Business Management

Are You Sure Your Independent Contractors Really Are?

Expertise: Real Estate Investing Basics, Real Estate News & Commentary, Flipping Houses, Mortgages & Creative Financing
35 Articles Written

As a real estate investor — and especially if you're a house flipper — you will no-doubt be hiring a lot of independent contractors to support your business. And I'm not just talking about the people who will be working on your houses; your real estate agent, your attorney, your CPA, and most of the other people who support your business day-to-day will be independent contractors (ICs) as well.

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While it may be clear in your mind that these people are ICs and not employees, it’s very important that the IRS agrees with you. If the IRS determines that the people who are doing work for you are employees, it could end up costing you dearly. Not just in terms of extra tax payments — which would amount to about 15% of the total amount paid in wages plus responsibility for unemployment wages — but also in terms of risk to your business.

For example, if a roofer working on one of your properties falls off the roof, as an IC he is responsible for his own medical costs; but, if the courts determine that he was actually an employee at the time of the fall, you might be responsible for paying his medical costs, disability and even potentially death benefits to his family!

So, what can you do ensure that the IRS and the courts also recognize your workers as ICs and not employees? Keep in mind that the IRS and the courts will use a number of different criteria to subjectively make the determination, so your job is to ensure that you do as many of these things as possible for your independent contractors:

  • Independent Contractor Agreements: First and foremost, make sure you have a contract that specifically calls out the independent contractor relationship you have with your contractor. If you plan to hire a lot of ICs, it's probably worth the time and cost of getting a contract attorney to create a sample agreement that you can use for all your projects and all your contractors. In fact, I've written a couple previous posts on contracts and independent contractor agreements — feel free to check them out.
  • Separate Entity: Encourage your ICs to set up a separate corporate entity under which they do business. If they have their own LLC or corporation under which they provide services, they are less likely to look like your employees to the IRS.
  • Invoices: Have your ICs invoice you at regular intervals, from their corporate entity. Being able to show invoices to the IRS will support your claims that the workers are ICs and not employees.
  • Sub-Contractors: Independent contractors are allowed to hire out the work you contract them to do. If you specifically state that your contractors must do the work themselves, you are likely to be viewed as their employer. Your ICs can hire subs, bring in additional labor, etc.
  • Work for Others: If possible, ensure that your ICs do contracting work for someone (or better yet, many someones) other than yourself. If a worker receives 100% of their income from you, they are more likely to be classified as one of your employees by the IRS.
  • Tools: Ensure that your contractors provide all their own tools for the job. If you provide the tools (or other materials, for that matter), the IRS will be more likely to look upon you as an employer.
  • Instructions: Employees are required to adhere to instructions about how, when and where to work; independent contractors are not. If you tell your workers how to do their job and when to do their job (i.e, you require them to work 8am – 4pm daily), they may be classified as employees.
  • Right to Fire: Make sure that if you “fire” an IC, you do so for a reason that has clearly violated your Independent Contractor Agreement. You can fire an employee for any reason, but you can only fire an IC based on contractual obligations and responsibilities.
  • Training: Never provide any type of training for your ICs. While employees are permitted to receive training from an employer, if you provide training to your ICs, they will look like employees to the IRS.

This is just a sampling of the criteria that the IRS and the courts will use to determine if your workers are employees or independent contractors. For more information, check out the IRS documents that address this issue specifically.

And remember, determination of employee vs IC can be subjective, so while you may not have to follow all the rules to get the classification you want, it’s in your best interest to follow as many as possible.

J Scott runs a real estate company that invests in several parts of the country and that specializes in new construction, as well as purchasing, rehabbing and reselling distressed properties. J is ...
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    Replied almost 10 years ago
    An EXCELLENT article. The IRS frequently will attempt to reclassify independent contractors to employees in order to collect additional taxes. FindLaw has additional information and a Twenty Factor Checklist to Determine Independent Contractor vs. Employee Status. You can find it here:
    Peter Giardini
    Replied almost 10 years ago
    Great article on a topic that most investors never even think about… and almost all gurus are clueless about. Pete
    Peter Giardini
    Replied almost 10 years ago
    Great article on a topic that most investors never even think about… and almost all gurus are clueless about. Pete Reply Report comment
    Replied almost 10 years ago
    Good article. One note regarding “subcontractors”… For the purposes of maintaining your contractors independence, it is beneficial to allow them to employ help during their work for you. This shows they are free to make their own business decisions and are free from your control. Control is after all what it all boils down to. However, it is best that their help are actual W2 employees rather than subcontractors. This is especially true in the construction industry. One slip and fall, and you want your main contractor’s workers to be covered under their own Workers Comp policy. Otherwise, if they are really only misclassified workers, ultimately – you may be responsible for the “subcontractor’s” injury as they are ultimately providing services to you. YOU are the ultimate recipient of their services, they are providing work onsite at YOUR location, therefore in court, it may be YOUR LIABILITY.
    Mark Bechler
    Replied almost 10 years ago
    I am a sub contractor and will agree with the above statement, its people like you who keep me in business. When I take on a job, I must be able to hire who I wish to do the different types of work that may be involved. Most people think they can handle hiring, and or firing people but when it comes down to it most people dont have a clue to what they really want. Its my job to help them see what they want. I ask them then design it for them, if I am to do my job I must be able to hire the people I trust and know.People who have been working with me for 20+ years, craftsman. You can go the route of hiring different contractors for each task, but having a contractor with a master plan will always be better. Unless you have blueprints and everything made up, and most people don’t. Most people have a vision and that’s where I come in. People could do what you are suggestion but I feel they only should consider it based on the volume of houses being flipped. And even then sometimes hiring a LLC like myself can save you time and we all know time is money. I liked the article and its pretty point on but for the typical person or even beginner house flipper, the investment in time and money may be a bit to high. P.S also any contractor in PA must have their insurance and the AG 1-800 number since the start of 2010 so if they dont please think twice about hiring them!
    Christy Barton Wholesaler from Indianapolis, Indiana
    Replied almost 5 years ago
    Despite this blog being written over 5 years ago, it still answers all of the questions I had about the differences between a W2 employee and IC. We are discussing hiring a part time bookkeeper/general admin person part time and although I know a lot of people have their PT admin staff set up as 1099’s, I’m very much aware of the IRS’s definition and wanted to be sure there wasn’t something I was missing about that. I’d much prefer to pay the extra overhead versus owing the IRS. 🙂 Thanks J!