Money Matters

Misclassification: The Ultimate Nightmare

It is a true, life-changing story that can easily happen to anyone who is not classifying salon personnel correctly in the eyes of the government. You probably think you know the rules about employment classifications, but you’re probably wrong.

Most of the time technicians and salon owners in our industry do not realize that they are working and reporting income incorrectly. Many people I’ve spoken with have relied on the advice of a CPA, like I did, thinking they are paid a higher fee than a regular accountant to know the law. Wow…what was I thinking?

I want to share my story to help others understand what is considered legal. I would not want anyone to experience what I, my family, and my friends did for two full years of our lives. It was the most devastating and life-changing experience I have ever had.

My Story Begins

The year was 1986 and I was working full time for a great company and living at home; I was 24 years old. I wasn’t sure where my life was going but I had quite a bit of energy and was pretty creative. My mom had always loved the beauty industry even though she wasn’t in it herself. However, she encouraged my sisters and me to attend nail school and become licensed. My sisters took her advice and had completed school and now I wanted to do the same. I went part-time after work and took the course and received my license. I realized I had a deep passion for doing nails and wanted to continue in the beauty industry.

While in beauty school I met really great girls and wanted to stay in contact with them. However, we soon became frustrated trying to find employment. The only positions that seemed to be available back then were in hair salons that didn’t see nail technicians as a higher source of income. There was little space in the salons for manicurists; usually an old table with a mismatched chair in the corner. I was so discouraged. I really saw nails differently; I saw it bigger and as its own standalone business. So, after much consideration, I gave up a great full-time job with full benefits, weekends off, and little worry to open a nail salon and employ the nail techs I went to school with. People who knew me weren’t shocked, but some really couldn’t believe that I would give up stability for “polishing fingernails,” as they saw it. I didn’t know everything about salon ownership but I would dedicate my time, educate myself, and hire the necessary people to fill in the blanks for areas in which I was not informed — such as tax law and legalities.

VIP Nails & Tans opened after one year of planning and dealing with tons of bumps in the road. Not to mention the fact that after being open a few short weeks I got sick and had to be off for six weeks. My mother stepped up and held things together while I struggled to get better and back to work. If it had not been for the simple fact that I still lived at home and kept expenses at a minimum I could not have survived financially. I was very blessed that I was conservative enough with my spending and planning. But even so, you never can completely budget for the unexpected.

Business in the late ’80s was really starting to catch on. Nails were booming. Opening with three nail technicians in 1986, we ended the ’80s with a total of 10. VIP was surely growing. By 1992 we went from leasing a 1,400-sq.-ft. building to 2,200 square feet. We increased our boutique area with more unique purses and jewelry. With more than six years having passed since our opening it was an exciting time.

A Letter From the IRS

So, the real story begins when a letter from the IRS arrived in the late summer of 1994 stating that the IRS was reviewing our company for a random payroll audit. The only correspondence I had ever received was from the State of Michigan in 1987, the year after we opened, requesting information regarding my technicians. I filled out the form and they sent back that everything was correct and that my technicians were deemed independent contractors. I thought, OK, was there an issue? I had no idea. I called my accountant and told him about the letter. He too did not seem concerned and said he had all the company records in order and he would work with them. I called the agent and set up our meeting at the salon. Since I was doing everything the way the business was set up, was never late filing anything, and always paid my bills on time, I felt confident the audit would be just fine. The agent met with me and my mother at VIP. The agent was, of course, very businesslike but asked us many questions that didn’t feel relevant to a random payroll audit. A few of the questions that were asked were: “Who set up the business ­organization?” “Do you write off your car?” “What type of benefits do you give your technicians?” She requested mileage logs, copies of bank deposits, and any type of agreements that we had with technicians. I told the agent to schedule a meeting with our accountant for that information. She spent the next few weeks at his office going through all of our company’s financial information.The dreaded phone call came on October 11, 1994, from my accountant. He told me the IRS felt the workers were misclassified. He said they were currently classified as independent contractors and the government felt they should be classified as employees. I will never forget the words said to me after that. He told me, “If this is true you would owe the government more than $85,000.” I was absolutely speechless and in total in shock.

The truth of the matter was that I had no idea what the differences were between an independent contractor or employee when I opened my company. I did not know that one matched FICA/FUTA payment for Social Security to the federal government and one didn’t. I had gone to a CPA firm to set up my company and find out if I should be a corporation, DBA, etc., and also how to handle everything from the payroll to any legal requirements. If I had been told the differences, I would have set my company up completely differently.

I also had an attorney who oversaw the incorporation for me but was not involved in the day-to-day set up and filings. There are many things that you do not realize need to be prepared to create a business such as your sales tax licenses, federal identification numbers, state requirements, etc. I paid the CPA to take care of those business details for me. I was busy setting up the business strategy, lease, signage, inventory, equipment purchases, and all the many things it takes just to open the doors. My passion was nails, not really business.

After receiving the dreaded call I immediately started researching everything. I called the CPA who had set me up (he is out of business now) and he indicated to me that it was industry practice, but he would not have set me up that way unless I had agreed. Agreed? If that was so, why was I not privy to the implications of doing it wrong? I was devastated. I felt that, at the least, responsibility for doing the job incorrectly would be a burden that he should incur. He obviously was paid to do the job that I didn’t know how to do. I was livid to say the least.

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