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Columns by June Walker: IPs Face Unique Tax Challenges Tax Deductions Are There For The Taking You Say You're Self-Employed -- Will the IRS? Criteria for Self-Employment Do You Have a Business or a Hobby? Proving That You're a Business Keeping Records -- It's Not Just for Taxes Three Ways to Expand Your Business Deductions Can I Deduct Disneyland and Other Questions Mixing Business with Pleasure and Other Gray Areas Quicken for IPs Courses That Qualify Training You Can't Deduct Getting There is Half the Battle Taking Deductions on the Road Getting Credit and Taking Allowances Advertising: Do It, Then Deduct It The Subtle Art of Advertising Deductions Billy Bridesnapper's Start-up Saga Starting Up and Shutting Down Start-Up Wrap-Up Giving Gifts, Taking Deductions

Criteria for Self-Employment Are you really self-employed, or are you an employee? In my previous column I showed how to distinguish W-2 income from self-employment income, while pointing out that the method by which one is paid does not determine whether or not one is self-employed. What, then, does determine your legal status for tax purposes? To claim that a worker is "self-employed" may be to the advantage of the person or firm doing the hiring, and perhaps the person hired as well. Often, then, the issue is complicated by an attempt to make things look other than they are. As a result, the criteria for independent contractors get stretched or squeezed. For example, when a one-person business grows enough to require additional help, the boss is often reluctant to get involved with the payroll, withholding taxes, insurance, and pension requirements of hiring "employees," so instead he hires "independent contractors" to help out. In fact some companies will have the worker sign a contract that labels the worker as "self-employed." When the IRS goes looking for tax money that is slipping between the cracks, it reclassifies many of these "independents" as employees. In a recent case of this type, the employer was no "mom and pop" shop. The IRS ruled that thousands of people working at Microsoft had been wrongly classified as independent contractors. They worked the same hours as other workers who were designated as employees, performed the same functions, and reported to the same supervisors. As far as the IRS was concerned, they were employees -- despite the words written in their contracts -- because Microsoft controlled the "manner and means" of their work. The consequences of misclassification can be severe. If the IRS retroactively reclassifies "independent contractors" as "employees," back payroll taxes and penalties can hit the employer hard. And the newly classified employee may lose many of his deductions -- or, if the deductions are still applicable to his new employee status, they must be moved from the self-employed section of his tax return to the employee section. In that case, their tax-reduction value is greatly reduced. The questions that the IRS raises about self-employment underscore this point: if you claim to be self-employed, you must be able to prove it. Typically the IRS will look at 20 different factors to determine whether you're an employee or an independent contractor. Some people erroneously advise that you must meet all 20. This is wrong. No single factor rules, and both the nature of your business as well as standard practice in your profession are taken into account. The 20 factors that the IRS uses to determine if someone is truly self-employed boil down to the following four areas: 1. Autonomy vs. Control You may be self-employed if no one tells you when, where, or how to perform your services or make your product. Examples: You log into your client's computer from your home office. You pick up material at your client's house to work on at your shop. You throw pottery in your garage-cum-studio when the spirit moves you. Your project is finished when it meets your standard of perfection. 2. Investment in the Business You may be self-employed if you provide yourself with the training, tools, and equipment to do the job. Examples: You own your computer and all the equipment in your office. You have developed your skill as a public relations consultant and amassed contact database to be envied -- and perhaps sold. You've created recipes and bake your own cakes, which you distribute to local stores in your own van. 3. Who Takes the Financial Risk You may be self-employed if you are paid by the project or product rather than by the hour, week, or month, and can increase your profit by working more efficiently. Examples: You don't get paid if you don't meet the deadline or contract requirements. You mortgaged your house in order to develop and promote the computer game you just invented. If it flies, so do you. If it dies, you're back at the 9-5 job. 4. To Whom Do You Sell You may be self-employed if your product or service is available to a number of customers. Examples: You hand out your business cards to every Jane, Joan, and Jeanie you meet. It doesn't matter to you who buys your pottery (as long as they love it). You'll sell your cakes to the store that pays you the most. You'll do public relations for anybody but the NRA. Whether a worker is an employee or self-employed depends primarily on the extent to which the individual or company receiving the service or product has the right to direct and control what the worker does and how he does it. The greater the degree of control your "client" has over you, the more likely it is that the "client" is really an "employer," and that you are really an "employee." Real independent contractors determine for themselves how the work is to be performed. Even if you prove that you're self-employed according to the criteria discussed in this column, you're still only halfway through the IRS independent contractor maze. In order to treat yourself as self-employed on your tax return, you must still show the IRS that you're running a business, not a hobby. The next installment of this column will show you how. (c) 2000 June Walker. All rights reserved. We'd love to hear your feedback about this column, or put you in touch with June Walker if you like. You may also like to see her biography.