Downsizing and Hiring Freelancers? Here's the scoop on The Tax Implications

How to treat freelancers as independent contractors, so you won't be liable for their payroll taxes and healthcare benefits

By Alan G. Orlowsky, J.D., C.P.A. and David M. Freedman

In the 1990s, Microsoft Corp. supplemented its workforce by hiring "freelance" computer programmers. The freelancers signed agreements when they were hired, stipulating that they would work as independent contractors, receiving cash payments for their services. In the agreement the freelancers also stated that they would be responsible for paying their own social security, unemployment, and workers' compensation taxes.

By treating those workers as independent contractors, Microsoft believed it could avoid the cost of providing benefits and paying employment taxes.

Microsoft made a very costly mistake. The company integrated the freelance programmers into its workforce. They worked on projects with regular employees, under the same supervisors, using the same supplies and equipment, during roughly the same hours, performing similar tasks, and on the company´s premises.

Microsoft believed that merely executing a formal agreement, in which the freelancers classified themselves as independent contractors, would insure the freelancers´ independent-contractor status.

The IRS, on the other hand, believed Microsoft was treating the freelancers as if they were employees. As a result of an IRS action, Microsoft agreed to pay all the freelancers´ back employment taxes plus penalties. But the company was in for an even bigger shock.

In 2000, the United States Court of Appeals, reviewing the case of Vizcaino vs. Microsoft, decided that since the freelancers were really employees, Microsoft should have provided them the same benefits that all regular employees enjoyed -- including group health insurance and 401(k) plans. Now Microsoft must pay those freelancers millions of dollars in "back benefits."

Guidelines, Not Laws

The rules for hiring and compensating independent contractors are not precisely defined or uniformly applied. The IRS might view your situation one way, and the National Labor Relations Board or the Wage and Hour Division of the Department of Labor might see it another way. And your state department of revenue might not agree with the feds.

Although the government doesn't provide clear, concrete rules for distinguishing freelancers from employees, the guidelines given below will help. Be sure to consult your attorney and your accountant to formulate your hiring policy, and any work contracts, before you engage a freelance newsletter writer, editor or designer.

Control Over Work Methods

The most important test of whether a worker qualifies as an independent contractor is how much control he or she has over the methods and means used to accomplish the assignment.

For example: An independent contractor (IC) should be free to decide how, when, and where the assigned work is done.

The IC should use his or her own equipment, transportation, and supplies whenever possible.

The employer should not have to train the IC for the assignment.

Compensation

An IC should be paid by the job, upon submitting an invoice or series of invoices to the employer, and not according to a monthly or yearly salary. At the end of each year the employer should file Form 1099 for each IC who was paid at least $600 during the year.

A Freelancer Should Run a Real Business

The independent contractor usually has his or her own office that they operate out of, even if it's little more than a desk and a phone in a spare bedroom. If you provide the IC regular desk space on your premises, the IRS might consider that worker your employee.

Other considerations: Most freelance writers, editors and designers make their services available to many publishers in the marketplace. If yours is the only 1099 attached to an IC's income tax return, expect an IRS audit.

ICs should have the ability to subcontract the work you assign to them, or reassign the work to an assistant who works for the IC.

Workers are more likely to be considered ICs if they advertise their services, use their own printed business cards and letterhead, carry business insurance, and have a separate business telephone line.

Industry Standards

Some industries -- including publishers, professional practitioners, consultants, and marketing firms -- customarily hire freelance writers and designers more than other industries, and the IRS knows who they are. If your company is in any of those fields, you are more likely to convince the IRS that the ICs you hire are really not your employees.

If your company reports significantly more IC compensation than is standard in your industry, you'll attract IRS attention.

Contracts

As the Microsoft case illustrated, a written contract won't guarantee a worker IC status if all the other factors point to a classification of employee. But getting an IC's signature on a work-for-hire contract will help reinforce your efforts to comply with the rules. At the very least, such a contract should spell out the nature of the assignment, deadlines, compensation, and an acknowledgement of the worker's IC status. Check with your attorney to see if other provisions are also necessary.

About the Authors

Alan G. Orlowsky, President of Orlowsky & Wilson, Ltd. in Lincolnshire, Illinois, has been counseling people on estate planning for 28 years. He previously worked for the IRS in its Estate and Gift Tax Division. He also worked for the Deloitte & Touche accounting firm, and he has taught taxation and accounting at Loyola University of Chicago, School of Business.

David M. Freedman is a Chicago-based writer, editor, and newsletter developer. He is the founder and director of Newsletter Strategy Session, a website for publishers of non-commercial newsletters.

If you have questions about this post or about a particular legal situation, please contact Alan Orlowsky by

email

by calling 847-325-5559.

Boomers: Do Your Parents Have an Estate Plan?

By Alan G. Orlowsky, J.D., C.P.A. and David Lansky, PhD.

Baby Boomer Joe McGill (not his real name) loved his parents, and when they died, Joe and his sister grieved. The fact that his parents left their estate in a chaotic mess didn´t diminish Joe´s affection for them, but it did cost him and his sister hundreds of thousands of dollars in estate tax and legal fees, plus many hours of administrative hassles. Since their mother´s will was confusing, Joe and his sister feuded when deciding which of them would keep their mother´s collection of fine sculptures, because Joe wanted to keep it intact rather than divide it.

The taxes and fees were paid by the estate, to be sure. But if the older McGills had planned their estates wisely, their children - not the IRS and the lawyers - would have inherited that money.

Estate planning not only preserves wealth for succeeding generations, it also gives the aging parents satisfaction and peace of mind. If they really think about it, most parents would rather leave behind a grand legacy than a costly mess - not to mention help their children and grandchildren achieve their dreams and goals.
We´ll explain what a good estate plan consists of, and then suggest strategies for raising the subject of estate planning with your parents if they normally avoid talking about their financial situation with you.

What´s in a good estate plan?

Each of your parents (in fact, every parent and person with substantial assets) should have a solid estate plan. At the very least, such a plan includes a will, durable power of attorney for property, and power of attorney for health care. Affluent parents should also use revocable trusts to keep trust assets out of probate - which in Illinois can take months or years.

Depending on the value of the estate, the nature of the assets, and the family relationships, a plan might also include a life insurance policy and irrevocable life-insurance trust, or a generation-skipping gift trust, for example. Irrevocable trusts help protect assets from estate tax.

If your parents have trusts, each year they should transfer new probate assets to their trusts. probate assets include cash, stocks and bonds, limited partnership shares, valuables, and collectibles.

An estate plan may also involve life insurance to provide estate liquidity, if a substantial portion of the estate comprises illiquid business interests or real estate.

Each parent should appoint a competent and reliable executor (in the will), trustee (for a trust), and agents (for powers of attorney), and update those designations over the years if any of those people die or become disabled.

Finally, if either parent´s estate is worth more than $2 million in 2005 ($4 million for a married couple), they should give annual tax-free gifts of up to $12,000 to each of their children and to as many others as they wish.

Raising the subject

In many families, especially in your parents´ generation, talking about your personal finances is taboo. Some parents don´t feel comfortable telling their adult children how much money they have and what´s going to happen to their wealth when they die. In some families, if adult children ask their aging parents about their assets, wills, trusts, beneficiaries, or heirs, the parents might suspect their children of having purely selfish motives. If the children raise the subject of powers of attorney, the parents might wonder if their kids are trying to take control of their property. And they might feel a little wary suspicious if you advise them to give you and your spouse and your children $12,000 each, this year and every year.

Before you raise these issues with your parents, discuss them with your siblings, so you present a unified, concerted message. Then you can either approach your parents as a team, or approach them alone, acting as the quarterback of the team with their consent.

Here is the best way to raise the subjects of money, death and taxes with parents who don´t normally discuss those topics with you. First - maybe over the course of several visits - ask them questions about their lives, their ancestors, and your family history. Ask them how they hope to live out the rest of their lives, their dreams and goals, their worries and concerns, how they would like to be remembered, what they would like their grandchildren to know about them, and what family values they want you to preserve.

These questions, and the discussions that follow - if you are sincerely interested in the answers - will not only give you and your children a sense of continuity and heritage, they will also build trust and open up an avenue for talking about sensitive issues like money, estate planning, their health and welfare, and other personal concerns that your parents were previously reluctant to reveal.

If you still have trouble getting through to them, you might suggest that they talk to their legal and financial advisers about their future - including their financial security, estate plan, long-term health care, and future residential options.

If that suggestion fails, you may have no other alternative than to contact your parents´ legal and financial advisers yourself, and explain to them that you are concerned about your parents´ well-being and, frankly, your own. There´s no shame in wanting to help your parents protect their estates from the ravages of taxes, or the greedy fingers of unscrupulous advisers and peddlers of fraudulent investments.

There is also no shame in wishing to preserve your parents´ wealth for the sake of your children and future generations.

About the Authors

Alan G. Orlowsky, President of Orlowsky & Wilson, Ltd. in Lincolnshire, Illinois, has been counseling people on estate planning for 28 years. He previously worked for the IRS in its Estate and Gift Tax Division. He also worked for the Deloitte & Touche accounting firm, and he has taught taxation and accounting at Loyola University of Chicago, School of Business. Al is a contributing author of the book 21st Century Wealth (Esperti Peterson Institute, Denver, 2000), and has written numerous articles on the subject of estate planning. Contact Alan Orlowsky by email or call 847-325-5559.

David Lansky, PhD, is a clinical psychologist who has been working with families and organizations for over a decade. His involvement with business-owning families and families in transition focuses on team building, conflict management

A Checklist for Life's Only Certainty

Planning ahead can bring comfort when a loved one is dying.

Hopefully you won't need this checklist soon, but keep it in a safe place -- you will need it someday.

By Alan G. Orlowsky, J.D., C.P.A.

When a loved one is gravely ill or suffers a life-threatening injury, you may be too distraught to think rationally about that person's financial and legal affairs. But someone will need to take care of those matters, to protect your loved one's estate and prevent matters from falling into neglect or chaos.

All too often, a client calls my office in a state of panic, saying something like, "My father (or my spouse) is dying, I don't know where his money is or how to pay his bills, I don't know where the deeds and titles and tax returns are, I can't find the name of his accountant, I don't even know if he has a will. What should I do?"

I can't tell you how many times that conversation has taken place even though I had advised the same client years earlier to discuss those matters with their spouse or parents, in order to prevent an estate-planning train wreck in the family.

Even if you do have such discussions and become familiar with your loved ones' estate, when the time comes that you must take action to protect the estate, you may be too distraught to remember all the tasks that must be accomplished and phone calls that must be made. That's when you need a checklist like the following -- keep it in a safe place with your own estate planning documents.

The deathbed checklist

Talking to a dying loved one about money and burial instructions may seem difficult now, but in most cases the loved one derives comfort from knowing that his or her wishes will be noted and followed.

Here is a list of tasks to undertake in tending to the last wishes of a loved one:

Ask if there are any last-minute instructions, changes, or wishes regarding funeral and burial arrangements. If so, prepare a letter to be signed by your loved one.
Make sure you know where estate planning documents and other important papers are stored, including a will, trusts, powers of attorney, insurance policies, buy-sell agreements, real estate deeds, contracts, and business agreements. If any documents have been misplaced, check to see if copies are in the possession of an attorney, financial adviser, or insurance agent. If your loved one is competent, ask him or her to review the will to see if any last-minute changes are necessary.

If there is no will or power of attorney, encourage your loved one to hire an attorney to prepare one as soon as possible.

Prepare an updated list of assets (including business assets and partnership interests), as well as the locations of safety deposit boxes (and the keys to them).
Assemble the most recent bank account, brokerage account, and pension plan statements.

If the person has young children and there is no other surviving parent, then a guardian should be appointed; otherwise the courts will make this appointment.

Make a list of the loved one's professional advisers, with contact information. Include lawyers, CPA, banker, broker, financial planner, and any other professional who has knowledge of the estate.

Become familiar with the debts and obligations that must be paid before and after death.

Make a list of individuals to be contacted before and/or after the loved one's death.

Urge your loved one to prepare a list of important items of personal property such as jewelry, collectibles, clothing, art, and furnishings, and the people to whom those items should pass before or after death.

Post-death checklist

After your loved one passes on, you will have to take care of the following additional matters:

Notify the Social Security Administration, Veterans Administration, and other state and federal government pension providers -- as well as any private providers -- if the individual is receiving benefits. If there is a surviving spouse or minor children, they may be entitled to continued benefits.

Contact life insurance providers to obtain claim forms. Gain access to safety deposit boxes.

Determine if it will be necessary to open a probate estate.
Notify all executors, trustees, beneficiaries, potential heirs, and creditors. If you haven't done so already, prepare an inventory of assets.

Pay off current bills.

Contact legal and financial advisers. They may have information that you'll need to properly administer the estate, and they may be able to shed light on missing assets not previously inventoried.

These checklists are not necessarily all-inclusive -- some estates are quite complex, especially when they are complicated by divorce, blended families, complicated business relationships, adopted children, hostilities among family members, disputes with or distrust of advisers, etc. But the checklists touch on the most common and most important items that you'll deal with upon the death of a loved one.

The ABC's Of Michael Jackson's Will

By Alan G. Orlowsky, J.D., C.P.A.

For the past several months we all have been witness to the drama surrounding the death of Michael Jackson. His personal life, played out on the public stage, was by any reasonable standards as bizarre as it was tragic. However, notwithstanding his failings of character and eccentricities, he died a very wealthy man, was revered by many and possessed the common sense to reduce his testamentary wishes to paper.

Unlike many "relatively normal well adjusted" entertainers, Michael "got it" and understood that he needed to prepare a Will to protect his family.

So, what did Michael´s Will state? What did he declare therein to protect his family and perpetuate his legacy that we can learn from? And how did he overcome the psychological hurdle of confronting his own death when most other mortals could not?

The ABCs of the Will of Michael Joseph Jackson

What was declared therein and the filing thereof are as follows:

A. Michael´s Will was filed in the Superior Court of California, County of Los Angeles on July 1, 2009, shortly after his death on June 25, 2009. Upon filing it was made public to the whole world!

B. Publication of the Will was immediately requested so that the statute of limitations for contesting such wills would immediately begin to run, thus barring claims against the estate as quickly as possible.

C. Surety Bond was waived by the Will and, hence, not required, perhaps saving the estate from tens of thousands of dollars of unnecessary bond premiums.

D. Michael appointed 3 individuals as co-executors, namely, John Branca, John McClain and Barry Siegel. Only McClain now acts as executor.

E. Michael was a US citizen and a resident of California at the time of his death, although he spent most of his time out of country.

F. Paul Gordon Hoffman, Attorney filed the Will.

G. Character and estimated value of the property of the Estate were reported as follows: "The petitioners are not certain of the value of the Estate. Petitioners believe that the value of the Estate exceeds $500 million. Petitioners believe that almost all of the Estate consists of non-cash, non-liquid assets, including primarily an interest in a catalogue of music royalty rights which is currently being administered by Sony ATV, and interests in various entities. Petitioners do not have any information at this time regarding the liquid assets of the Estate."

H. Michael was divorced and had no registered domestic partner.

I. Michael declared 3 children, natural born or adopted, namely, Prince Michael Jackson, Jr., Paris Michael Katherine Jackson and Prince Michael Joseph Jackson, II.

J. The entire estate was given to the Trustee of the Amended and Restated Declaration of Trust executed on March 22, 2002 and named the "Michael Jackson Family Trust."

K. Michael specifically excluded his former wife, Deborah Jean Rowe Jackson, from taking under the estate.

L. Katherine Jackson, Michael´s mother, was named guardian of his children and Diana Ross successor guardian.

Was Michael´s Will well drafted?

In my opinion... yes!

It has served him well by providing for the transfer of his assets to his Family Trust, by providing that his trusted mother be appointed guardian of his children and, so far, by withstanding attack from outsiders. Also, since Trusts are not subject to public scrutiny, Michael was able to keep the disposition of his estate free from the public eye. One omission I am able to infer from the filing of the Will is the failure by Michael´s attorney to have re-titled his considerable assets in the name of his Family Trust prior to death...a common mistake which not only subjects estate assets to potentially costly probate proceedings, but also to otherwise avoidable public view.

What we learn from Michael´s Will is that good planning can prevent a clash of family members and outsiders who may otherwise have pitted themselves against each other in order to lay claim to Michael´s considerable estate and to the custody of his beloved children. Clearly, millions of dollars were saved and lengthy litigation avoided because Michael planned.

Why did Michael plan while many others fail to do so? Maybe Michael understood the fragility of life and was not in denial about his risky behavior. Perhaps Michael had a death wish or just wanted to protect his children. Perhaps he had a proactive attorney who made it crystal clear that catastrophe would ensue if he suddenly died having failed to plan. We will never know for sure his reasons for planning, but you can take a cue from his forward thinking and establish a plan to protect your family as well as he protected his.

For more information on Personal Estate Planning or Asset Protection for your business, contact Alan Orlowsky at 847-325-5559.