With the rise of independent contractors in the new, shared economy, distinctions between employees and contractors are increasingly blurred, especially at public relations firms. The tax implications of misclassification can be significant, and the U.S. Department of Labor and even some states are now weighing in on employee classification.
PR firms often prefer to classify workers as independent contractors. Employers are obligated to pay the employer portion of FICA taxes for employees, but not for independent contractors. They must also withhold income taxes from employee pay, but not from independent contractors. Independent contractors do not have to be included in employee benefit plans or receive compensation for “family leave” among other examples.
There are other obligations associated with employees that make independent contractors appealing to business, but they draw attention to taxing authorities.
IRS guidelines say that no single factor typically determines whether a worker should be classified as an employee or independent contractor. Instead, the decision hinges on an “economic realities” test that attempts to distinguish workers who are economically dependent on an employer: those in business for themselves and, therefore, not economically dependent.
The following are some of the issues that can help make the employee independent determination:
Is the work performed by the worker an integral part of your business? The more integral the work, the more likely the worker is economically dependent on the firm and is most likely an employee. The work can be considered integral even if it’s one step in a process, performed away from your business location, or performed by multiple individuals.
For example, your PR firm may be serving the New York City marketplace and, therefore, you rent office space in town. You’re also expanding in the California market and just secured a new client. Rather than renting office space and hiring employees in California, you decide to engage a freelance person to assist in servicing the California client.
Does the freelance person’s opportunity for profit or loss depend on his or her managerial skill? A key word here is “managerial.” An independent contractor demonstrates managerial skill by, for example, deciding whether to hire employees or other freelance or purchase equipment. A worker (employee) in business for him/herself also faces the possibility of a financial loss.
Has the worker invested in the work? A truly independent contractor will invest in his or her business, the investment will go beyond simply purchasing equipment to perform the servicing of clients.
What role does the worker’s skills and imitative play? Just because workers are technically proficient at a task does not mean they’re independent contractors. However, skilled workers who demonstrate initiative to operate as an independent business may be. Operating as an independent business generally means that the worker exercises business judgment, is in open market competition with other PR firms and isn’t economically dependent on an employer.
Is the relationship between the worker and your PR firm permanent or indefinite? Many at-will employees are considered permanent or indefinitely employed, rather than employed on a project or contract basis.
What is the nature and degree of your control versus the workers? A truly independent contractor will exert control over a meaningful part of the work and relationship with an employer. Indeed, it’s almost impossible for PR firms — due to client demands or regulations — to prevent contractors from exerting control over the work and relationship.
The question of proper classification becomes urgent for employer PR firms due to potentially harsh tax penalties associated with misclassification. Costs can be steep and may include back taxes and interest. In New York, the failure to secure worker’s compensation insurance, as an example, can be extremely high if there’s a misclassification. In most cases, I recommend that this insurance be purchased although a worker is considered an “independent contractor.”
Potential tax issues
This section will review some important tax issues that can be faced by you or your agency.
Above-the-line Charitable Contribution Deduction
Rep. Chris Smith (R-NJ) and Rep. Henry Cuellar (D-TX) have introduced the “Charitable Giving Tax Deduction Act,” a bipartisan bill that would make charitable tax deductions “above-the-line” such that all taxpayers would be able to write off charitable donations without limitation if they choose to itemize.
The proposed legislation would address concerns that changes made by “TCJA” will result in fewer taxpayers itemizing deductions, reducing the tax incentive to make charitable contributions. These changes include — for tax years beginning after 2017 and before 2026 — significantly increased standard deductions and new limitations on deductions for state and local taxes and for mortgage interest.
Booster club donations
Many of us donate to a booster club for our alma mater or local school you otherwise root for. Under pre-TCJA law, you may have donated money to a college or other program entitling you to buy tickets at an athletic event and receive preferred seating. As a result, you were entitled to deduct 80 percent of the cost of the donation. However, that part of the payment for the cost of actual tickets was not deductible. The new tax law repeals this write-off.
However, there’s nothing in the new tax law to prevent you from donating to a booster club that benefits the college athletics program. If you do not receive a benefit in return, the donation will be deductible assuming you itemize deductions. If you want preferred seating, just buy them! No deduction is available, but you will have great seats!
Richard Goldstein is a partner at Buchbinder Tunick & Company LLP, New York, Certified Public Accountants.