I do not know of any business owner who wants to be audited by the IRS or their state tax authority. Audits can be simply random as “decided” by the IRS computer, or they can be triggered by certain characteristics of your business operation, for example how you’ve classified independent contractors or employees (especially if they apply for unemployment insurance, worker’s compensation benefits, or even welfare).
Do you operate a beauty salon? Here are three key items the IRS and state tax authorities look for if you are an independent contractor or if you use them in your business.
1. Is there a lease between the independent contractor and the owner?
There must be a lease signed by the salon owner/landlord and each booth renter for every year of the audit. The IRS and your state can audit your records for the past three years (or as far back as they want if they determine your returns were fraudulent). The lease must clearly define the day-to-day operations of the booth rental operation and clearly define the separation between the salon owner/landlord and the booth renter. It should be clear how and when rent is paid: how service receipts are collected: hours of operation (hint: the independent contractor sets her own); receptionist services; who provides the equipment; who pays for supplies. Every aspect of the relationship must be spelled out. A true independent contractor can incur financial loss (which means she invests in the business as well as earns a living from it).The salon owner must not have any control over when, where, or how the independent contractor works.
2. How is rent paid?
Independent contractors must pay a flat rate – not a percentage of their service income – based on the space used. Tax agencies take a dim view on charging rent as a percentage of services because it makes it difficult for the independent contractor to incur a loss (0% of 0 income is not a loss). Paying a commission also ties the economic well-being of the salon owner to the independent contractor, making it harder to argue that the independent contractor’s services are not integral to the success of the salon.
3. Who collects payment for services rendered?
The booth renter is responsible for collecting payment for all services rendered. That doesn’t just mean taking the money from them at the front desk; it means the independent contractor must have her own cash box and have checks in her name. They should be able to make change for cash paying customers and handle bad checks. A good rule of thumb is that a salon owner should never give an independent contractor money, and she should never issue an independent contractor a 1099 form.
I only discussed three factors but the IRS and State tax agencies have other factors they can consider in determining whether the relationship is truly that of salon owner/landlord and independent contractor.
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