By: Alan H. Morgan, CPL (713)

Transcription

1 By: Alan H. Morgan, CPL (713)

2 The independent contractor status of land professionals has been challenged by the Internal Revenue Service and state employment agencies for many years.

3 The IRS and state agencies rarely are successful in their audits of independent landmen when both the independent landman and their payor have recognized the tests that have been applied by those agencies and have satisfied the requirements which determine an independent landman s independent contractor status.

4 Who are independent contractors? Independent contractors are workers who are engaged in their own independent enterprise.

5 Why do the IRS and state agencies care about the independent contractor status of independent landmen? The General Accounting Office has determined that independent contractors generally under report income and over report expenses.

6 In addition, the IRS has found that independent contractors generally do no make proper quarterly payments of withholding and FICA, depriving the government of the use of those funds. The IRS has also found that it is easier to go after the payors and try to reclassify independent contractors as employees, thereby forcing payors to begin the withholding of income taxes and FICA, than it is to go after independent contractors and make them pay the taxes they owe.

7 It is also important to note that once an independent contractor has been reclassified as an employee, the IRS can disallow those expenses previously taken by the independent contractor leaving the independent contractor subject to additional taxes, interest and penalties.

8 How do most audits arise? Most audits conducted by the IRS or state agency occur when an independent contractor files a claim for unemployment compensation benefits with the appropriate state agency and that agency finds that the payor has paid no withholding tax on that particular worker

9 As a result, the state agency comes to audit the payor and wants to determine why the worker was treated as an independent contractor rather than an employee. Other common audit situations arise through random selection by the IRS or state agency, a disgruntled former worker reporting a payor to the IRS or state agency, workers compensation audit or an overtime audit.

10 The IRS or state agency applies a Common Law 20 Point Factor Test to determine whether a worker is an employee or an independent contractor. The 20 Point Common Law Test is designed to show whether the payor has the right to control and direct the worker not only as to the result to be accomplished but also as to the details and means by which that result is to be accomplished.

11 The issue of whether the payor has the right to control and direct a workers result is the most important factor that the IRS and state agency use in determining the independent contractor status of a worker.

12 It is very difficult to satisfy all 20 factors to determine the independent contractor status. Each factor will be analyzed. It is important to note that factors one through ten generally carry more weight than others and that it will be impossible for an independent landman to satisfy all 20 points. The 20 Point Common Law Factors are as follows:

13 Instructions: If the worker must follow instructions on when, where and how to perform his (used herein in a generic connotation) work, then this is evidence of control which is indicative of employee status.

14 Services rendered personally: A worker who is personally required to render services has the appearance of employee status. The ability to assign or delegate the work by the worker is important. Continuing Relationship: A continuing relationship between the worker and the employer is evidence of employee status. Both regularity and the duration of the relationship are taken into consideration.

15 Doing work on payors premises: Use of the service recipient s premises and office equipment may constitute evidence of control and employee status. Evidence of payment: The fact that a worker is being paid at regular intervals is evidence of control and employee status.

16 Significant Investment: If a worker does not invest in the facilities and/or equipment used in the performance of services, this is evidence of employee status. Realization of profit or loss: If a worker is compensated at a fixed rate for this service, regardless of the profitability of the operation, this is evidence of employee status.

17 Working for more than one firm at a time: When a worker performs services for no more than one firm at a time, this is evidence of employee status. Right to discharge: A worker who can be discharged at any time is usually perceived to be an employee. An independent contractor generally can be discharged only for failure to comply with the terms of his contract.

18 Training: The more training a worker receives from the employer, the more likely that the worker is an employee. Hiring, supervising and paying assistants: If a payor hires, supervises and pays a worker s assistants, then this is evidence of employee status.

19 Set hours of work: If a worker is required to perform services during set hours, this is evidence of control and employee status. Full time required: If the worker is required to devote full time efforts to the employer, this is evidence of control and employee status.

20 Order of sequence set: If a worker is required to perform tasks in a set way and to follow set routines and schedules, this is evidence of employee status Oral or written reports: A requirement that the worker submit regular reports to the employer is evidence of employee status.

21 Payment of business and/or traveling expenses: If a worker s expenses are paid or reimbursed by the payor, this is evidence of employee status. Furnishing of tools and materials: A worker who is furnished tools and materials is typically controlled by the payor, which is evidence of employee status.

22 Making services available to the general public: If services are not offered to the general public, this is indicative of employee status. Right to terminate: A worker who may terminate his relationship with the payor at any time evidences employee status.

23 There is a second criterion that the IRS can use to determine the independent contractor status of independent landmen. Section 530, the Safe Harbor provision, of the Revenue Act of 1978 allows payors to treat workers as independent contractors regardless of the common law test.

24 To obtain the benefits of Section 530 a payor must meet a three part test:

25 A payor must meet all filing requirements: A payor must issue 1099 s to the worker claimed as an independent contractor and at no time given the worker a W 2, withheld from the worker s compensation, paid FICA or FUTA on the worker and/or filed a Form 940, 941 with the worker s name on it.

26 Consistent treatment: Payor must consistently treat all workers in the class in question as independent contractors. A payor should not change the status of an independent contract to employee and back again. For example, it is advisable to treat all field landmen as independent contracts or as employees, but not some field landmen as independent contractors and others as employees.

27 Reasonable basis test: The payor must have reasonable basis for treating the worker as an independent contractor. Case law, IRS rulings, Technical Advice Memorandum, Private Letter Ruling issued to the payor and/or prior state audit on independent contractor or employee issue are reasonable basis for treating a worker as an independent contractor.

28 In addition, the IRS will consider a long standing practice in a significant segment of the industry as a reasonable basis for treating a worker as an independent contractor. The proof needed to substantiate a long standing practice in the industry can be affidavits from industry leaders, a study conducted by a recognized accounting firm and/or letter from the executive director of your professional association.

29 AAPL has recognized and is addressing the independent contractor issue as it pertains to landmen. AAPL has done several things that should help provide landmen protection of Section 530 of the Revenue Act of 1978.

30 AAPL has passed legislation in Texas, New Mexico, Oklahoma, Louisiana, Colorado, Montana, and North Dakota amending the states respective Unemployment Compensation Acts to exclude independent contract landmen.

31 AAPL was responsible for a 1994 survey of AAPL s membership, conducted by KMPG Peat Marwich, which recognizes the long standing industry practice of treating independent contract landmen as independent contractors.

32 If you come under audit by the IRS or state agency it is critical that you seek expert assistance from a qualified attorney and/or accountant.

33 The AAPL is not able to provide any legal or accounting assistance to its membership. AAPL can make available, to its members, a copy of the 1994 KMPG Peat Marwick Survey and a letter or affidavit from Executive Vice President Martin Schardt, CPL which substantiates the long standing industry practice of treating independent contract landmen as independent contractors.

34 It should also be pointed out that if a state that you are doing business in recognized the independent contractor status of independent contract landmen through the passage of legislation, this to should be a reasonable basis for treating and independent landman as an independent contractor.

35 There are several things that you can do to reduce your risk of having your independent landmen reclassified as an employee by the IRS or state agency. They are as follows:

36 The independent landman can incorporate or setup a trust or partnership and obtain a Federal Tax Identification Number. If this is impractical, the independent landman could file an assumed name at the county courthouse and then seek a Federal Tax Identification Number.

37 Have a written contract with each independent contractor. It is important to use a well written contract. Some contracts offer little protection and are clearly employment contracts, not a contract for and independent contractor. AAPL offers its Contract for Land Related Services through its Fort Worth office. Payors should always issue 1099 s to its independent contractors.

38 Independent landmen should always have their own letterhead, stationary and business cards with their name stated and not the payors. A state auditor stated that he usually walks right back out the front door if the independent contractor has business cards, stationary and a written contract with the payor.

39 An independent contractor should advertise his services. This can be accomplished many ways through Yellow Pages, Landman Magazine, AAPL Membership Directory or local association directory or newsletter. An independent landman should work for two or more different payors over the course of a year, receiving more than one 1099 at the end of the year.

40 An independent landman should have his own office, either inside his home or out. If the independent landman has an office on the payor s premises, he should pay rent for the office, furniture and equipment and be billed for all the services he uses.

41 Payor should try to pay by the completion of a task, do not pay by the hour or month. Payor should not provide any benefits to the independent landman such as sick leave or paid vacation.

42 Payor should not provide detailed instructions, establish work hours, routine or schedule and require regular reports, call ins, etc.

43 The independent contract issue is impacting many professions in and out of the oil and gas industry. Arbitrary enforcement of the issue by the IRS and/or state agencies can have an impact on the way we traditionally conduct our business in the oil and gas industry.