Should an associate be classified as an employee or an independent contractor? Under most circumstances the associate dentist should be classified as an employee. Generally, businesses and or business owners must withhold income taxes, withhold and pay Social Security taxes and Medicare taxes, and pay unemployment tax on wages paid to employees. Employers generally do not have to withhold or pay any taxes on payments paid to independent contractors.29 In many cases owner dentists are looking for ways to avoid having to pay payroll taxes, unemployment insurance, pension contributions, etc. Thus, it is advantageous financially for an employer to designate an associate as an independent contractor. An attempt to classify an associate as an independent contractor in the long run may prove to be costly to all parties concerned. As far as the IRS is concerned, employment agreements carry no weight in the determination as to the status of the individual performing the services. How does the IRS differentiate an independent contractor and an employee?
Determining Whether the Individuals Providing Services are Employees or Independent Contractors
Before an employer can determine how to compensate someone, it is absolutely necessary to analyze the business relationship that exists or will exist between the employer and the person performing the services. For the purposes of this course, the person may be classified either as an independent contractor or a common law employee. As a general rule, according to the IRS, an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who works as an independent contractor are subject to Self-Employment Tax (the total amount of social security/Medicare tax as discussed in a previous section, ~15.3% up to an income threshold which increases from time to time). In determining whether the person is an employee or independent contractor in the eyes of the Internal Revenue Service, a preponderance of the evidence defines the business relationship that exists between the employer and the person performing the services. All information that provides evidence of the degree of control and independence must be considered. The facts that provide evidence of the degree of control fall into three categories.
IRS Form SS-8 delineates the lengthy list of questions to be answered in determining employee vs. independent contractor status.
The key is to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in determining the relationship. If classification as an independent contractor is desired, the following steps need to be taken. First, both the owner and the associate need very good legal counsel. It is probably best to secure the services of employment or labor law attorneys. Next, each party should form a corporation if not already incorporated. Many dentists still practice as non-incorporated solo practitioners, thereby exposing their personal assets to potential lawsuits. By law, corporations may not be treated as employees, and corporations provide a veil of protection for personal assets such as houses, retirement holdings, cars, etc. The associate’s corporation then contracts with the owner’s corporation for services. These arrangements need to be carefully executed and documented as harsh penalties exist for both the owner and the associate should the IRS determine an employee relationship exists and not that of an independent contractor. This type of an arrangement can carry with it advantages and disadvantages for both parties. Legal counsel will be able to provide those details.
As a practical matter, there are two long-term consequences for both parties to consider should an associate work for the owner as an independent contractor. First, structuring a reasonable and enforceable non-compete/restrictive covenant (in states where this is enforceable) can be quite a legal challenge when applied to independent contractors. So, attorneys specifically experienced in this precise area should be involved in crafting contracts. In most cases, restrictive covenants do not readily apply to independent contractors. Applicable state law and counsel from a labor law attorney are definitely needed. The second consequence correlates with the first one. Namely, an independent contractor is, in fact, developing his/her own dental practice, possibly “under the roof” of the owner’s practice and/or at other locations. In any case, if the independent contractor builds a thriving practice in two to four years, the independent contractor may have no interest in buying out the owner or in forming a partnership because the independent contractor already has a strong equity position in a successful dental practice. Owner-dentists considering developing an independent contractor relationship with an associate need to carefully consider these two long-term consequences.
Finally, any associate practicing as an independent contractor MUST form a corporation and, in turn, be hired by his/her own corporation. There are two main reasons for this. First, being incorporated provides at least a shield of protection against potential lawsuits, affording much more protection for personal assets such as retirement accounts and real estate. Second, tax strategies are available to mitigate legally and ethically the increased tax burden in a corporation context, especially the 15.3% self-employment tax.