Employees vs independent contractors: Knowing the difference matters to the IRS—and you

By Melissa Hoffman

Do you know the difference between an employee and an independent contractor? Does it really matter which way school owners in the United States classify and pay their staff teachers? The answer is yes. It matters to the Internal Revenue Service, and that means it should matter to you.

When I began teaching, more than 25 years ago, I was always paid as an independent contractor. Thus, when I opened my studio I did the same with my teachers, simply because I knew no other way. Not until I received a registered letter from the State of New Hampshire unemployment office informing me that I owed a substantial amount of money in back taxes did I learn otherwise. Here’s what happened: One of my teachers, who had a full-time job elsewhere, filed for unemployment and needed to list me as an additional employer. This prompted the unemployment office to ask if I employed independent contractors. When I reported 15 people whom I paid as contractors, that sent up a red flare.

After a nerve-wracking hearing with my attorney with five years of business records in tow, it was determined that my teachers are employees, not independent contractors. I was lucky, though, because I did not have to pay back taxes and penalties from the previous years, which could have put me out of business.

What saved me was that six years earlier, a representative from the unemployment office had questioned me about the fact that I had numerous independent contractors. Based on our conversation, he determined I had paid them properly. Because I had documented that conversation, the unemployment office had no basis for collecting back taxes. However, I was told that the advice I had received was incorrect and that all the teachers who worked for me on a recurring weekly schedule were employees.

Responsibilities with employees
This change in my teachers’ status meant that I was responsible for putting all employees on payroll and withholding all the appropriate taxes. On my accountant’s recommendation, I signed on with a payroll service. Though there is a monthly fee, it takes care of all tax filings, quarterly and annually.

Once my teachers were on the payroll I quickly learned why some business owners like to keep teachers on as independent contractors: Having employees is more expensive. As the employer, not only do you withhold payroll taxes, but you also pay into Social Security, federal, and unemployment tax funds. New Hampshire has no state income taxes; therefore there is no state withholding. However, if you choose to do payroll on your own, be sure that you understand the laws in your state.

As an employer you are responsible for workers compensation insurance as well, and the rate is calculated annually based on the previous year’s total payroll. In other words, if your payroll is high, your rates for workers compensation will be correspondingly higher than those for employers whose payroll is low. Because having employees is more expensive than paying contractors, school owners may feel forced into decreasing the base pay rate to offset the taxes being paid.

But there is also a positive side to having employees. For me, the biggest advantage is the loyalty I feel from my employees. Not only do they know they have a steady job and, according to our policy, cannot be terminated unless the school has three poor reviews on record, they also know that I rely on them throughout the year. That’s an important factor, especially in today’s economy. My employees and I work as a team and don’t feel uncomfortable asking for a hand with something extra. This extra help does not go unrecognized. I might buy them dinner or give them a stipend after a competition weekend, and I pay them for rehearsals and staff meetings.

With a payroll system, my school not only pays into the teachers’ Social Security benefits, we are also able to offer a 401(k) plan. Dance teachers who have always worked as independent contractors may not have had an opportunity to plan for their futures, and offering them such funds can be of great benefit to them. Our employees now can collect unemployment benefits during the summer months if they choose to, which they could not do as independent contractors.

Defining the difference
The IRS defines an independent contractor as someone who has the right to control or direct only the result of the work and not the means and methods of accomplishing the results. Some examples of contractors in the dance education business are master teachers who are hired for summer programs; former students, now working dancers, who return to a school to fill in as temporary teachers; or choreographers who are hired to set works on your students.

If you hire someone to work as an independent contractor, it’s wise to document each factor you used in determining that person’s status. That way, if you are ever audited you will have concrete reasons for your decision.

In contrast, an employee is someone who can control what will be done and how it will be done; the important distinction is that an employee has the right to control the details of the services being performed. For example, at my school there is a Pre-Ballet I class every Monday at 3:00 p.m.; it uses the same syllabus as all the other Pre-Ballet I classes and the same dancers come every week. Within that structure, my teachers can make their own decisions; thus they control the details.

Common law rules
Common law rules can help you determine whether you have employees or independent contractors. The common factor in these rules is the amount of control you have regarding what, when, and how classes are taught.

Advantages

• Behavioral: Does the company have the right to control what the worker does and how the worker does his or her job? In my school’s case the answer would be yes, depending on the level of the class. The teachers of the younger classes work via a syllabus, and although I don’t give exact class plans, I do ask them to accomplish a certain goal by year’s end.
• Financial: Are the business aspects of the job controlled by the payer? Again, in my case the answer would be yes since I alone control the business of signing up dancers and collecting tuition.
• Type of relationship: Are there written contracts or employee-type benefits (such as pensions, insurance, vacation time)? Will the relationship continue and is the work performed a key aspect of the business? This one was harder for me to answer because I do not use contracts and it was not until we went on payroll that we had employee-type benefits. However, I could answer yes to the second part of the question since each teacher brings something different to my school and each is key to its success.

Documentation and communication
If you hire someone to work as an independent contractor, it’s wise to document each factor you used in determining that person’s status. That way, if you are ever audited you will have concrete reasons for your decision.

For many school owners, the thought of increasing expenses by putting teachers on payroll is overwhelming. However, not doing so and having the IRS or the state determine that you do indeed have employees could put you at great risk of owing back taxes and penalties. If you have determined that you should be paying your teachers as employees and need to adjust your rates to compensate for the increase in your expenses, sit down with your teachers and explain the situation. They should understand that having Social Security and Medicare taxes withheld ultimately benefits them.

For more information, visit the IRS website, irs.gov, and go to the small-business section to learn about your state’s unemployment policies. We encourage you to get an accountant’s or tax lawyer’s help if there is any doubt about whether to treat your staff as contract workers or employees.

Tips for Independent Contractors        

By Caroline Batson

Many young dance instructors come and go because of their lack of experience in dealing with studio owners. Don’t be your own worst enemy!

Appearance. Don’t dye your hair four different shades and wear all of your piercings. Watch what you wear. Don’t show your midriff, and if you are going to don those booty shorts, wear tights for the sake of the dads who come to watch their children’s classes. You need to find a look that is attractive to the studio owner and the parents of the children you will be teaching. Find a style that is all yours, but shoot for the conservative side.

Say yes. You’ve landed your first job; now what? Make yourself available to try new things. Teach the preschoolers? Why not? Read everything you can on child development. You can’t always start off teaching the competition team, and if you won’t take the job unless you can, you are shooting yourself in the foot.

Be there. Don’t start your new job by taking days off. If you’re hired in the fall, you should stay on the job steadily until after Christmas; too many substitutes can cause some of your students to leave. Be consistent; you’ll be assigned to more classes the next season.

Be on time.  Some teachers think that being a contractor means they can come and go. Wrong! You signed a contract saying you’d be there. Show good character and arrive a half-hour before class. Get organized, chat with the studio owner, and engage with the children as they arrive. The more you bond with your students, the more they will want you to teach them next year.

Be memorable. Help the owner with whatever she needs. Finish your recital dances by mid-April; be positive and encouraging; and when other teachers don’t show up, step in for them. Give your best, and payback will come in the form of more classes and a good reputation.

Leave your troubles at the door. Come to the studio with a smile, ready to change the world. Keep your eye on the goal: You are there to teach, not to tell your students about your life and hard times. Say, “Isn’t it a great day to dance? Let’s get to it.”

Love the work. Love to keep learning. Love the students, the crazy backstage moms, the studio owner, and that older teacher who keeps tabs on you. (She wants you to have a job next fall.) Enjoy the ride!

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