The first thing you should know about the difference between being an employee and being an independent contractor is that the choice may not be up to you. Stay on the right side of the law ... and the IRS.
If you have doubts as to where you or your workers fall, you can let the IRS determine your status by filing form SS-8, entitled “Information for Use in Determining Whether a Worker Is an Employee for Purposes of Federal Employment Taxes and Income Tax Withholding.”
When In Doubt, Ask
Be careful. If you classify an employee as an independent contractor with no reasonable basis for doing so, you may have to pay employment back taxes for that worker. Further, if you do not withhold income and social security taxes from his or her wages, you may be held liable for a penalty of 100 percent of the tax if you are the person responsible for the collection and payment of withholding taxes.
Let’s look at a couple of examples that are typical of the nail industry.
Barbara, a nail technician, signed a lease to rent a booth at Helen’s Nails. Helen bears all the shop expenses, including rent, utilities, advertising, linens, and other supplies.
Their agreement provides that 70 percent of Barbara’s booth receipts go to her and 30 percent to Helen. All receipts are put in Helen’s cash register. At the end of the week, Helen pays Barbara the agreed percentage of the receipts.
Shop hours are displayed on the shop door. Barbara is expected to comply with them. She must take customers in turn, maintain clean premises, use clean towels and sterile equipment, and keep a clean personal appearance. Although Helen does not actually supervise Barbara, she can dismiss her for acting in a manner that would cause Helen’s Nails to lose customers. Barbara can also be dismissed for any other reason.
Although Helen does not control or direct Barbara in the performance of her duties, she does have the right to dismiss her. Helen’s income depends on a percentage of Barbara’s receipts; thus Helen retains the right to direct and control Barbara to protect her investment and to be assured of a sufficient profit from the shop, Barbara has no investment in the shop, assumes no liability for its operation, and furnishes nothing except personal services. These circumstances indicate that Barbara is an employee of Helen.
In the case of Tony and Sarah, Sarah owns World of Beauty. The two professionals have an agreement under which Tony, a nail technician, furnishes nail care services to shop clients during business hours.
According to the agreement, Tony regulates his own hours, furnishes his own equipment and supplies, and keep the proceeds from his work. He does not use the shop cash register nor does he report his earnings to Sarah. He does not have to perform his services personally but can hire a substitute. Sarah cannot direct the way Tony performs his services. Either Sarah or Tony can end the arrangement at any time.
Although Sarah has the right to dismiss Tony by ending the agreement, and although she furnishes a place for Tony to work, she does not have the right to exercise the degree of direction and control over his work necessary to establish an employee-employer relationship. Therefore, Tony is an independent contractor.
Besides how the IRS views your status, there are important legal divisions between employees and independent contractors. If a worker is classified as an employee, her employer is responsible for abiding by the Fair Labor Standards Act, which assures that workers are paid minimum wage and are subject to overtime laws (which vary from state to state). Also, salons with employees are obliged to abide by federal, state, and local laws that prohibit job discrimination based on race, color, religion, sex, national origin, pregnancy, handicaps, or age. Sexual harassment laws also apply.
The IRS can be unforgiving when it comes to money owed, so you do not want to find yourself on the wrong end of compliance. Use this guide to help determine the classification in your own salon, and consult an IRS counselor or an accountant for further clarification.
Besides the tax status and legal definition of employees and independent contractors, there are other considerations. First make sure that your current system is correctly defined, and we’ll cover these other matters in a future issue.