A topic that gets beat to death is what I figured I’d hit it again for the heck of it. Seriously though, I’m seeing this topic more frequently lately. So instead of re-publishing one of our older employees vs. independent (EE vs. IC) blogs, I’d write another more current one.
As new doctors enter the dental world, they hear about this independent contractor situation for the first time and try to figure it out. I could shine a light on it for their benefit.
When the issue pops up on the Dentaltown forums board, I see some of the same comments we always see. Words like; “ICs are illegal,” “an associate can’t be an IC,” “employers are just trying to save payroll taxes and benefits,” and so on. Because the topic gets beat to death, I tend not to comment anymore; however, maybe a blog now and then is just what the topic needs.
Let me address the comment “ICs are illegal” first. That’s false! If ICs were illegal, there wouldn’t be tax code sections dealing with them or various forms the IRS wants companies to use to report payments to them, etc. Being an IC is entirely legal (Yes, the IRS even has a Form (SS-8) completed by the business or the worker providing services for the industry to determine the worker’s status). However, negative comments are established when employers try to identify an employee as an IC. While it isn’t illegal to attempt to misclassify an employee without a reasonable basis, it is wrong. Employers can be held liable (without the opportunity for relief) for payroll taxes, penalties, and interest if they get caught. In my opinion, that is NOT the same as “illegal.” Employers will not be charged with a crime, there are no court hearings, and there’s no jail time; it’s just a mistake that can cost you some money. In my opinion, using terms like “illegal” is simply an exaggeration.
Next, let’s address the notion that “an associate can’t be an IC.” Newsflash, this is also an incorrect statement. I agree that associates are often misclassified as ICs when they should be employees. We certainly advise our clients (employers) on how they should address the issue depending on the facts and circumstances, which will drive the determination of IC vs. EE. There are times an IC is a correct classification, and we will advise the client accordingly as their facts and circumstances exist that will allow them to defend a challenge from the feds or a state regarding misclassifications. No doubt some employers are misinformed or ill-advised and will take advantage to save some money. Those employers are few and far between, at least in our client base.
Speaking of saving money, let’s address the comment “employers are only trying to save payroll taxes and benefits” when they classify someone as an IC. Well, there’s some truth to that. However, I’m confident some employers have yet to be caught with misclassification issues and continue to roll the dice. Some do it for the savings, others do it out of habit, and some do it because it’s easier to pay someone as an IC vs. EE. Does that make it right? Of course not. Lastly, let me address some of the benefits of being paid as an IC from an income tax perspective. It goes hand-in-hand with the IC discussion, and some new doctors wonder why an IC MIGHT be better than paid as an EE.
First and foremost, any employee who incurs and pays their professional expenses like; malpractice insurance, CE, dues, licenses, business travel, business meals, business use of the automobile, business tools, supplies, and equipment, business use of a mobile phone, and so on, cannot take a tax deduction for those expenses. In some cases, this can add up to a LOT of money. Whereas someone paid as an IC can take a dollar-for-dollar tax deduction for every one of these items against their IC income. That can be a HUGE income tax AND payroll tax (also known as self-employment tax or SE tax, for the IC) savings for the IC.
Employees will have half of their payroll tax (or SE tax for an IC) paid by the employer. Some supporters of EEs over ICs tout this as the main reason an associate should select EE over IC classification. It is undoubtedly a benefit; however, the employee (or IC) needs to know that the SE tax would apply to an ICs NET income, NOT gross IC income. Therefore, if someone is going to “run the numbers” on EE vs. IC, they need to account for this.
Proponents of employees over IC will also tout employer benefits that an IC would benefit. That’s true; however, the employer will often pay two to three percentage points more if paying an associate as an IC vs. EE to help compensate for those lost benefits AND the extra SE tax. Also, ICs CAN deduct their health insurance for themselves and their family, which may also negate an employer benefit like health insurance.
ICs will also have the option of implementing their retirement plan and enabling them to shelter much more of their taxable income compared to an employer’s 401k\PS plan. Generally, an IC will have to make a lot of money as an IC to warrant this; however, it can be a HUGE benefit.
Suppose the IC is genuinely an aggressive taxpayer. In that case, they may be able to justify placing family members on their payroll and taking advantage of many other “fringe” benefits from which business owners would benefit.
Then there’s the ability as an IC to create a Scorp and possibly reduce their SE tax even further through Scorp profits\distributions. Though many associates do it properly, the IC still must jump through the proper hoops to be classified as an IC. My advice, if presented with the option of being paid as an EE or an IC, is to consult with a knowledgeable CPA to help guide you through the various hurdles you might face when making the decision. I suspect most will want to get paid as an EE as they likely won’t qualify as an IC, however, do NOT assume that’s always the case.