58 JOURNAL OF COURT REPORTING / APRIL 2001

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1 ?? 58 JOURNAL OF COURT REPORTING / APRIL 2001

2 B Y P E T E R W A C H T Independent contractor status remains a hot issue for freelance reporters. If you don t know and follow the requirements, an unpleasant experience with the IRS may result. Almost 90 percent of NCRA s freelance reporter members are independent contractors. Having such a large segment of the industry with that designation automatically puts the profession on the Internal Revenue Service s radar screen. When investigating a court reporting firm, the IRS is usually trying to answer one question: Are your independent contractors really independent contractors? Those firm owners who treat their reporters as employees often cite this as a primary reason why they moved away from independent contractor status to avoid the scrutiny of the IRS. But there are other reasons for doing so. Jason Meadors, RPR, of Fort Collins, Colo., chose this status for three reasons. Consistency, reliability and control, he says. With an employee, I can simply direct her to take a job as opposed to calling around and hoping that someone in the first tier of our subs is available. I take the title of independent contractor very seriously. I can only direct their activities along fairly narrow guidelines. With an employee, I can be sure that the work product is consistent with the firm guidelines in appearance, content and format. Of course, there are additional recordkeeping and withholding requirements. And employees may have the option of health and dental insurance, retirement programs and other benefits. Working as a freelance reporter also offers distinct advantages and disadvantages. I love the independence and freedom of being my own boss, says Debra Codiga of Sacramento, Calif. I joke about being permanently unemployable because I m spoiled after all these years of calling my own shots. Some additional benefits are getting a larger percentage of the per-page rate, more deductions for tax purposes, working with other firms if it gets slow, and potentially making larger investments in retirement programs for people who are self-employed than allowed with employee retirement programs. And the challenges? Paying for health insurance, reporting-related expenses and making estimated tax and Social Security payments. Obviously, how a freelance reporting firm chooses to treat its reporters is an individual decision. The most important aspect of this process is to ensure that independent contractors are actually being treated as independent contractors and that employees are being treated as employees. Otherwise, scrutiny from the IRS could lead to some unpleasant circumstances. Making a Judgment How does the IRS examine the legitimacy of independent contractor status? IRS Publication 15A, Employer s Supplemental Tax Guide, states that public stenographers are generally not employees. Still, determining whether a court reporter is an employee or independent contractor depends on the facts of each individual case. Generally, a court reporter is considered an independent contractor if the payer has the right to control or direct only the result of the work and not the means or methods of accomplishing the result. (Under the common-law rules followed by the IRS, anyone who About the Author Pete Wacht is Editor of the JCR. JOURNAL OF COURT REPORTING / APRIL

3 performs services for you is your employee if you can control what will be done and how it will be done.) It doesn t matter how the relationship is labeled, even if it s set out in an independent contractor agreement. (See the sidebar on page 64.) The substance of the relationship, not the label, governs the worker s status. The factors that will determine the degree of control and independence fall into three categories: Behavioral control. Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of: Instructions the business gives the worker. An employee is generally subject to the business s instructions about when, where and how to work. Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods. Financial control. Facts that show whether the business has a right to control the business aspects of the worker s job include: The extent to which the worker has unreimbursed expenses. Independent contractors are more likely to have unreimbursed expenses than employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. The extent of the worker s investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. For the court reporter, that would include his or her steno machine, CAT/realtime software and other necessary equipment. The extent to which the worker makes services available to the relevant market. If a reporter only works for one freelance agency, and will not accept work from any other firm, then that reporter may be considered an employee. How the business pays the worker. An independent contractor is usually paid by the job, as is the case for most freelance reporters. The extent to which the worker can realize a profit or incur a loss. An independent contractor can make a profit or loss. Type of relationship. Facts that show the parties type of relationship include: Written contracts describing the relationship the parties intended to create. This one factor demonstrates why it s critical for freelance agencies and reporters to base their relationship on a written independent contractor agreement. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan or vacation and sick pay. The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employeremployee relationship. The extent to which services performed by the worker are a key aspect of the regular business of the company. If the worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. The IRS often uses a 20-factor test (see the sidebar on page 61) as an analytical tool to make an initial determination of the working relationship. However, as tax attorney James Urquhart points out in his book The IRS, Independent Contractors and You, there are more than 50 other common-law factors that can go into this determination. For example, some additional considerations that suggest independent contractor status include demonstrating that: You are engaged in a distinct trade, occupation, profession or business (which can be accomplished with letterhead and business cards); You have the required licenses, permits or certificates to do business; You do business as a corporation; You hire help to complete your work, such as a scopist; You supply all the tools necessary to work as a court reporter; and You have many sources of income. Some of the additional factors that suggest employee status include having noncompetition clauses in your working agreements or you receive free training from a freelance agency. Protections Available Nevertheless, Section 530 of the tax code, as amended by the Small Business Job Protection Act of 1996, does offer some relief from federal employment taxes if certain requirements are met. In a November 1999 IRS memorandum, Chief Counsel Advice for Worker Classification, it was pointed out that the first step in any case involving whether a business is liable for employment taxes on the compensation paid to particular workers is to determine whether the business meets the requirements for section 530 relief. If so, the business will not be liable for employment taxes on the compensation paid to the workers, even if they are its employees under the common law standard. IRS Publication 1976 states that to receive relief under the section 530 safe-harbor provision, you must meet the following three requirements: Reasonable basis. To establish that you had a reasonable basis for not treating workers as employees, you can show that: You reasonably relied on a court case about federal taxes or a ruling issued by the IRS, or Your business was audited by the IRS at a time when you treated similar workers as independent contractors, and the IRS did not reclassify those workers as employees, or You treated the workers as independent contractors because you knew that was the long-standing practice of how a significant segment of your industry treated similar workers, or You relied on some other reasonable basis. For example, you relied on the advice of a business lawyer or ac- 60 JOURNAL OF COURT REPORTING / APRIL 2001

4 Do You Know the Difference Between an Independent Contractor and an Employee? To help determine whether sufficient control is present to establish an employer-employee relationship, here is the 20-question checklist commonly used by the IRS as an analytical tool. Answering yes represents a common aspect of the employer-employee relationship. Answering no represents a common factor when dealing with an independent contractor. Not every factor applies to every situation, and the degree of importance of each factor varies depending on the type of work and individual circumstances. Yes No 1. Does the worker have to comply with instructions about when, where and how the work results are achieved? Yes No 2. Has the employer trained the worker to perform services in a particular manner? Yes No 3. Has the employer integrated the worker s services into the business operations because they contribute to the success or continuation of the business? Yes No 4. Does the worker render few if any services personally? Yes No 5. Does the worker have authority to hire, supervise and pay assistants? Yes No 6. Does the employee have a continuing relationship with an employer? Yes No 7. Does the worker have set hours of work established by the employer? Yes No 8. Does the employee have to work or be available full time? Yes No 9. Does the worker work on the premises of an employer, or work on a route or at a location designated by an employer? Yes No 10. Does the worker have to perform services in the order or sequence set by an employer? Yes No 11. Does the worker have to submit reports to an employer? Yes No 12. Is the worker paid by the hour, week or month? Yes No 13. Does the employer pay for the worker s business and travel expenses? Yes No 14. Does the employer furnish the worker with significant tools, materials and other equipment? Yes No 15. Does the worker have little or no investment in the facilities he or she uses in providing services for someone else? Yes No 16. Does the worker have no stake in the profit or loss of an employer? Yes No 17. Does the worker work for only one person or firm? Yes No 18. Does the worker only make his or her services available to one employer? Yes No 19. Can the employer fire the worker? Yes No 20. Can the worker quit his or her job at any time without incurring liability? countant who knew the facts about your industry. Long-standing is defined by the IRS as a practice that has existed for 10 or more years. When defining significant segment in the past, there was no set standard. However, that changed with the 1996 Small Business Job Protection Act. The firm now only has to demonstrate that 25 percent of the industry uses independent contractors. Based on NCRA s latest membership survey, 87 percent of freelance reporters are independent contractors, and only 13 percent are treated as employees. The Conference Agreement on section 530 of the 1978 Revenue Act explains Congress s intention with respect to the reasonable basis guideline: Generally, the bill grants relief if a taxpayer had any reasonable basis for treating workers as other than employees. The committee intends that this reasonable basis requirement be construed liberally in favor of taxpayers. Substantive consistency. You must have treated the workers, and any similar workers, as independent contractors. Reporting consistency. You must have filed Form 1099-MISC for each worker, unless the worker earned less than $600. A key point to remember is that this requirement applies only to the period under investigation. The IRS will determine whether the workers are independent contractors or employees if you do not meet these relief requirements. If the IRS decides that the reporters are actually employees, then the firm may be held liable for employment taxes for those workers. Why is the section 530 safe haven such a potentially useful tool? Because in most general tax cases, the taxpayer is required to demonstrate innocence. Before the Small Business Job Protection Act, a reporting firm had to show that it had a reasonable basis for treating reporters as independent contractors. Now, if you can establish a prima facie case that it was reasonable not to Continued on page 64 JOURNAL OF COURT REPORTING / APRIL

5 Independent Contractor Agreements The primary purpose of a written contract between a reporter and an agency is to define the relationship between the two so that the parties know where they stand. This also proves critical from the standpoint of having to deal with the Internal Revenue Service if there is a dispute as to whether the reporters working for a freelance agency should be classified as independent contractors or employees. The March 1998 JCR article What Independent Contractor Agreements Should Cover touched on several common contract clauses. Following are those that have clear applicability to this issue. Keep in mind, however, that the IRS training document Independent Contractor or Employee? states, A contractual designation, in and of itself, is not sufficient evidence for determining worker status. The facts and circumstances under which a worker performs services are determinative of the worker s status. Working relationship. One of the primary purposes of the contract is to clarify that this is in fact an independent contractor relationship. For example, the agency will not provide office space, equipment or supplies; withhold taxes; or in specific ways direct or supervise the reporter s work. Work volume/method. The reporter has the discretion to produce a transcript where and when he or she chooses. Conversely, the agency does not guarantee the reporter a certain amount of work each week or month. Freedom to refuse. As an independent contractor, the reporter can turn down work requested by the agency. Noncompetition. If a reporter works strictly for one firm, and the contract says the reporter must give preference to the firm, the IRS may question the individual s status as an independent contractor. Equipment/transportation. Independent contractors are usually responsible for furnishing their own equipment and transportation. Business expenses. Except for a few small items such as transcript covers, independent contractors usually pay for their own supplies and equipment and other expenses. This would include hiring scopists or proofreaders. Taxes. The contract should note if, as is likely, the contractor is responsible for all taxes, and that the firm will not withhold any taxes or other fees from the reporter s compensation. Liability. Who is liable for the services performed? If it s a true independent contractor relationship, probably the reporter. Contract termination. Making this an at-will decision makes it appear to be an employee relationship. Termination should be allowed for cause with a written notice requirement. treat the individual as an employee and you cooperate fully with reasonable requests from the examiner, the burden of proof is shifted to the IRS. What About Officials? How do the independent contractor regulations affect official reporters? Almost all official reporters are employees of the courts, which means they are eligible for all the benefits offered by the court system or government and they have taxes withheld. The independent contractor regulations apply with respect to transcript income. In Lisanti, et al. v. Administrative Office of the U.S. Courts, et al., the Seventh Circuit Court of Appeals recognized the two types of income official reporters receive: They are paid an annual salary which is set from time to time by the Judicial Conference of the United States... and they also may charge and collect fees for transcripts requested by the parties... at rates prescribed by the court subject to the approval of the Judicial Conference. The court stated quite clearly that The government considers court reporters to be independent contractors, as opposed to employees, while they are preparing transcripts. This was confirmed in a January 1999 Private Letter Ruling by the IRS regarding a district court reporter and the worker s federal employment tax status with respect to the services performed in selling transcripts. And, in fact, the basis for the ruling goes all the way back to a 1958 ruling on the same issue, which concluded that fees received by federal court reporters from the preparation and sale of official transcripts represent income from a trade or business, such activity being aside from their basic duties for which they receive a statutory wage. Such additional income is includible in computing net earnings from selfemployment for purposes of the tax on self-employment. Therefore, the worker is not the firm s [court s] employee with respect to the services he performs in selling transcripts. 64 JOURNAL OF COURT REPORTING / APRIL 2001