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Using Independent contractors – be careful!

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Using Independent contractors – be careful!

This article was previously published in Appraisal Today and was written by Ann O’Rourke. It is copyrighted. For reprint permission, Contact Us.

The only useful book I know of for appraisers is the Independent Contractor/Appraiser Defense Guide, written by Atom Levi, MAI, SRA, Steven Davenport (attorney), and Gary Mesmer, CPA. The Guide has a sample independent contractor contract and provides excellent advice. To purchase the book for $99, call 800-835-0640.

Every month at least one appraiser calls me about using independent contractors. Unfortunately, it is usually in reference to an ongoing audit by the IRS or a state employment department. Often the audit was triggered by an appraiser filing for unemployment.

Correctly treating your appraisers as employees or independent contractors is very critical to the success of your company. Incorrectly classifying appraisers as independent contractors can bankrupt your firm if you fail an IRS audit.

What if all your appraisers are employees or correctly classified as independent contractors (ICs)? This article can help you stay “legal.” If you know another appraisal firm using risky practices, you can tell them the primary factors and where to go for advice.

Why does the government care about ICs?

Money, money, money. ICs pay their taxes at much lower rates than employees, who have taxes deducted from each paycheck.

There is some concern about worker exploitation, i.e., being paid less than the minimum wage for piece work, but the primary reason is money. Some appraisal firms got into trouble when they had trainees working for free.

Appraiser myths

Appraisers have many misconceptions about independent contractors. Here are the most common ones:
• I pay on a fee split so my appraisers are ICs. No. Fee split appraisers can be employees or ICs.
• Appraisers are the same as real estate agents. No.
• I have a “right” to classify my appraisers as ICs. No.
• None of my appraisers will ever file for unemployment compensation. Maybe, if you’re lucky.
• My appraisers will always file their tax returns and pay their taxes. Maybe, if you’re lucky.
• I’m just doing what “everyone else does.” If you’re lucky they won’t audit you first.
• I have a written independent contractor agreement, so I’m okay. It is better than nothing, but auditors look at what you are actually doing.
• My appraisers want to be ICs. They would also like company cars, higher fee splits, free tuition, etc.
• Trainees can be independent contractors. No. ICs are already trained.

What are independent contractors, legally?

The basic factor for independent contractors is that the company gives up control. You can’t tell them which appraisals to do, when to work, etc.

Independent contractors are experienced appraisers and businesspeople who pay their own taxes, set their own hours, etc. If you have an appraisal business, you are an independent contractor to your clients. Your ICs should have the same relationship with you.

You have your own business cards, phone number, computer, data services, multiple clients, etc. Your ICs should also. They are your competitors.

If you provide desk space, data, phones, photocopies, etc. it is safest to charge the ICs back for everything they use in your office. Buy the Independent Contractor/Appraiser Defense Guide, which shows how to set up this type of “umbrella” company. See bottom of the next page for ordering information..

Why is the use of IC appraisers so common?

I have never been able to find out why the use of ICs is so widespread and has been going on for so long in the fee appraisal industry, but I suspect it is a “legacy” from the old days when many appraisers were also real estate agents.

For many years, commercial appraisal firms have used independent contractor appraisers to handle their volume swings. They worked for a number of different appraisal firms. These IC appraisers were usually very experienced and had their own businesses, often doing both full fee and fee split work.

In recent years, the lender component of the appraisal industry has seen a major restructuring. Many lenders downsized (or eliminated) their appraisal departments, shifting the workload to independent fee appraisers. Independent appraisal firms, especially residential firms, handled a larger amount of the work load and needed appraisers who worked for them exclusively. Firms hired both trainees and experienced appraisers who were often classified as ICs.

What about incorporated ICs?

ICs who are incorporated are independent contractors. They are separate business entities.

What about real estate agents?

For some reason, appraisers think they can treat their associate appraisers just like real estate agents are treated. This is incorrect.

Since agents must work under a broker and be supervised, obviously they don’t meet the requirements for independent contractor status. As far as I know, all states have a special exemption from employment laws for real estate agents. They also have an exemption from the IRS.

What about special state appraiser laws?

At least one state has passed a law allowing appraisal firms to classify their appraisers as ICs, just like real estate firms. Unfortunately, these laws don’t apply to the IRS regulations and laws.

What about “safe harbor”?

If you are audited by the IRS and lose, you could qualify for safe harbor, which only applies to federal taxes. Special rules apply.

Your tax attorney should be familiar with this regulation.

What about SS-8 rulings?

I don’t recommend filing an SS-8, request for an IRS private letter ruling. The rulings cost between $500 and $2,000, depending on the income of the requester, according to my sources.

Four rulings were made between 1986 and 1990 by appraisal firms. All of them found the appraisers to be employees.

SS-8s can be sent in by disgruntled appraisers. If one of your current or former appraisers sends in an SS-8, contact a labor law attorney specializing in independent contractors.

When are appraisal firms audited?

Typically, firms are audited when an independent contractor appraiser files a claim for unemployment insurance.

Other reasons include:
• Dramatic increase in amount of dollars for 1099s from one year to the next.
• Appraisers in your area are targeted by the IRS or a state agency.
• Workers compensation claim.
• An appraiser doesn’t file income tax returns.

What is your financial risk?

Losing an IRS audit is the greatest financial risk. You can be liable for up to three years of federal income and social security taxes that your ICs owed. If you lose, the financial costs can be substantial, in the $100,000s for larger firms.

If audited by a state employment agency, you would be liable for state income taxes, unemployment, and other taxes. The dollar amount is usually much lower than for the IRS. However, you are more likely to be audited by your state agency, due to an unemployment claim.

Get a good labor law attorney to negotiate for you. Defense costs can be high but cheaper than the taxes, fines, and penalties.

What to do when you get a request for an audit

Don’t ever, ever try to “do it yourself” in an audit. Don’t communicate in any way with the auditing agency until you speak with a labor law attorney experienced in independent contractor audits.

Don’t rely on your regular attorney, accountant, or other appraisers for advice.

Don’t allow an auditor to speak with your workers or to step inside your door.

Changing from ICs to employees 

I changed from ICs to employees in my second year of business (1987). In my first year of business I had an IC trainee because that’s “what everybody else did.” Then I read the IRS rules and knew I would fail an audit. I figured I would owe about $10,000 and sweated out my three-year waiting period. Since then, all new appraisers have been employees. ICs are too much of a hassle for me and the state employment department here in California is very aggressive.

Changing when you have appraisers working for you can be difficult. Appraisers used to getting a “gross” check don’t want to have deductions taken out. Appraisers who were employees don’t want to become ICs and set up their own businesses.

Having both appraiser employees and full time ICs is very, very risky, unless the employees are trainees, who can’t be ICs until trained. If you are incorporated, your officers can be employees and you can still use ICs.

Why use ICs if it is so much of a hassle?

Increasingly, our economy is changing from long-term employment to short-term employment and independent contractors.

Managing work flow in an appraisal business is tough, because of the unpredictable volume.

ICs are hired for a specific assignment and the client has no obligation to use them again. Many laws apply to employee terminations.

Many appraisers want to be classified as ICs so they can receive “gross” checks with no deductions. Of course, that’s why the IRS and states don’t like ICs!

If you don’t reduce your fee splits to cover your share of Social Security, workers comp, unemployment, etc. your profits will go way down.

Where to get more information

There are many articles and a few books about Independent Contractors, but all of them I found too general to use for appraisers.

The only useful book I know of for appraisers is the Independent Contractor/Appraiser Defense Guide, written by Atom Levi, MAI, SRA, Steven Davenport (attorney), and Gary Mesmer, CPA. The Guide has a sample independent contractor contract and provides excellent advice. To purchase the book for $125, call 800-835-0640.

Previously published in Appraisal Today. Written by Ann O’Rourke.