7 Must Know Items When Using Independent Contractors for Your Real Estate Business

9

You may be aware that as an investor in the real estate business, you can save tons of money each year in taxes by hiring independent contractors rather than employees, as you can avoid paying, withholding, and filing costs each and every year for your independent contractors that you would otherwise incur with an employee.

It should come as no surprise to you that the IRS has been working hard to close this amazing loophole as part of its efforts to raise tax revenue. I met a man who owned a mortgage company and paid all his sales people as independent contractors. He got under a brutal IRS audit and ended up losing EVERYTHING…his business, his investments, and his home. Needless to say, the IRS will continue to enforce this area of the tax code because it is a high revenue generator for the Treasury Department. So what does this mean for you as an investor? This means that you need to protect yourself! If you have independent contractors in your investing business, you need to make sure you have all the correct documentation to protect yourself in case of an audit.

Download Your FREE Tenant Screening Guide!

Hey there! Screening tenants can be a tricky business, and this critical step can be the difference between profits and disaster. To help you with your real estate investing journey, feel free to download BiggerPockets’ complimentary Tenant Screening Guide and get the information you need to find great tenants.

Click Here For Your Free Tenant Screening Guide

How to Protect Yourself

In order to protect your real estate business from the auditor, you first need to know “how” they conduct their audits in this area. Currently, the IRS agents take a special class that trains them on how to audit worker classification of small businesses. The good news is that the materials in this auditor training course are actually available for us to see! We can all access the IRS playbook and learn about “how” they plan to audit our real estate businesses!  This manual, entitled “Independent Contractor or Employee?”, is available at www.irs.gov/pub/irs-utl/emporind.pdf.

If you aren’t too excited about reading through all 160 pages of the manual, you are in luck. Here is a highlight of the important areas that you need to know.

Independent Contractor or Employee Qualifications

The auditors are taught to analyze the employee versus independent contractor status of your workers using a series of seven factors. These factors are:

1) Degree of control exercised by the principal.

2) The worker’s investment in facilities.

3) The opportunity of the worker for profit and loss.

4) The right of discharge.

5) Whether the services performed were part of the principal’s regular business.

6) The permanency of the relationship.

7) The intent of the parties.

In addition, the auditors focus on the dynamics between the employer and the worker in terms of behavioral control, financial control and relationship of the parties. In short, the IRS wants you to have little or no control in the behavior and finances of your workers in order for them to be classified as independent contractors.  The more financial and behavioral control the employer has, the more likely the relationship is one of employer/employee.

As an example, a general contractor was able to qualify as an independent contractor and not an employee because the contractor:

1) Controlled the manner in which he scheduled work hours.

2) Invested a significant amount of money in his equipment and supplies.

3) Had other clients that he worked as a general contractor for

4) Operated out of his own legal entity

Audit Protection Checklist

Now that you know “how “ the IRS looks at the independent contractor status when doing their audits, here are some things you can put in place to protect yourself in case of an audit:

1.) Create a job description for the position which indicate limited control and an independent working environment

2.) Ensure your Company’s operating agreement and employment policies treat the position as an independent contractor

3.) Get a signed independent contractor’s agreement between the Company and the worker

4.) Have a completed Form W-9 from each independent contractor you hire

Real Estate Investor Must Do’s

We all know that as real estate investors, a lot of times we hire temporary workers to help out for things like repairs, maintenance, or landscaping. In an effort to avoid taxes, your temporary workers may request that you do not even issue them a 1099 at all. It is important for you to know that issuing the 1099 to your temporary workers protects you and helps you to prove that the money you spent was a legitimate business expense. So be sure to take that extra step to issue the 1099 to your contactors when appropriate so that you are protected in case of a future audit.

As we discussed, independent contractors are a great way to efficiently add to your investment company. Savings in money and resources can make hiring independent contractors an attractive alternative to hiring employees.  Now that you know the IRS playbook, you are armed with the strategies that can help you to safely maneuver potential future audits.

Photo: SalFalko

About Author

Amanda Han

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

9 Comments

  1. Great post, Amanda.

    When we began hiring years ago, the gurus were teaching how to use independent contractors for many of the potential cost saving reasons you mentioned. Our CPA told us back then, probably 7-8 years ago, that using independent contractors was a red flag for audits and our chance of being audited would sky rocket.

    So, we have w2 employees. Sometimes “a penny saved” is not worth it – even if you dot all the i’s and cross all the t’s…..

  2. Great article Amanda.

    I am new to the business and just completed my first flip. I had a contractor agreement in place with my contractor that outlined him as an independent contractor, after 1 week on the job he quit. Trying to get the rehab completed in a timely manner I hired another contractor that was as simple as a phone call saying “I need you to finish this house, do it in 3 weeks and for 15k of less”. I did not get a contractor agreement for him or any of his subs, I am now going back to them and requesting W-9s but so far haven’t received anything (surprise surprise since they have already been paid).

    Will the multiple invoices I received from them be sufficient to protect myself from any IRS issues?

    And I’m assuming your advice for the future would be to not hire a contractor without getting the W-9 and independent contractor agreement signed before starting any work? Do I need to get these document as well from each subs that he subs any of the work out to?

    • Matt:

      Yes…you are correct in that after you pay them …it is extremely hard to get them to fill out W-9s or sign any contracts since there is no incentive for them to do so. I would suggest in the future that you get both of these up front prior to giving them any money.

      In terms of receipts, although that will help you to substantiate your deduction, the IRS can come to you to argue that you should have withheld payroll taxes on their behalf. If that were to happen, then they can assess you payroll taxes of ~15%. Not the end of the world….but my suggestion is to get the agreement in place to protect yourself. Also, you don’t want anyone to go to the EDD to argue that they were an employee to collect unemployment as that could be costly for you.

      • Amanda,

        Thank you for the tips and for writing this informative article. I definitely realize that we screwed up by having this guy do any work prior to getting this necessary documentation. Definitely a newbie mistake that we will not make again and I never thought about the EDD possibility, that could be very costly to a new business like ours.

        Thanks again!

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php