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.
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.
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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 the author of The Book on Flipping Houses and The Book on Estimating Rehab Costs, which you can get here on BiggerPockets.