weighing of factors. While there are many factors listed in the Regulations and IRS publications, the following appear to be the most critical:

    1)Making a profit from the activity in the past
    2)Time and effort put into activity indicate an intention to make a profit
    3)If there are losses, they were due to circumstances beyond your control or they occurred in the start-up phase of the business
    4)Changing methods of operation to improve profitability
    5)Having the knowledge needed to carry on the activity as a profitable business
  • Regardless of the above factors, an activity will be presumed “for-profit” by the IRS if the activity makes a profit in at least 3 of the last 5 tax years (including the current tax year).
  • If the activity is for-profit, then :
    • The expenses are not subject to the Hobby Loss Rules.
    • The income and expenses are reported as normal (i.e, on Schedule C).
  • If the activity is NOT for-profit, then:
    • The expenses are reported on Schedule A.
    • Expenses are subject to the special Hobby Loss Rules below.

Hobby Loss Rules:

General Rule: taxpayer can only deduct expenses from a not-for-profit activity to the extent of gross income of that activity. Expenses cannot be applied to income from any other activity.

MARRIAGE CERTIFICATES DEATH CERTIFICATES OF FAMILY
BIRTH CERTIFICATES AUTOMOBILE TITLES
ADOPTION PAPERS SERVICE PAPERS
CITIZENSHIP RECORDS LEASES
DIVORCE AND/OR OTHER CONTRACTS
LEGAL PAPERS REGARDING
DISSOLUTION OF MARRIAGE NOTES
PROOF OF OWNERSHIP PAPERS WILL
(e.g. deeds for real estate)
PATENTS & COPYRIGHTS
MORTGAGE PAPERS
  • IRS Hot Button!!
    • Billions of dollars in lost Social Security taxes
    • Issue: In many cases, the Shareholder Compensation is not reasonable and customary for the job performed resulting in lower total social security taxes collected leading to:
  • 176% increase in “S” Corp audits 2004-2007
  • 25% increase in “S” Corp audits 2006-2009
  • Resulting in readjusting compensation for years audited and increasing SS tax amounts plus penalties and interest, affecting the individual’s tax return.
  • Compensation Must be Reasonable and Customary
    • Includes base salary and bonus
    • What is the job of the officer?
    • How are like positions compensated in the same market area?
    • What percentage of an average workweek does the officer work in that capacity?
    • Written documentation is needed as back up to support how the compensation dollar amount was derived.
  • Call JBND Tax Books, Inc. to assist you with this issue.