Officers as Independent Contractors?
DOES THE CALIFORNIA EMPLOYMENT DEVELOPMENT DEPARTMENT (EDD) TREAT CORPORATE OFFICERS AS INDEPENDENT CONTRACTORS?
By Robert S. Schriebman, SJD
If you are an officer of your small corporation, may you legally treat yourself as an independent contractor of your corporation? It is an all too common thing. The EDD audits a small business corporation to determine if the workers hired are truly independent contractors. Included in the treatment of independent contractors are corporate officers. These corporate officers are usually husband and wife. The husband is the president and chief financial officer, and the wife is vice president and secretary. The corporation has a history of not filing quarterly state and federal employment and withholding tax returns. It is not uncommon for me to learn that the corporation was advised by its accountant that treating corporate officers as employees was permissible under the tax law.
Let us set aside for the moment the status all the other workers, and let us focus on Mr. and Mrs. Corporate Officer; let us call them Mr. and Mrs. Smith. The Smiths have their accountant issue to each of them an annual Form 1099 reflecting monies taken from the corporation each year.
Under both federal and California law corporate officers are known as “statutory employee.” This term means that by law corporate officers, particularly those who own the company, must be treated as employees. This means that quarterly state and federal tax returns must be filed timely. Withholding and employment taxes must be taken out of their respective paychecks and remitted timely to both the EDD and the IRS. There really is no getting around this law legally.
Even if the EDD concludes that all non-officer workers are independent contractors, the EDD can not rule that Mr. and Mrs. Smith are also independent contractors. The failure to treat Mr. and Mrs. Smith as statutory employees will result in heavy withholding tax assessments along with several levels of EDD penalties, and interest on everything owed.
In a recent IRS case, a public accountant tried unsuccessfully to treat himself as an independent contractor of his professional corporation. Let us call him Mr. Grey. Mr. Grey was the president and sole shareholder of his professional S-corporation. The corporation did not treat Mr. Grey as an employee. Mr. Grey argued before the U.S. Tax Court that he was not an employee for employment tax purposes because he did not consider himself an employee under common law. He asserted that his professional corporation never exercised control over him in the performance of his services. This was a rather silly argument because in reality Mr. Grey is his corporation. The U.S. Tax Court held that because Mr. Grey was an officer of his professional corporation, he was by law an employee.
The U.S. Tax Court agreed with the IRS. Not only was the professional corporation liable for a large amount of federal employment taxes, but also penalties and daily compounding interest. If you would like to read this case, see Joseph M. Grey, Public Accountant PC v Commissioner of Internal Revenue, 119TC No.5 (2002).
The bottom line is simple and basic – if you form a small California corporation and treat yourself as a corporate officer, you can not legally be an independent contractor. Professional who advise officers of small corporations that they can be treated as independent contractors for payroll tax purposes may be committing malpractice.
© Copyright 2011. No part of this article may be taken and used in any way whatsoever
without the express written consent of Robert S. Schriebman
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure”, both published by Commerce Clearing House.