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Clarifying the status of independent contractors : hearing before the Subcommittee on Taxation and Finance of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, first session, Washington, DC (Volume Pt. 1) online

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CLARIFYING THE STATUS OF INDEPENDENT
CONTRACTORS — ^PART I



Y4.SM 1:104-43



ClaTifgUg the Status of Indepeaden.. .

HEARING

BEFORE THE

SUBCOMMITTEE ON TAXATION AND FINANCE

OF THE

COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES

ONE HUNDRED FOURTH CONGRESS

FIRST SESSION



WASHINGTON, DC, JULY 26, 1995



Printed for the use of the Committee on Small Business



Serial No. 104-43



JUN 4 me

£2!!!2!Wocuments Dept.



U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1996



For sale by the U.S. Government Printing Office

Superintendent of Documents. Congressional Sales Office, Washington, DC 20402

ISBN 0-16-052576-4




CLARIFYING THE STATUS OF INDEPENDENT
CONTRACTORS — PART I



Y 4.SM 1:104-43



Clarifsing the Status of Independen. . .

HEARING

BEFORE THE

SUBCOMMITTEE ON TAXATION AND FINANCE

OF THE

COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES

ONE HUNDRED FOURTH CONGRESS
FIRST SESSION



WASHINGTON, DC, JULY 26, 1995



Printed for the use of the Committee on Small Business



Serial No. 104-43



JUN 4 1996



U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1996



For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

ISBN 0-16-052576-4



COMMITTEE ON SMALL BUSINESS



JAN MKYP^RS, Kansas. Chair

JOHN J. I^FALCE, New York
IKE SKELTON, Missouri
RON WYDEN, Oregon
NORMAN SISISKY, Virginia
KWEISI MFUME, Maryland
P^LOYD H. FI^KE, New York
GLENN POSHARD. Illinois
EVA M. CLAYTON, North Carolina
MARTIN T. MEEHAN, Massachusetts
NYDIA M. VELAZQUEZ, New York
CLEO FIELDS, Louisiana
WALTER R. TUCKER III, California
EARL F. MILLIARD, Alabama
DOUGLAS "PETE" PETERSON, Florida
BENNIE G. THOMPSON, Mississippi
CHAKA FATTAH, Pennsylvania
KEN BENTSEN, Texas
WILLIAM P. LUTHER, Minnesota
PATRICK J. KENTS'EDY, Rhode Island
JOHN ELIAS BALDACCI, Maine



JOEL HEFLEY, Colorado

WILLIAM H. ZELIFF, JR., New Hampshire

JAMES M. TALENT, Missouri

DONALD A. MANZULLO, Illinois

PETER G. TORKILDSEN, Massachusetts

ROSCOE G. BARTLETT, Maryland

LINDA SMITH, Washington

FRANK A. LoBIONDO, New Jersey

ZACH WAMP, Tennessee

SUE W. KELLY, New York

DICK CHRYSLER, Michigan

JAMES B. LONGLEY, JR., Maine

WALTER B. JONES, Jr., North Carolina

MATT SALMON, Arizona

VAN HILLEARY, Tennessee

MARK E. SOUDER, Indiana

SAM BROWNBACK, Kansas

STEVEN J. CHABOT, Ohio

SUE MYRICK, North Carolina

DAVID FUNDERBURK, North Carolina

JACK METCALF, Washington

STEVEN C. LaTOURETTE, Ohio

Jenifer Loon, Staff Director

Jeanne M. RoslaNOWICK, Minority Staff Director



Subcommittee on Taxation and Finance

LINDA SMITH, Washington, Chairwoman



JACK METCALF, Washington
FRANK A. LoBIONDO, New Jersey
WALTER B. JONES, JR., NoHh Carolina
MARK E. SOUDER, Indiana
SAM BROWNBACK, Kansas
ROSCOE G. BARTLETT, Maryland
STEVEN C. LaTOURETTE, Ohio

LiGIA SaLCEDO-McWimjams, Subcommittee Staff Director



MARTIN T. MEEHAN, Massachusetts
WALTER R. TUCKER III, California
KEN BENTSEN, Texas
PATRICK J. KEN^^EDY, Rhode Island
JOHN ELIAS BALDACCI, Maine
CLEO FIELDS, Lousiana



(II)



CONTENTS



Page
Hearing held on July 26, 1995 1

WITNESSES

Wkdnksday, July 26, 1995

Christensen, Jon, a Representative in Congress from the State of Nebraska ... 2

Denholm, F'em, owner. Flowers and Ferns, Burke, Virginia, on behalf of

the Society of American Florists 8

Goldstein, Benson S., legislative and tax counsel, National Association for

the Self-Employed 29

Horton, Debbi-Jo, accountant, I^videncc, Rhode Island, and New England
Taxation Chair for 1995 White House Conference on Small Business Imple-
mentation Team 10

Johnson, Paul, owner, P.J. Nice Construction, Hanover, Maryland, on behalf

of the Associated Builders and Contractors, Inc 12

Kane, Raymond Peter, owner, I'isa Brothers, Inc., New York, New York,

on behalf of the American Society of Travel Agents 14

Kim, Jay, a Representative in Congress from the State of California 5

Phillips, Ix)ckwood, publisher, The Carteret County News-Times, Morehead

City, North Carolina, on behalf of the National Newspaper Association 16

Satagaj, John S., president. Small Business I^egislative Council 25

Schneier, Abraham L., counsel, McKevitt & Schneier, Washington, DC, on

behalf of the National Federation of Independent Business 24

APPENDIX

Opening statements:

Smith, Hon. Linda 34

Baldacci, Hon. John E 39

Prepared statements:

Christensen, Hon. Jon 41

Denholm, Fern 45

Goldstein, Benson S 50

Horton, Debbi-Jo 57

Johnson, Paul 63

Kane, Raymond Peter 67

Kim, Hon. Jay 71

Phillips, Ijockwood 75

Satagaj, John S 88

Schneier, Abraham L 104

Additional material:

Written Statement of Patti Burgio, Director of Government Affairs, Na-
tional Association of the Remodeling Industry 109

Written Statement of Debra J. I>essin, CPA 112

Written Statement of the National Association of Woman Business Own-
ers 118
Written Statement of Donald Gene Wade, EA, on behalf of ^

Financial Services 120

(HI)



CLARIFYING THE STATUS OF INDEPENDENT
CONTRACTORS PART I



WEDNESDAY, JULY 26, 1995

House of Representatives,
Subcommittee on Taxation and Finance,

Committee on Small Business,

Washington, DC.

The subcommittee met, pursuant to notice, at 10:01 a.m., in room
2359-A, Raybum House Office Building, Honorable Linda Smith,
(chairwoman of the subcommittee) presiding.

Chairwoman Smith. Good morning. I'm going to start this right
on time because we have some unusual things that are happening.
We will have a joint meeting of Congress this morning that we
didn't plan. It came up at the last minute. So, I will give you the
order.

What's going to happen is that His Excellency Kim Young Sam,
the president of South Korea, will be coming, and so officially we
have to adjourn this meeting, and start again after his presentation
before Congress. What we will do with the Members approval is
submit our opening statements for the record, and not take the
time, so that we can make sure there is enough time for the panel
of witnesses.

The reason that we are reviewing this particular issue is that we
are trying to make a recommendation from this Subcommittee on
what we think should happen with this issue, and we will rec-
ommend to the final committee of jurisdiction, what we think the
small business community is asking, and what we think is the best
solution.

Just last month, the delegates stated very clearly that this was
their top issue, the small business delegates to the White House
Conference, and it truly is. I was in business for many years, and
probably one of the greatest problems I had, and my clients had,
was independent contractors, and that was 20 years ago, and it
hasn't gotten much better.

So, with that, we want to start, and I have a witness, Mr. Gene
Wade, of Toledo whose written testimony we will submit for the
record. The IRS has just moved in and decided that his whole in-
dustry will be determined to be employees instead of independent
contractors, and it has nothing to do with the folks that work with
his product. He is an independent salesman, but it shows how far
this designation has come.

Now, we'll go to the two authors of two bills that are before Con-
gress. Obviously both of these gentlemen have worked extensively,

(1)



both with coalitions, and I have read their proposals, and they have
good recommendations.

What we would like to do is have them present before Congress
officially what they would like to do, and then we'll have those that
are affected by the independent contractor status, individual entre-
preneurs, testify.

Then in the third panel, which will be at noon, we will hear from
the groups that are trying to help small entrepreneurs resolve this.
While some of the groups may not agree on everything, there is
quite a bit of agreement from what I could see amongst them.

So, with that, I want to welcome Mr. Christensen, and Mr. Kim.
I want to commend you both for the work that you have done. This
is not an easy issue, but it's exciting that you're doing it, and it's
exciting that you have picked up the top issue, especially for small
businessmen and women.

So, while we have talked about small businesses, you have taken
action behind that talk. So, Mr. Christensen, would you begin. You
know where the rest of our colleagues are, at conferences, but we
need to start on time with this. So, please begin.

[Chairwoman Smith's statement may be found in the appendix.]

TESTIMONY OF JON CHRISTENSEN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF NEBRASKA

Mr. Christensen. Well, thank you. Madam Chairman, and I
want to thank you for holding this hearing, because it is very im-
portant. I think you very eloquently stated the fact that this was
the number one issue in the White House Conference on Small
Business.

We have all seen the headlines in the last few years: 'The IRS
Wages War on the Self-Employed." "Rebuffmg IRS Attacks on
Workers." "Revenge of the Tax Man." The headlines go on and on.

Even yesterday, there was one in USA Today that I didn't bring
along, but it was quite graphic. These are the recent articles on
how the IRS has used murky, subjective criteria to target honest,
self-employed entrepreneurs, and reclassify them as employees.

Let me lay out some of the background on this pervasive prob-
lem. Although in today's high-tech world there are many working
relationships with businesses and individuals, the Internal Reve-
nue Code classifies all such relationships into two categories; either
you are an employee, or you're an independent contractor.

Some workers are categorized by law as one or the other. Other
workers may be classified as independent contractors, with a rea-
sonable amount of certainty under the safe harbors enacted in Sec-
tion 530 of the Internal Revenue Code.

Those not fortunate enough to fall under these two classes are
carefully scrutinized under the IRS' infamous 20-factor test derived
from common law.

What does it matter whether someone is an employee or an inde-
pendent contractor? This distinction is important because it deter-
mines whether the payor or the payee is responsible for the with-
holding of income tax, and the payment of FICA and unemploy-
ment. In other words, it has little to do with how much tax gets
paid, but everything to do with who pays it.



Almost everyone will agree that the 20-factor test is unclear, and
far too subjective. It is quite possible to take two seemingly iden-
tical situations, and find employee status in one, and independent
contractor status in another.

Nevertheless, in recent years, the IRS has bludgeoned small
businesses over the head with the 20-factor test, targeting truckers,
florists, travel agents, computer programmers, and even ministers.

According to one recent estimate, the IRS' war on our Nation's
job creators has resulted in the reclassification of 439,000 inde-
pendent contractors, and the collection of $678 million in fines and
taxes since the mid-1980's.

The IRS' actions have been especially deadly to small business
people. Unlike their Fortune 500 counterparts, our Nation's small
businesses cannot afford to pay the fancy tax lawyers and litigators
needed to defend themselves against the IRS legal hit squads.

Consequently, rather than fighting the IRS and its use of the
murky 20-factor test, many entrepreneurs are forced to close their
doors, putting countless industrious Americans out of work. We
will hear from some of those entrepreneurs today as a matter of
fact. I've gotten to know a couple of the people who are going to
be testifying in a little bit, and their stories are horrendous.

America's small business people have finally said enough is
enough; and as you said. Madam Chairwoman, the White House
Conference on Small Business named this as the number one issue.
They had over 60 proposals, and this got the top vote.

The delegates recommended that Congress should recognize the
legitimacy of an independent contractor, stating further that the
current common law 20-factor test is too subjective. The conference
delegates called upon Congress to establish realistic and consistent
guidelines.

Those on the front lines have spoken and we've listened. On June
30th, just 2 weeks after the Small Business Conference, I and 100
original cosponsors introduced H.R. 1972, The Independent Con-
tractor Tax Simplification Act of 1995.

Unlike past attempts to resolve this issue, H.R. 1972 defines who
is not an employee. It establishes distinct, clear, and objective cri-
teria for those seeking to perform services as an independent con-
tractor. These new criteria may only be used if the independent
contractor and the business for whom the services are being per-
formed correctly comply with income reporting rules.

Specifically, H.R. 1972 establishes a three-part objective test for
determining whether someone is not an employee. To qualify as an
independent contractor, you must meet all three parts. Two of the
parts contain subparts, but you must only meet one to satisfy that
part. Let me go through the criteria briefiy.

Part one: Investment. Does the individual have a significant in-
vestment in training or assets; or incurs significant unreimbursed
expenses; or agree to work for a specific time, or complete a specific
result, and is liable for damages for failure to perform; or receive
compensation primarily on a commission basis; or purchase a prod-
uct for resale. If the individual satisfies any one of these subtests,
then part one has been met.

Part two: Independence. Can the individual demonstrate just one
of the following subparts. The individual has a principal place of



business; or does not primarily provide the service in the service
recipient's place of business; or pays a fair market rent for the use
of the service recipient's place of business.

Or is not required to perform service exclusively for the service
recipient, and has performed a significant amount of service for
others; or has offered to perform service for others through adver-
tising, individual written or oral solicitations, listing with agencies,
brokers, or others; or provides service under a registered business
or trade name. Meet any of these four subtests, and you satisfy
part two.

Part three: A contract. Is there a written agreement between the
parties? This helps clarify each party's responsibility for the pay-
ment of taxes, thereby aiding compliance.

That's it. Meet all three parts — independence, investment, and a
written contract — and you qualify as an independent contractor.

But remember the independent contractor and the business for
whom the services are being performed must correctly comply with
income reporting rules. If they fail to do so, then they are left with
the burdensome 20-factor test, and all of its traps.

It is important to note that my bill does not eliminate the 20-fac-
tor test, nor the safe harbors under Section 530. It simply provides
for an alternate test that can be used if you comply with all income
reporting requirements.

As a matter of public policy, our tax laws should not favor em-
ployee status over independent contractor status, or vice-versa. In-
dividuals should be free to enter into business arrangements of
their own choosing without the IRS pushing them into one category
or the other.

Despite a well-documented record of discouraging independent
contractor status, the IRS is now on record that it will not discrimi-
nate against independent contractors. Margaret Richardson, the
Commissioner of the Internal Revenue Service, told delegates to
the White House Conference on Small Business, that the IRS "does
not care whether someone is an employee, or an independent con-
tractor, as long as they properly report their income."

H.R. 1972 clearly satisfies her reasonable request, and I look for-
ward to working with Mrs. Richardson on this important issue.

In closing, Madam Chairman I want to thank you and my col-
leagues on the subcommittee for holding this hearing today.

We are in a changing world. No longer will the majority of Amer-
icans earn a living in the fields and factories that many of us and
our ancestors toiled in. Rather, we are at the brink of the Third
Wave Information Age as Speaker Gingrich has so vividly de-
scribed.

This new era will feature new types of employment relationships,
where people can work out of their homes and "telecommute";
where individuals can service thousands of customers all over the
world through the push of a button. It will foster the entrepreneur-
ial spirit that has made this country great.

This new era has the potential of bringing enormous improve-
ment to the lives of all Americans. Our laws should encourage, not
hinder, this development. That's precisely why we need to adopt a
new, clear, objective standard for determining who is self-employed,
and who is not; a standard based on freedom, which allows those



who wish to benefit from this new era to do so. Thank you, Madam
Chairman, for the opportunity to testify here today.

[Mr. Christensen's statement may be found in the appendix.]
Chairwoman Smith. Thank you, Mr. Christensen. We would like
to have Mr. Kim next. He does have to leave at 10:30 this morning.

TESTIMONY OF HON. JAY KIM, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CALIFORNIA

Mr. Kim. Well, thank you. Thank you, Madam Chairwoman. My
colleague already stated beautifully, and his bill and my bill are
about the same, except for what I will go over later. But let me add
to what my colleague said, and that is that my bill was submitted
almost a year ago.

The problem is that often if you hire somebody, like an independ-
ent auditor, or accountant, or a marketing consulting firm, and you
thought that they were an independent contractor, or an independ-
ent businessman. Five years later the IRS comes down and audits
your books, and says, I'm sorry, he should have been carried as an
employee.

Can you imagine the penalties that he has to pay back — and all
the FUTA taxes, PICA taxes; and not only that, since he is an em-
ployee, you have got to pay all the holiday, and sick leave, and va-
cation, and combine this together, sometimes it's about $200,000
per case, and all you have to have is a couple of those, and you're
going to go out of business.

This is the horror story that I have been hearing. I was a small
businessman myself, and I have had similar experience. So, that's
why the White House Conference on Small Business recognized
this problem, and they took this problem as their number one pri-
ority, and I'm glad of that, because I presented this problem a year
ago to various small businesses.

So, all I'm trying to do here is correct the problem. Back in 1987,
I believe. Congress passed a Section 530 Rule, which failed to clear-
ly define what independent contractor means. It's not clear.

So, what happened is the IRS set their own regulations, their
own rules, called the 20-factor test, as my colleague mentioned. It's
arbitrary, and here it is, and if you don't meet the criteria, then
automatically you are no longer considered as an independent con-
tractor.

You go back and have back taxes, and back penalties, and there
is nothing much you can do as an employer, and as a businessman.
So, as my colleague mentioned, my bill is simple. The first half de-
fines what the independent contractor is, and I'm going to tell you
what that is. It's almost the same as his. Are you sure you didn't
copy mine?

Mr. Kim. To be an independent contractor, you must meet one of
four criteria: First of all, the worker must be able to realize a profit
and loss. I mean, you have to have some kind of practical law. If
you are an employee, you never have a loss. So, that's the first cri-
teria.

Second, you've got to have some kind of a separate, physical
place of business. You can't use the place that you are doing busi-
ness with. You have got to have some kind of business place.



Third, you've got to have some kind of investment. You have to
have a computer or something. You can't just say I am an inde-
pendent business, and have nothing. Finally you have got to have
some commission basis rather than a paycheck. But most of all, one
mandatory is that you must have a written agreement between two
parties, which spells out the scope of work, and duration of the
services.

It is common sense, very common sense. Instead of all the com-
plicated 20-factor test, all you have to do is look at it with very
common sense. Now, the only difference between his bill and my
bill is that my bill goes one step beyond.

My bill gives a tremendous break to small business owners, how-
ever, there are a couple of things they have to do in return. First
of all, all the service providers, and this gets the independent con-
tractor, must file an income tax at the end of the year, which would
spell out individual services they rendered.

Right now they don't have to. It just simply says total amount
of revenues is $500,000, period. After this bill is passed, they have
to itemize, and at the same time the recipient, the service recipient
has to even file a 1099. You must file a 1099, so that the IRS can
match easily.

It only takes a couple of seconds to match it by computer. Right
now there is no way they can match it, because service providers
simply lump together as a revenue, and the 1099's spell out what-
ever service they receive, and it's hard to match.

So, they have to be under some obligation for making sure that
they list individual services they rendered, and then the recipient
has to file a 1099 so that the IRS can match.

The second inclusion I have, and which my colleague doesn't
have, is if a business fails to issue a 1099 to the worker, then we
are going to increase the penalty. Not very much. If you did it un-
intentionally, then that would be a $75 penalty per case instead of
$50.

If you did it intentionally, then it increases to $125 per case. It's
really a marginal penalty fee. Basically, that's it. I do have a 530
safe harbor clause which protects the employers, but those are
minor provisions.

Basically, I just have gone a little beyond my colleague here, and
that's about it. I'd be more than happy to answer any questions you
have.

[Mr. Kim's statement may be found in the appendix.]

Chairwoman Smith. Thank you, Mr. Kim. I have read both of
your bills, and I like the basic concepts and principles of both of
them. I would have drafted both of them slightly differently, but
that's what this place is all about. In general, it looks like you used
the recommendations of the GAO study of 1977; is that right?

Mr. Kim. That's correct.

Chairwoman Smith. They were reasonable, and so I see where
you're going, and I think that they are both well-drafted bills, and
I like to see new concepts come together. But with that, I would
like to introduce Mr. Meehan, and his opening statement, and then
we will go right to questions so that you can get over to the presen-
tation before Congress.

Mr. Kim. Sure.



Mr. Meehan. Briefly, I thank both of my colleagues for testifying
here. Small businesses in my district agree that the 20-factor test
used by the IRS to determine compliance is too objective. I, along
with many of my colleagues, support the White House Conference
on Small Business recommendations to establish a clear definition
of independent contractors, including the existence of a written
contract, and the realization of profit or loss, and a separate place
of business, and payment of commissions.

But most importantly, I think it's crucial to include the small
business community in any legislative clarifications of independent
contractor status. It seems to me that too often the small busi-
nesses lose their voice in Grovernment regulatory agencies.

So, again I thank you for your testimony, and I think that work-
ing together we will be able to legislate a solution to a nagging
problem for the small businesses across the country; and as a Dem-
ocrat, I look forward to working to a solution to this problem.
Again, I thank you for your testimony.

Mr. Kim. I would like to propose that my colleague maybe would
join this together and make one bill instead of two bills. They are
about the same anyway.

Mr. Meehan. I have an inquiry as to who copied whose bill.

Mr. Kim. We copied each other.

Mr. Meehan. Maybe we could have a special hearing on that
after the House hearing on this?

Chairwoman Smith. I think when he says it's common sense, it
was probably true. But, thank you. I'm going to start with ques-


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Online LibraryUnited States. Congress. House. Committee on SmallClarifying the status of independent contractors : hearing before the Subcommittee on Taxation and Finance of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, first session, Washington, DC (Volume Pt. 1) → online text (page 1 of 12)