Be sure your salon is in compliance with the IRS’s rules; salon owners who’ve incorrectly classified workers as independent contractors can be liable for back taxes, penalties, and fines.
Illustration: Robina Mann
What would you do if the Internal Revenue Service (IRS) visited your salon and asked to see your records? When IRS agents showed up unannounced and asked to see one Dallas salon owner’s records, he invited them in-and immediately called his tax attorney.
The IRS agents told the salon owner they were just doing a routine report and asked to see his federal tax records for the salon’s nail technicians. The salon owner (who asked to have his name withheld because the case is pending) explained to the agents that all the nail technicians in his salon are independent contractors (often called booth renters), not employees, and thus are responsible for their own taxes.
The IRS didn’t drop the matter. Two weeks after the agents visit, the salon owner discovered that the IRS had sent an “Employment Tax Examination Worker Interview Sheet “ to 70 current and former independent contractors of his salon. The eight –page interview sheet posed 54 detailed questions about the working relationship between the nail technician and the salon. The owner notified his attorney of the questionnaire; the attorney contacted the IRS and requested a meeting to discuss the IRS’s findings with the agents. (The meeting hadn’t taken place as of NAILS press time.)
If the IRS audited your salon tomorrow, would you feel confident that your both renters are legitimate independent contractors? Have you studied the criteria the IRS uses to classify workers and ensured that your salon practices comply?
From the salon owner’s point of view, operating a booth rental salon is financially attractive because she doesn’t need to withhold employees taxes or pay the employer’s portion of those taxes. But many salon owners who treat their nail technicians as independent contractors would be considered employers by the IRS and would be liable for back taxes and penalties.
EMPLOYEE OR INDEPENDENT CONTRACTOR?
Booth rental is a common practice in the salon industry; 30% of respondents to the NAILS 1993 Reader Survey classified themselves as independent contractors. But just as a rose by any other name is still a rose , an employee by any other name is still an employee. Ken Cassidy, owner of Kassidy’s Salon Management Consulting Company (Long Beach, Calif.) and a salon owner who’s an expert in this area, says 90% of the more than 1,000 booth rental salons he’s consulted with exert too much control over workers, a situation that would indicate to the IRS that those salon’s independent contractors are actually employees.
Most salon owners don’t set out to fool anyone; they themselves are confused by ambiguous guidelines from the IRS and a lack of industry standards on what constitutes an independent contractor. In a recent visit to 12 booth rental salons in Las Vegas, NAILS found that no two salons treat workers alike; yet all called the technicians independent contractors.
To help employers determine whether a worker is an employee, the IRS has a list of 20 guidelines. But these guidelines to help determine a worker’s status are naturally ambiguous because they are written to cover all industries. Even more confusing to salon owners and independent contractors is that some guidelines carry more weight than others, but the IRS won’t differentiate. The facts and circumstances surrounding how the salon operates are judged on a case-by-case basis, says Judith Golden, public affairs officer for the IRS’s Laguna Niguel district office in California.
Says tax attorney Steve Breitstone of Meltzer, Lippe, Goldstein, Wolff, Schlissel, and Sazer in Long Island, N.Y., “It comes down to whether the independent contractor is in control of her own situation. The 20 factors are examples of the criteria the IRS uses. They are simply guidelines. “Breitstone has experience in independent contractor cases and recently won a case for a floor coverings company against the IRS.
According to Golden, the degree of control is the key factor the IRS evaluates when determining a worker’s status. If the salon owner has the right to control when, where, or how the work is done, the worker is an employee. Salon owners who hire nail technicians as employees to do nails a certain way but a salon owner who rents space has no control over how the independent contractor performs her services.
An independent contractor cannot be required to use a certain technique to apply acrylics, for example, and the salon owner cannot set an independent contractor’s work hours or demand she use a certain product line. A salon owner may not force an independent contractor to comply with state board regulations, even if the salon owner risks being cited for the violation.
To avoid problems with the IRS, Cassidy recommends that booth rental salon owners view themselves as landlords. In exchange for rent, the landlord (salon owner) provides as space for the independent contractor to perform her services. Like any business owner, an independent contractor must provide her own equipment, tools, and materials for the product she produces; generate her own clientele; book her own fees; and carry general and personal liability insurance independent of the salon owner’s coverage. Most important, an independent contractor must be able to make a profit or suffer a loss independent of the salon’s income.
CONSIDER THESE SIX AREAS OF CONTROL
While the IRS reviews each salon’s operation on a case-by-case basis, the sources NAILS interviewed agree on six specific areas in which booth rental salon owners tend to exhibit too much control technicians work schedules, access to the salon, training, appointment bookings, how and who a client pays, and how the technician herself is paid.
Scheduled work hours. Salon owner’s want to know technicians hours so they can plan salon schedules. However, an independent contractor cannot be required to work a set schedule or a certain number of hours. According to the IRS’s guidelines, an independent contractor should be allowed to hire another technician to work at her station if she is going to be out sick or on vacation. If an independent contractor calls in sick, she should reschedule her appointments herself or refer her clients to another technician.
Salon access. Many salon owners are reluctant to give independent contractors a key to the salon. However, just as you can’t tell an independent contractor when she will work, you really can’t tell her when she will work, you really can’t tell her when she won’t work. You can require an independent contractor set her hours within the salon’s states business hours. For example, if a salon is open 9 a.m. to unlock the doors and at 9 p.m. to lock them. Cassidy warns salon owners who choose this route to be prepared to stay late when a technician is running schedule.
In-salon training. A salon owner can offer to train independent contractors, but she cannot require them to participate. Some salon owners offer in-salon education, and many have training programs for new technicians. As long as participation is optional, the salon owner is on firm legal ground.
Who takes the money? Who books appointments and collects payment for services rendered represents another gray area. “The intermingling of funds is a hard issue to overcome with the IRS,” Says Susan Hedstrom, an accountant and fiscal operations director for Estes Institute in Visalia, Calif. Many salons have a receptionist who books appointments and use one cash register to collect payments, but as the Dallas salon owner discovered, the IRS considers intermingling of funds a key factor in determining that a worker is an employee.
“They’re trying to say that because I collect the money for the booth renters they are employees. They say technicians need to take I their own cash, “the Dallas salon owner says. He plans to fight the IRS on this point, arguing that many clients pay by check or credit card and check guarantee companies. Until the IRS makes a ruling that salon owners can cite to back up their decision, making independent contractors collect their own money and maintain their own cash drawer constitutes the safest route. Clients who write checks should make them out to the independent contractor, not the salon. “If you had a cash register or computer system that could spell out what each person made and you distributed his or her money each day, you might be okay. But I tend to be conservative and I would advise salons to stay away from this “ says Hedstrom.
How is rent paid? The sources NAILS interviewed recommend that owners charge independent contractors rent or rent plus commission. According to Hedstrom, who helped research and draft the National Cosmetology Association’s handbook on independent contractors (not yet available), the NCA found that salon owners who paid independent contractors a straight commission were consistently declared employers by the IRS.”This is not in writing anywhere; it’s based on case history for the cosmetology industry,”says Hedstorm.
While the IRS’s guidelines state that an independent contractor is usually paid by the job or by straight commission, they also state that an independent contractor must be able to make a profit or suffer aloss.”Flat rent and flat rent plus commission are strong indicators of an indepent contractor relationship because they allow the independent contractor to incur a loss ,”says Breitstone.
USE A CONTRACT TO DEFINE THE RELATIONSHIP
While a contract is not required to establish an independent contractor relationship, it is considered by the IRS. A contract serves three important purposes for the salon owner. It sets the para-meters of the relationship with the salon’s independent contractors, it ensures similar treatment of all contractors and it is a written record of the business relationship. At the same time, a contract cannot be used as a protective cloak for your salon; in other words, you can’t create in it your contractor if it violates the IRS’s guidelines. “The contract has to set forth an independent contractor relationship, and the realities of the situation have to be consistent with the contract. A self-serving contractor isn’t going to fly,“ cautions Breitstone.
To write a legal, effective contract, study the IRS’s 20 guidelines carefully, outline how you want to set up the relationship, and then consult a lawyer who specializes in taxes issues for advice. Work with the lawyer to create a contract that addresses the guidelines while meeting your needs as well (see “11 key Points to Cover in Your Contract” on page 111).
Once you have a legal contract, adhere to the policies you’ve established. While the IRS will consider a contract in determining a worker’s status, it gives more weight to the actual facts and circumstances of the real-life situation. If the practices don’t match what’s outlined in the contract, the contract will be discounted by the IRS, and it may even be held against you.
KEEP RECORDS UP TO DATE
Good recordkeeping can help protect the salon the salon owner against the IRS. Salon owners should keep receipts or a ledger that shows who paid rent, the amount, and the date it was received, says Hedstrom. Detailed records may also be used to back up the contrast. For example, if the contract states that the independent contractor will pay $80 per week for the space, the salon owner should save copies of the receipts for rent paid.
Other important records to keep include copies of the independent contractor’s liability insurance certificate (or copies of the check she wrote for her portion of the premium if she is covered under the salon’s policy). The salon owner should also maintain a file for each booth renter, which should contain any correspondence, a copy of the independent contractor’s business card, ads placed by the independent contractor, and anything else that shows the independent contractor, and anything else that shows the independent contractor’s independence.
AVOID COSTLY MISTAKES
Salon owner’s who wrongly classify employees as independent contractors risk paying a high price. According to Golden salon owners could be charged back taxes for Social Security, Medicare, and federal unemployment insurance, plus penalties. And once the IRS is through, the state where the salon is located can conduct its own investigation and collect applicable back taxes and penalties. An IRS audit can go back three years, and even further if they find the salon owner has committed a crime, such as under reporting of income.
It is to the advantage of both the salon owner and independent contractor to establish a clear-cut relationship. If the IRS questions even one salon procedure, clearing up the matter can be time-consuming and costly. The Dallas salon owner expects to spend approximately $50,000 in attorney and advisory fees before his battle with the IRS is finished. Instead of waiting for the IRS to audit your business, ensure you’re in compliance with the guidelines now (see “Are Your Workers Really Independent Contractors?” for sources of help on page 100).
If you determine that you’ve been treating independent contractors as employees, don’t call the IRS and admit your mistake, says Cassidy, “Correct your procedures and justify the mistake. For example, document that you attended a seminar and realized you had been misinformed, then show you changed things from that date forward.”
Golden agrees. “If you’ve been doing it wrong, you should change. If the salon is audited, it [showing that you corrected your mistakes] would be a factor in your favor. If you said you went to a seminar and changed you wouldn’t owe, but it would be viewed favorably.“ While it’s doubtful the IRS would excuse you from paying back taxes, it might waive the penalties if you demonstrated that you made a good faith effort to comply.
To avoid making mistakes that can lead to problems with the IRS, take action now. Review your salon procedures to ensure that your workers are correctly classified and make any changes required. If you are setting up a new salon, start off on the right foot. While the Dallas salon owner may have $50,000 to spend on lawyers’ fees, few salon owners can afford to tangle with the IRS.
SHOW A SEPARATION OF SALON AND CONTRACTOR
The more ways you can show that an independent contractor’s business is separate from your salon, the better View each independent contractor as a business owner, and treat your relationship with the independent contractor as landlord-renter. Here are some specific areas to look at when determining If the separation is dear in your booth rental salon.
To be a true independent contractor, a nail technician should.
- Pay rent for her work space
- Have her own telephone number and book her own appointments.
- Collect her own service fee from clients and have her own cash drawer (Checks should be made out to the independent contractor, not the salon.)
- Have a key to the salon and the freedom to set her hours.
- Reschedule her clients when she is out sick or on vacation.
- Supply her own equipment and products.
- Provide the salon owner with proof of general and personal liability insurance
- Supply her own business cards or have printed on the salon’s cards at least as large the salon’s name
An independent contractor should not be required to.
- Schedule her vacation around the salon owner’s
- Work set hours or days.
- Follow a dress code.
- Charge service prices set by the salon owner
- Attend salon meetings or training classes.
- Use a particular product line or technique.
11 KEY POINTS TO COVER IN YOUR INDEPENDENT CONTRACTOR CONTRACT
When Ken Cassidy decided to make his salon a booth rental operation 10 years he researched the independent contractor issue and worked with his lawyer to create an easy-to- understand 11-page business lease that he now markets to booth rental salon owners. From his own salon experience and from what he’s learned as a salon consultant, Cassidy recommends answering the following questions in the independent contractor lease to clarify the relationship and safeguard your salon from the IRS. (See “Are Your Workers Really independent Contractors?” on page 110 for information on purchasing the lease.)
- How is rent paid? Rent can be as flat rent or by rent plus a percentage of the independent contractor’s income. Cassidy recommends charging a flat rent or by rent plus a percentage of the independent contractor’s income. Cassidy recommends charging a flat rent for a certain number of clients and a percentage of income for any clients above that for coffee, restroom use, receptionist services, etc.
- How is money collected? The booth renter should be responsible for collecting payment for services rendered. This means she has her own cash drawer and all checks are made out to her. However, if receptionist services are included in the rent, the salon can collect all payments for services in one cash drawer. Cassidy recommends that the salon charge an additional fee for receptionist services and make the service optional for the booth renter.
- Do independent contractors have a key to come and go as they please? The salon owner can designate the salon’s hours of operation and open and close the salon, but Cassidy says this can get tire-some for both the salon owner and the independent contractor. He recommends providing independent contractors with a key, adding that this helps show the separation.
- Who purchases supplies? The booth renter is responsible for purchasing all her equipment provided by the salon should be specified in the lease. According to Cassidy, the less equipment the salon provides, the better.
- Who provides liability insurance? A booth renter must provide the salon owner with a copy of her general and personal liability insurance policy. The independent contractor’s insurance should be equal to the dollar amount required by the salon owner’s master lease. For example, says Cassidy, if the building owner requires $1 million liability insurance, each operator must have $1 million of coverage.
- Who provides disability insurance? Booth renters are not covered by worker’s compensation insurance, and Cassidy says this should be clearly stated in the lease to release the salon owner from liability. Independent contractors should be encouraged (although they can’t required) to purchase individual disability insurance.
- Who pays for advertising? A booth renter is responsible for generating her own clientele. This means if an independent contractor donates a service to charity, advertises, a special in the newspaper, or creates fliers to pass out, she pays herself. What advertising the salon the salon pays for, if any, should be spelled out in the lease.
- Who provides business cards? Independent Contractors should order and pay for their own business cards. If they use the salon’s business cards, their name should be printed at least as large as the salon name.
- Who answers the phone? A booth renter should have her own phone line and book her own appointments. If a booth renter wants the salon to provide a receptionist for booking appointments, the salon owner should charge an additional fee for the service.
- Who cleans the salon? Booth renters are responsible for the general maintenance, cleaning, and equipment they lease. This includes, but is not limited to, common areas such as the reception area and restroom, says Cassidy.
- What is the length of the lease? The lease should specify the length of the agreement. Cassidy recommends 30-day leases because an independent contractor cannot be fired. If it becomes clear that an independent contractor doesn’t suit her salon, a salon owner only has to wait until the 30-dat contract expires and then decline to renew it.
Lauren LaRue, a tax lawyer at Meadows, Owens, Collier, Reed, and Coggins in Dallas ,Texas, recommends a clause that allows the contract to b terminated at will by either part at any time. This way, although a salon owner can’t force a nail technician to comply with state board regulations, she can terminate the contract if the nail technician does not do so. According to LaRue, a termination -at-will clause allows the salon owner to retain the control she needs to ensure her business is not damaged by an independent contractor’s reckless actions.
Who files the tax return? LaRue recommends including a clause in the contract requiring nail technicians to file tax returns LaRue, who is part of a task force formed by the American Bar Association at the IRS’s request, says this is one of the task force’s suggestions to help the IRS get compliance from independent contractors.”If you look at the bell curve, there is a large percentage of people in the middle who will file their tax returns if they sign something agreeing they will, “says LaRue.