Contractor vs. Employee

Hoping for some guidance. I recently came across this issue. I'm not sure where to start from a research perspective.

Say you're viewing this issue from an employer's perspective. An employee approaches you and requests to paid as a contractor. What are the risks as an employer for agreeing to this arrangement?

If both parties agree the relationship, is there any issue with this arrangement being reported as contractor vs. employee?

I was thinking if relationship soured, the "employee" could say they were an employee all along. Is there any recourse for the employer in this circumstance?

The fact that there is an agreement to treat an employee as an independent contractor is immaterial. All independent contractors effectively have an agreement to be so treated. So that is not a persuasive defense.

The tax issue is common. And as a practical matter it almost always ends up with finding an employment relationship.

This problem can easily get magnified. For example, it is common for dancers at strip clubs to refuse to work other than as independent contractors. In many cases they pay to work. Some sue for back wages when they retire. These suits are class actions because the fees are so much higher. The plaintiff almost invariably wins and the judgment can be enough to put the club out of business.
https://news.bloomberglaw.com/daily-lab ... omys-norms

The "solution" to the class action problem is to put an arbitration clause in the contract.

Gator, appreciate the response.

In this case, my chief concern is with the IRS. Will the contractor relationship be respected by the IRS if both parties agreed to, and continue to agree to, the contractor relationship?

In this case, my chief concern is with the IRS. Will the contractor relationship be respected by the IRS if both parties agreed to, and continue to agree to, the contractor relationship?

No.
Gator provides some important context for you (and your client) to be mindful of. Quantifying the tax consequence is often a small part of the "puzzle".

I explain this to clients by saying: "You and I can have a contract or other written agreement that the sky is red or purple or green, but if the sky is blue; the sky is blue. Our agreement/contract won't affect the color of the sky."

Capt I understand what you're saying.

It seems odd to me that the IRS wouldn't respect the arrangement given the two parties are not related and have both agreed to terms.

Gotta also watch out for your state unemployment tax. They likely won't honor it either, because then they don't get the tax. Also be mindful of worker's comp insurance ramifications as well.

If both parties agree the relationship, is there any issue with this arrangement being reported as contractor vs. employee?

As was mentioned earlier, an agreement that the sky is green does not change the facts.
If the parties don't want the relationship to be that of ER/EE, then the way to do that is for the employer to stop behaving like an employer, and the worker to start behaving like an independent person running his own business.

Capt I understand what you're saying.

It seems odd to me that the IRS wouldn't respect the arrangement given the two parties are not related and have both agreed to terms.

With all due respect, it doesn't appear you do understand.

I understand the "sky is blue" analogy. The facts dictate the treatment.

The unemployment aspect was not something I had considered.

In the particular case I'm looking at, the payor would pay the "contractor" (unrelated 100% owned S corp) with the S corp paying wages to its sole shareholder. For payroll tax purposes, the arrangement would be similar to the shareholder being employed by payor. The S corp wants to retain its employee benefits.

So how much and what kind of benefits are we talking about?
Given the current labor shortage, why doesn't employee negotiate with employer for better benefits and/or a raise?

And what kind of annual salary/1099 income is in play? Is it even worth all the extra S Corp compliance costs?

Although I agree with everyone else, calling an employee/employer relationship an independent contractor relationship doesn't make it so.

I don't prepare the S corp, but based on the amounts discussed I believe it's a solo 401k. I'm also under the impression the shareholder is looking to pay W2 wages less than the gross payment the S corp would receive.

There are something like 15 or 20 factors the IRS looks at to make an employee vs independent contractor determination.

It's a facts and circumstances, substance over form analysis.

Then you have state law wrinkles, like the California ABC test.

Unless the corporation is disregarded as a sham, payments to an S corporation are not payments to an employee.

In my youth, I was a PAYE Auditor in the UK. I loved status disputes. (Good points for my performance appraisal.)

Anyway, what happened between Friday night and Monday morning, in practical terms? Is the sky still blue or did something concrete change that turned the sky green? Food for thought: https://www.irs.gov/government-entities ... 530-relief

Form SS-8, but you have to know the answers to get them right.

Gator, this sounds significant:

Unless the corporation is disregarded as a sham, payments to an S corporation are not payments to an employee.

I'm struggling to determine exactly what you mean. Are you saying that because the payments are made to an S corp there is no reclassification risk?

I think you left out something like:
Individual employee goes to his employer and says:
I want to be an independent contractor. I formed an S Corp. Why don't you pay my S Corp for what I do instead of paying me?

My apologies -- I didn't know the S corp would be an important factor. I'm very inexperienced with employment related issues.

Again...substance over form.

How many of us have seen employees become contractors (after discussion with their employer), and then form an S Corp, but they only have one "client" -- the "former" employer -- and the "client" continues to exercise a great deal of control over the "contractor".

I didn't take gator's post to mean that an S Corp automatically rebuts the employee treatment, I took it to mean you have to apply the standard analysis to determine if the S Corp is a sham and the individual is really an employee of the company that is contracting him or her. Maybe I'm speaking out of turn, and he can chastise me if so, but I don't view his post as significant and changing the course of this thread. We're speaking in circles at this point.

The IRS is much more likely to kick out somebody claiming their Sch C (or 'other income' line on the 1040 for real idiots) makes them a 1099 contractor instead of an employee than somebody who has a C or S corp that gets paid. They may still declare the corp to be a sham and declare the contractor to be an employee, but simply having an operating corp and the associated taxes/business license/etc will tick a lot of the facts & circumstances boxes.

I believe in CA they might still claim that somebody is an employee despite the checks going to a corp though. The ABC law is weird and far-reaching.