Hiring - Employees vs Subcontractors

Stan: Very good. Good. So let's talk about the difference between an independent contractor and an employee. Especially within the construction industry, it's real easy to confuse these two things. Especially, if you start to use somebody on a regular basis, you have to be very careful. Now, the IRS is awesome enough to give us a 20 factor checklist. Something that you can look up on your own, on the internet. Here's the form. I'm actually gonna use to go down that Jeff was nice enough to print off before we started this. They also have a second set of forms, which gives you links, which gives you consequences, which gives you a more thorough outline. But today, we're gonna talk about this 20 point checklist. We're gonna go down, what we consider, the most important points of this checklist. What do you find, Jeff, are the things that contractors make the biggest mistake on when they hire a subcontractor?

Jeff: As far as classification?

Stan: Yes.

Jeff: Yeah. Well, I mean a lot of people, it's obviously, we kind of stressed on how much easier it is, as the employer, if you have a contractor. So people will kind of err on, especially just starting out. Oh, I just want things to be easy and that. I think a lot of times people are too scared about what it looks like to have an actual employee, to be able to pay taxes on that. The fear of the unknown, it's always been one of the great, great things people are afraid of. That's the biggest mistake I see is people just think it's so difficult and oh, I have to do quarterly filings, and then these are just things I hear from people. 

Jeff: Then again, it would be the same with me if you told me to go out and dig that swimming pool. I'd be in the same boat I think, now what do I do? That's the biggest mistake I see, is people are just too afraid and think it's gonna be a lot worse than it actually is. They'll just kind of ignore, maybe knowing that it maybe should be an employee and they can go the contractor route instead.

Stan: So the big things, I want to call them the big points that I notice. Because I've hired dozens and dozens of subcontractors. I have a very clear set of rules that I require all of my guys to follow, especially because I'm a person that works off relationships. I've worked with Jeff for years. I've worked with his father, before him. I don't vary, I don't price shop. I don't go here; I don't go there. Once I've developed trust with somebody, I use them time, and time, and time again and I believe that they're going to do the absolute best they possibly can for me because they should know that they're always going to have work. That's where the IRS frowns upon it, okay? Because now you're developing a continual relationship, which can be construed as an employee rather than a subcontractor. So a few of the things you gotta make sure you have on hand when you hire that independent contractor is they set their own hours. You as the boss, as the employer can't go and remember ...

Stan: Okay, so here's a few of the big things that I really want to point out that you gotta make sure. You do not set the hours. You cannot tell an independent contractor when they can start their project or when they can stop. That's out of your control. They are an independent. They are their own bus. That's what being an independent means, right?

Jeff: Right.

Stan: Also, they don't turn in hours to you guys. They may want to have their invoice be on an hourly basis, but they don't actually have to give you the breakdown of the hours. They can just give you an invoice. Now that is kind of a gray area that you can request specific hours. You can request, just like if you're working at ... Bringing your car to the auto body shop and they tell you they worked on it 17 hours. You can ask for a breakdown of hours and you can ask for that. But as an independent, it's not up to them to give you the hours. It's not up to them to show you, on a daily basis, when they worked, when their lunch break was and when they finished. Am I right Jeff?

Jeff: Yes. And I think the two terms you're using is one of the things that would cause issues and it's if you're an employee, you're gonna turn in your hours to your employer. If you're a separate entity, an independent contractor, just as I would give you an invoice, I don't say, here's my hours, Stan. It's just that separate entity, and you want to establish that, that's the relationship. I don't report when they come to work.

Stan: One of the other things, they don't report the hours to me. They don't have to report the hours to them. Here's something else, as an independent, they need to carry their own insurance.

Jeff: Correct.

Stan: They really should be their own legal business entity. Whether that is a corporation, which is actually the best way to get an S corp., that's my advice.

Jeff: Definitely, mine as well.

Stan: Okay. So if you really want to have somebody that's coming in, you don't want to have any repercussions. They really should be their own S corp. They should also have their own EIN number. Right? Is that the right term?

Jeff: If they're going the route to be an S corp., they would have to get an EIN number.

Stan: EIN stands for what Jeff?

Jeff: Employer Identification Number.

Stan: Oh okay, you're gonna want to copy that. They carry their own insurance. That's a big thing, right? Because they're an independent, something happens to them, it's not on your guys' dime anymore. It's on their own dime and you're gonna want a copy of that insurance.

Jeff: Yeah, and you're gonna want to make sure you get the W-9 filled out, that you have their Fed ID [crosstalk 00:05:45]

Stan: Before you come on, anybody.

Jeff: And another thing with 1099s then, which is a good point, if you have LLCs or S Corps with Fed ID numbers, currently, and if the IRS doesn't change this, you don't even need to issue a 1099 to somebody who's using a Fed ID for their ID number. There are some exceptions, but in this [crosstalk 00:06:08] example, we have to. 

Stan: Okay, wait a minute. You just lost me Jeff. Say that again.

Jeff: If you have a subcontractor and it's Jeff Law, individual and I make over $600, which is the threshold for issuing a 1099, you have to file a 1099 with the IRS and send it to me. If I am Jeff Law Incorporated, using my EIN rather than my social, you don't have to issue me a 1099. 

Stan: That's huge.

Jeff: It cuts down on your reporting as well.

Stan: But is that nationwide Jeff?

Jeff: Yeah.

Stan: Okay, that's not just Minnesota.

Jeff: That's the current IRS rule. 

Stan: That's the current ...

Jeff: Like I said, there's some masters for attorney's fees and a couple of other things [crosstalk 00:06:55]

Stan: And all you guys in Australia and the United Kingdom, see all the crap you're avoiding right now? Half the time I wish that I lived in a different country, but God Bless America. It's just all this red tape and paperwork that they make us go through and all the hoops that they jump through.

Stan: Another thing with being an independent contractor versus being an employee would be they have to have their own tools. They can't use your tools. They can't use your skid loaders, unless they lease them, right? Can you do that lease thing where if they get on a ... Let's say you hire an independent to mow lawns for you. Can they lease your lawnmower from you or skid loader, or a truck?

Jeff: Yeah, and it just kind of tying it back again to the separate entity type thing. If I'm Jeff Law, Incorporated, I should have all my own equipment and not be just Jeff Law, the individual working for Stan, Stan Genadek one of your corporations.

Stan: So they should actually own the equipment, would be the clearest, [crosstalk 00:08:03] easiest possible.

Jeff: It's possible but then I mean if you don't own anything and you use all of the employer's stuff, it's gonna be a tough sell if you're ever questioned on that relationship whether it's contractor or employee. Sometimes you're not gonna have all the equipment ,so do you use some of it? It's just kind of when you abuse things, if I don't have anything myself, and say I'm gonna be a contractor. I'll only work for you and I'll only use your equipment. You're not gonna win that argument. You're more of an employee then.

Stan: Exactly. When they question you, they're not just going to question you. Okay? If you actually get brought in for an audit, or you get brought in for an investigation, it's not gonna happen quickly. It's going to take about a year to 18 months probably to complete, on average wouldn't you say Jeff?

Jeff: Yeah, some can go quicker but that's probably average.

Stan: Okay. So they'll start it, then you'll think, Oh, I don't know what's going on. Then they just keep going, and keep going. They will interview everyone and they will also pull all of your bank records. They will pull all of your documents. They will pull from every bank, every transaction you made. They will go through, analyze, and then they will contact each one of those people, and interview those people as well. This isn't something that just gets brushed under the rug. You want to make sure you're doing this the right way. That's why we're taking the time to record this interview, because I want to make sure you guys out there understand the implications of having a subcontractor or having an employee. Although you may perceive them as being one thing, if the IRS doesn't agree with you, guess what Jack? Guess what Joe? You guys just lost. There is no going back. It is what it is.

Stan: What other significant components of this 20 point checklist do you think we should bring up?

Jeff: Yeah, I mean I think we kind of touched on the main ones. I guess if you just read through instruction, training, we kind of talked about that if ...

Stan: Let's read through it. Number one is instructions. Two is training. Three is integration. Four is services rendered personally. Five is hiring, supervising and paying assistants. Six is continuing relationships. Seven is set hours of work. Eight is full time required. Nine is doing work on employer's premises. 10 is order or sequences set. 11 is oral or written reports. 12 is payment by hour, week, or month. 13 is payment of business and/or traveling expenses. 14 is furnishing tools and materials. 15 is significant investments. 16 is realization of profit or losses. 16 is an important one too, we should probably go back and hit on. 17 is working for more than one firm at a time.

Jeff: Yeah.

Stan: You're gonna always want to make sure that they're not just working solely for you cause if they are ... you're dead there. 18 is making services available to the general public. They shouldn't just work for you. 19 is right to discharge, and 20 is right to terminate. So those are ... Couple of things that stood out there was realization of profit or losses, and working for more than one firm at a time.

Jeff: Yep. And that is all kind of, again, if it's just Jeff Law, the individual, I know what I'm making. I'm making 10 bucks an hour, getting my check for that each week. If I'm Jeff Law Incorporated, I'm billing by the job. Then I have a realization of profits and losses. I have my own expenses, insurance, which we talked about, materials, tools, supplies, all those types of things. As opposed to being an employee, and your employer provides all of those things and I am making my [inaudible 00:12:07]. That's what that one's referring to. 

Stan: Okay, and one of the things that I want to point out is to you guys and gals out there right now, I want ... This isn't a reflection of Jeff, this is a reflection for you guys. If you're going to H & R Block, if you're going to one of the big generic law firms, where you are more of a number, then you are a name and a relationship established working continually, you're not going to have a person that you can call up, that knows your company's history that you can go, hey Jeff, I need this, this, and this done and expect to get results. 

Stan: I'm going to recommend to you to find an accounting firm that works with small businesses, that specializes in the type of work that you work with. Now a lot of them will tell you, oh yeah, I know this. I hear it all the time. But really what you need to do is you need to sit down and you as the employer, need to interview the accounting firm that you're working with. You need to make sure that that firm that you're working with, will be there year after year, because you plan on being in this business for the long term.

Jeff: Yep.

Stan: That's an important thing, then once you do that, they can also handle your payroll. Jeff handles all my payroll for me. He handles the quarterlies. He handles pretty much everything that I need to do. I'm hands off. As a business owner, I have to be familiar with the workings of everything, but I don't have to know all the rules and regulations. Guess what? That's his job. I leave that up to him. He knows all that stuff. But I'll tell you what, if I had to sit here and look at that all day long, I think I'd probably go a little crazy.

Jeff: Yeah, no, that's a good point. I liken it to me, I'm not real handy. If I was to try to repair my own deck or something like that, it would be a nightmare. That's what I see and there are some that can handle their own payroll, or certain pieces. I tell everybody when I do a pre-consultation, when everybody comes in at first, I kind of tell them what each little piece costs, whatever they're interested in. The payroll or quarterlies, or returns, just kind of what they're looking at and explain people can do any of those pieces or all themselves.

Jeff: But again, I think it goes back to me doing my own deck, if you don't have any experience or know what you're doing, I mean the information's online, you can try to read up on it, and follow what you're gonna do. It's exhausting, I mean people that are starting a new business, you remember when you were starting. You were not working 40 hour weeks as we touched on before, nor am I as a business owner. You work a lot. You don't have time to focus on stuff that's gonna take you a lot longer to do than just to pay somebody. I'm not saying to not look at your expenses either. Budgeting is another very important thing that I think people don't do that should be doing.

Stan: I want to bring up something that you mentioned Jeff. Don't hire your cheapest accountant. Okay? If you're gonna get by hiring your cheapest accountant, you're gonna pay more in taxes. They are worth their weight in gold. A good accountant will take a huge burden off your shoulders, Which allows you to do more work, which allows you to go out and pursue the things you're good at, whether you're a contractor, landscaper, business owner, doing whatever you do. When you stop worrying about the tax man, and you start worrying solely about optimizing your business, you will gain more profits, more freedom and you will grow. Okay? You gotta team up. I consider this a team effort. In fact, so much so, that Jeff brings me into the office and teaches me things that helps me run my business better. That's what we're doing here today. In part two, I got Jeff to agree to do a two part series with me. 

Stan: The second part, the next interview I do with Jeff, will be what I consider to be one of the most fundamentally important interviews on things you can do for tax planning, period, hands down, without question. That is pre-tax season planning. We're gonna go over strategies. What to do so you stop being a victim, and you start being in control. So look for the second part of this video series because I can guarantee you, to me, I can't give you any stronger advice, stronger opinion on any subject, than to make sure that you are prepared for the tax season. Look for that interview down the line in our series.

Jeff: Yeah, that's funny you mentioned it. I was thinking just how important the planning aspect of it is, and how people get ... So many people that I know that, especially when they're first starting out, don't do their records and file an extension and now you're trying to go back and recreate records from over a year ago. 

Stan: Right. 

Jeff: And it gets to be a burden, and once you get behind it's the old snowball effect. It's funny when people do get out of it. Yeah if you haven't filed for a little bit, you're gonna have to pay some money. I mean that's ... I won't be unrealistic with that and tell you otherwise, but it is a huge burden to get caught up. Yeah, don't ignore these things. Deal with them head on, and with a little planning, it really isn't that big of a deal. Like you said, once you've been gone for a while, you just kind of leave it here and you don't have to worry about too much of it. You just run your business, which is what you're supposed to do, run your business and make money doing what you do best.

Stan: Perfect. Jeff. Thank you.

Jeff: Thank you.