Taxes and Audits

Carol's post on Taxes / Back to Free Stuff

3/96, From Dianne Simon: This is a questionnaire received by an independent contractor MT from the IRS regarding her account with a hospital. (Note that there is no question on receiving instructions.)

Please answer all of the following questions as completely as possible. A follow-up questionaire or a short telephone conference call may be necessary to clarify any responses you may have made to this questionaire.

1. What is your occupation?
2. Please describe the nature of your business; the type and kind of service rendered.
3. How many years have you actively engaged in this business?
4. Please list your business address and business telephone number.
5. Who do you pay rent to, and how much do you pay?
6. Under what circumstances does your business conduct its services with clients. (formal contract, referrals, etc.)
7. What expenses are incurred by your business in conducting services to your clients?
8. Please list or provide a sample of your business expenses.
9. Who performs the services?
10. Do you have a payroll?
11. Do you hire assistants or employees?
12. Please list your federal employer identifying number.
13. Where are the services conducted?
14. Do you do any advertising?
15. What are the names of the telephone books, professional directories, etc. where your company is listed? How is it listed and classified. Please attach a sample.
16. Please list and estimate the value of your investment in your business.
- A. Furniture and Equipment.
- B. Material and Supplies.
- C. Other.
17. How do you generate new business?
18. Why and when did you decide to go into business for yourself?
19. How much time do you devote to running your business on a daily/weekly basis?

With respect to your business activity last year, please provide the following; if you have not provided any of the items listed, please explain.

1. A copy of your business license.
2. A copy of your professional license.
3. Certificate of insurance; business coverage protection and professional malpractice coverage.
4. A sample of your billing invoice.
5. A cancelled business check.
6. A sample of your business correspondence letterhead.
7. In addition to this company, please list your other business clients during the year.
8. Were you employed part time or full time during this time period by any other firm, hospital, health facility, or any other institutions?
- A. Please identify and indicate in what capacity.
- B. Please provide copy of Form W-2 or Form 199 as applicable.
9. What is your job description, your duties and responsibilities with respect to this company.
10. What is your educational background and employment history? (If you have a resume, please attach a copy.)
11. Where are you licensed to practice your skills?
12. How do you plan your typical workday, your weekly and monthly work schedule?
13. Please indicate percentage of time allocated/devoted to each activity and gross receipts derived from each activity.
- A. Business/Form 1099 Income.
- B. Form W-2 wages.
14. What do you do on a typical workday?
15. What exactly do you do in behalf of this company or related facility?
16. At what location do you perform your services for this company or related facility?
17. Do you have an employment contract with this company or related facility?
18. Please identify any benefit plans under which you are covered by this company; health insurance, malpractice insurance, profit sharing, etc.
19. How were hired by this company or related facility, and under what circumstances can you be discharged from your duties?
20. Were you ever employed by this company or related facility as a full time or part time employee and received a Form W-2? If yes, for which years?

2/96, from Donn: Remember, you do not have to pay self-employment taxes if you are a statutory employee as they are already paid. On the 1099, be sure to highlight the box stating you are a statutory employee. You can claim a home office, as you need this area and this equipment in your home in order to allow you to work for my employer at home, along with other business expenses.
From Toni Mercadante: If any of you own your own homes and are thinking of selling within the next several years, talk to your accountant about it. I, too, claimed a home office deduction when I lived in New York -- 10 room house, 1/10 of utilities, etc. When we were transferred to Georgia and sold the house, the government considered 1/10 of the sale price as "income" for the business. This was truly not "income"; after all, 1/10 of the money from the sale of the house was not actually seen by the business or available to the business per se, but the business, nonetheless, was responsible for paying the taxes as far as IRS was concerned. Our accountant worked us around it by submitting ammended returns for the previous three years and I submitted my check to make up for the three years' "underpayment" as far as taking the home office deduction for those years. It was, however, a lot less than the taxes I'd have to pay on 10% of the sale of our home. I no longer claim home office deduction. I'm not sure what the time frame is now; then, it was three years. So, if you have a home office and there is any possibility of selling your home in the not-too-unforseeable future, check with your accountant as to how soon you would need to stop taking the deduction before running into the difficulty I did.
2/96, from Toni Mercadante: Be sure to double check the amount indicated on each 1099 against your records. I just received 1099 from my NY client and the amount shown was $1,300 over what I had billed and they had paid in 1995. Yikes! I called, verified, and asked for either a corrected 1099 or the $1,300 immediately.

From Liz Hugger: I'd like to add a personal experience regarding your advice above. This happened to me about four years ago - client erred by over $2,000. I requested and received a new corrected 1099, but they forgot to check the little box on top - "void" for the incorrect one; "corrected" for the corrected one (and I never noticed this either). As a result, the IRS notified me that I had under reported my income by about $15,000! It seems they thought this account had actually paid me the original incorrect amount as well as the corrected one. My accountant solved the problem without difficulty, but the moral of the story is to make sure your amended 1099 has the "corrected" box checked.

1/96, from Ron Magnussen:
Question: This is our first year filing taxes for my wife's transcription service.One our customers has given us a 1099-Misc form for "non-employee income". Is this typical and is it correct? This same customer has told us they paid sales tax for us and we should start collecting it ourselves. They are in Connecticut. We have other customers in NY. I had posted a while ago on this question and got a response from a transcriptionist in Mass who said it is not necessary to charge or collect sales tax there for medical transcription. Does anyone have info about CT and NY? It would be great if we could get a list of all state's rules for the Web site, of course, all sorts of disclaimers about "checking this with your own accountant or tax attorney" would probably be necessary.

From Toni Mercadante: If your wife is an independent contractor, then a 1099 is appropriate. I may be off on the amount, but I believe a 1099 would be required from every client who has paid $600/yr or more in fees for service. I believe I may have responded to your note on the same subject last year. I was in business in NY for many years before relocating to Georgia. I checked on the sales tax question while I was doing business in NY, and the understanding I had at the time was that no sales tax is charged on this type of service (MT). There would, however, be a need to charge sales tax if you provided services consistent with operating a printing business. This doesn't encompass transcribing dictation and then presenting a hard copy plus perhaps one or two cc's as would be expected in the normal course of providing the services we do. However, if the scope of your business goes beyond that and includes, for example, preparing brochures and then printing them in volume (hundreds/thousands) for your client rather than having the client take the "master" to a printer for reproduction, then the "volume printing" charge would be subject to sales tax (just as it would be at PIP or QuickPrint).

The best way to make sure would be either to consult your personal accountant or call the New York State Office of Taxation and Finance (should be listed in the Blue Pages). I would suggest you contact the appropriate tax department for Connecticut as well. If you live in New York and provide services to clients in Connecticut, there may be some other "rules" you need to be aware of, and their requirements regarding sales tax on services may be considerably different from those in New York.

Employee or Independent Contractor Status
IRS and EED Audits
10/22/95, by Doris Anderson
Copyright by Doris Anderson

Recently, I was audited by the State of California, Employment Development Department (EDD). "The main focus was to review payments made to individuals who were not classified as employees and to validate their proper status as independent contractors or employees." This was in reference to the independent medical transcriptionists who assisted me in my medical transcription service. Upon notification of the audit, I felt that I was basically prepared. A few years prior, I obtained professional advice from an attorney and followed it. I also retained a C.P.A., and tried to keep accurate business records.

I chose to have my C.P.A., who had previous audit experience, represent me for my EDD audit. The audit was held at my C.P.A.'s office. The auditor asked about my medical transcription education, training, and work experience. I was requested to show my business license, letterhead stationery, and business card. I explained my daily routine and showed examples of my work and procedures. I brought all the requested documents, well-organized, for the three years requested; federal and state tax returns, Schedule C records, IMT invoices and my cancelled checks, check registers, IMT contracts, 1099-Misc Forms issued to IMTs just to name a few. The auditor requested copies for many of these documents, which my C.P.A. supplied. The auditor then questioned me extensively regarding my working relationship with the IMTs. Yes, the question and answer session entailed the 20- common law factors! The whole process took the better part of the morning. At the end of the audit, my C.P.A. and I were informed that "fraud" was not an issue in my business affairs. However, the auditor would have to contact the IMTS by telephone to get their input. A few days later the auditor completed the telephone interviews with some of the IMTs, verifying my audit statements or checking for discrepancies. The auditor later informed me of her decision by telephone, ruling in my favor. This was followed by a letter, listing the auditor's findings and decision. Fortunately, in my case, no change resulted.

The following is not intended nor should it be interpreted as legal or tax advice, but information I learned of prior to or during my audit process. Please consult with your professional advisors for your particular situation.

According to Independent Contractors: A Manager's Guide and Audit Reference, the IRS and several government agencies determine independent contractor (IC) versus employee status. The book offers the following: IRS, Employment Development Department/Franchise Tax Board (EDD/FTB), INS, CA Workers' Compensation Appeals Board, US Labor Department, CA Labor Standards Enforcement Office. The major issue is the right to control--whether it is exercised or not. Each of these agencies have compiled their own list of factors with regard to control in a relationship. Some of these rules are interpreted differently by each agency, creating conflict. I understand that some of the "gray" issues may be a subjective interpretation by the auditor.

The IRS has determined common-law rules, identified as 20 factors which are used as guidelines to evaluate an employer-employee relationship. Every situation is different and the degree of importance of each factor may vary. The 20 factors are listed in IRS Publication 937, Employment Taxes and Information Returns, entitled Employee or Independent Contractor? Some public libraries may have the Tax Information Publications, Volumes I through V, for reference, as well as copies of the various tax forms published by the IRS. Or, you can call the IRS's toll free number to request forms and publications: (800) 829-3676.

When starting your own business, think of your own protection. Your best audit defense may be to consult professionals, such as a C.P.A., attorney, and an insurance agent. A business that engages independent contractors is prone to risk. Surprise--a signed contract with an independent contractor may be disallowed in an audit. The element of control in the working relationship is the major issue. And circumstances may develop over the course of time in a working situation, converting an IC to employee status. If an audit occurs and the IC is reclassified as an employee, back payroll taxes, fines, and interest can be substantial, especially if the audit goes back three years.

Another defense is to keep detailed, accurate, well-organized business records for documentation in the event of an audit. Finance software is being recommended to track your business records and increase your credibility in an audit. Bottom line: the burden of proof is on you.

If you are scheduled for a business audit, you will be instructed as to the records that will be reviewed. You have the legal right to be represented at an audit, such as a C.P.A., tax attorney, or an enrolled agent. Some representative C.P.A.s and enrolled agents would prefer to meet alone with the auditor, as clients can sometimes be a problem in an audit. However, I do not buy into that idea. No one knows my business better than I do. If it is my business on the line, then I want to be present and hear what is being discussed. During an audit interview, if you are not sure of an appropriate answer, you do have the right to stop the process, confer with your representative, and then resume the interview.

There are generally three types of audits: (1) Correspondence; (2) office audit (you and/or your representative are requested to appear at the IRS office); (3) field audit (auditor visits you, usually at your place of business or the office of your representative). If you do not comply with the IRS' 20-common law factors, in some cases, you may be protected by the IRS "Safe Harbor Rules", Section 530. Consult with a C.P.A., enrolled agent, or attorney for expert advice. If you fail to resolve the disputed issues and lose an audit, you can appeal it, although the decisions are not easily overturned unless clearly in error.

IRS, forms and publications, (800) 829-3676
IRS Publication 937, Employment Taxes and Information Returns
IRS Publication 334, Tax Guide for Small Business

Public libraries: Tax Information Publications, Volumes I-V.

Independent Contractors: A Manager's Guide and Audit Reference, California Chamber of Commerce, ISBN 1-878630-57-1, (800) 331-8877. Although this is published by the California Chamber of Commerce, it is an excellent resource for information. It will offer dos and don'ts, as well as tips if you believe that you do not quite meet the 20-common law factors.

The Wall Street Journal Guide to Understanding Your Taxes, ISBN 0-671-50235-2, approximately $14.95.

The National Association of Enrolled Agents, (800) 424-4339, can be contacted for a referral in your area.

The 20 points for IRS Classification as Independent Contractor (IC):

1. INSTRUCTIONS. A worker who is required to comply with other persons' instructions about when, where or how he or she is to work is ordinarily an employee.
2. TRAINING. Training a worker by requiring an experienced employee to work with the worker or by using educational or other methods of training, indicates that the person for whom the services are being performed wants the services performed in a particular manner. Thus training usually evidences an employer/employee relationship.
3. INTEGRATION. Integration of the worker's services into the business operation generally shows that the worker is subject to direction and control of an employer.
4. SERVICES RENDERED PERSONALLY. If the services must be rendered personally by the worker, rather than someone hired by him, presumably, the person for whom the services are performed is interested in the methods used to accomplish the work as well as the results, indicative of the employer/employee relationship.
5. HIRING, SUPERVISING AND PAYING ASSISTANTS. If the employer hires, supervises and pays assistants, that factor generally shows control over the worker or the job.
6. CONTINUING RELATIONSHIP. An on-going relationship between the worker and employer usually indicates that an employee/employer relationship exists.
7. SET HOURS OF WORK. The establishment of set hours of work by the employer is a factor indicating control.
8. FULL TIME REQUIRED. If the worker must devote substantially full time to the business of the employer, such person is usually considered to be an employee. An IC, on the other hand, is free to work when and for whom he or she pleases.
9. DOING WORK ON EMPLOYER'S PREMISES. If the work is performed on the premises of the employer, that factor suggests control over the worker, especially if the work could be done elsewhere.
10. ORDER OR SEQUENCE. If a worker must perform services in the order or sequence set by the employer, that factor shows control.
11. ORAL OR WRITTEN REPORTS. A requirement that the worker submit regular oral or written reports to the employer indicates control.
12. PAYMENT BY HOUR, WEEK, MONTH. Payment by the hour, week or month generally points to an employer/employee relationship, while payment made by the job or on a straight commission generally indicates that the worker is an IC.
13. PAYMENT FOR BUSINESS AND/OR TRAVEL EXPENSES. If the employer pays the worker's business or travel expenses, the worker is ordinarily an employee.
14. FURNISHING OF TOOLS AND MATERIALS. The fact that the employer furnishes significant tools, material and other equipment tends to indicate the existence of an employer/employee relationship.
15. SIGNIFICANT INVESTMENT. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by the employees, that factor tends to indicate that the worker is an IC.
16. REALIZATION OF A PROFIT OR LOSS. A worker who can realize a profit or suffer a loss as a result of the worker's service (in addition to the profit or loss ordinarily realized by employees), is generally an IC, but the worker who cannot is an employee.
17. WORKING FOR MORE THAN ONE FIRM AT A TIME. If a worker performs more than minimal services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an IC. However, a worker who performs services for more than one person may be an employee of each of those persons, especially where such persons are part of the same arranagement.
18. MAKING SERVICE AVAILABLE TO GENERAL PUBLIC. The fact that a worker makes his or her services available to the public on a regular and consistent basis indicates an IC relationship.
19. RIGHT TO DISCHARGE. The right to discharge a worker without liability is a factor indicating that the worker is an employee.
20. RIGHT TO TERMINATE. If the worker has the right to end his or her relationship with the employer without incurring liability, that factor indicates an employer/employee relationship.

10/15/95, from Judy Karleen,

Information taken from "The 1992 Guide to Hiring Independent Contractors," published by the California Chamber of Commerce.
To qualify for independent contractor status for the IRS, a transcriptionist needs to meet the following "20 factors":

1. No instructions are furnished to accomplish a job.
2. A contractor cannot receive training from a hiring firm.
3. Contractors have the right to hire others to do the work for them.
4. A company's success or continuation should not depend on the service of outside contractors (i.e., the job the contractor does should not be the hiring firm's primary business).
5. Contractors set their own work hours.
6. Contractors do not have a continuing relationship with the hiring firm. Work can be frequent, but it must be at irregular intervals.
7. Contractors do not hire, supervise, or pay assistants at the direction of the hiring company.
8. Contractors should have enough time to pursue other gainful work.

9. Contractors control where they work. If it is on the premises of the hiring company, it must not be under that company's direction or supervision.
10. Contractors determine the order and sequence of the work they do.
11. Contractors are not required to provide interim reports.
12. Contractors are paid by the job, not by the hour.
13. Contractors work for more than one firm at a time.
14. Contractors pay their own business expenses.
15. Contractors have their own equipment.
16. Contractors have a significant investment in their business (equipment, furniture, etc).
17. Contractors offer services to public (by one or more of the following): An office and assistants; business signs; business license; list services in a business directory; advertise their services.
18. Contractors can make a profit or loss (employees cannot suffer a loss).
19. Contractors cannot be fired.
20. Contractors are responsible for satisfactory completion of a job or they may be legally obligated to reimburse the hiring firm.

The most heavily weighted factors in an audit are those that deal with control. If you are controlled in any way by the hiring company, you are an employee. All other factors are classified as important. Remember the second basic rule: "Workers are employees, unless a hiring firm can prove otherwise," and the fourth basic rule: "One mistake and independent contractors can be converted into employees." In other words, any action by the hiring firm or its employees to control independent contractors can convert them into employees).

If you are working at home for only one hiring company the following statutory employee situation should be taken into consideration: Workers who are automatically employees because of special rules include "At-home workers who are supplied with materials or goods and are given specifications for the work to be done." It might be contended in an audit that since you have only one account, that your status is that of an at-home employee for that company.

Of interest, however, in the Chapter "The Basic Rules"/ Business Owners, is this comment: "Sole proprietors and partners are owners, not employees or independent contractors." This may indicate that those of us who are registered as such with our state, county, or city, and operate as a bona fide licensed business do not have to worry so much about the 20-factors (at least from a contractor's standpoint; if we USE independent contractors, that is a different issue). Would suggest getting a comment on this from your accountant or legal advisor.

If you live in California there are more rules of qualification set by the EDD and the California Department of Labor. If you live in California e-mail me and I can send you a list of those.

All of this actually does not affect the contractor very much. If your status is questioned, and you are determined to be an employee the worst that can happen is you lose some expense deductions on your taxes. However, the penalties can be severe (and potentially devastating) for the hiring firm who calls their workers "independent contractors" and the workers are later determined to be employees. These companies may incur huge expenses to defend themselves in an audit, and may be required to pay all back withholding that was not withheld, plus stiff penalties. These expenses are more than adequate to put a small business not only out of business, but also effect a parting with home and other assets as well.

10/18/95, from: (Peter P. Benac)

While I am not an MT, I am self-employed in computer work and I was audited. IRS Rule 1079 is very clear on who is deemed an employee and who isn't. Some of the criteria you listed would deem us all employees. We all take direction of some sort from our clients, and at-home employees set there own hours most of the time.

The key factors the IRS looks for are:
1. Do you have more than one client? A no answer to this is dangerous. You better start advertising. You better have a business plan.

2. Are you listed as a 1099? Do you supply your SSN to a client? This is dangerous. Do you supply an EIN to a client? This is safer. The EIN means your company is listed with the IRS as an Employer. They like that. It means your at least trying to be a business.

3. Does your client supply you with all that is necessary to do there job? If you answered question one NO and this yes. Return the stuff to your client and get your own. Per the aditor who did me the Sparc station I have to support my client is okay as long as it's not the only piece of equipment I have. Luckily for me I have my own Novell Network. The Sparc belongs to my client and was part of a signed contract between them and my corporation. IRS loves contracts they also prove you're a business.

4. Do you have employees of your own? This was the first question my auditor asked. He told me if I answered yes, end of interview.

The key point here is if you act like a business, you are a business. If you act like an individual with a business name you are still an individual. Most counties in the US require you to file a DBA (Doing Business As) to be considered a business. If you are incorporated the DBA is done at a state level. A business plan and a complete set of accounting books is required. Those incorporated actually have to document all business decisions in the form a business meeting. Your accountant can set up the books. A lawyer can help you with the legal stuff like the business plan. Do you have a business phone or are you using your home phone? Business phone lines are more expensive, but they are BUSINESS phones. If your not sure of your status CALL A LAWYER. I have a friend who was deemed an employee and his client sued for money lost. For the record, they won.

From Mary
As a Statutory Employee, you are classified as an independent contractor and receive tax deductions for business expenses on Schedule C. Your taxes are not withheld so you pay quarterly payments as an IC. I believe these categories are going to change with the shift to so many more people working from home, either as employees or as contractors.
Standard Industrial Codes, Schedule C Codes, and Select Phone software:
From Toni Mercadante
SICs were established by the U.S. Government, Office of Management and Budgets, and have been around since at least 1941. They were developed as a means of categorizing industries, primarily manufacturing, and have since expanded to include retail and some service providers as well. SICs are used by the Department of Labor for statistical purposes and by corporate marketing departments and direct mail firms to target specific markets.

As I understand it, the 4-digit SIC number is completely unrelated to the 4-digit tax number used on a Schedule C. I was told today that as a sole proprietor, not incorporated, the 4-digit number on my Schedule C would be 6882 (Other Professional Services); however, I did not dig out last year's tax returns to confirm this. Those of us who are incorporated would fall under another set of codes. There is nothing specifically for medical transcription. SIC codes:

6234 - Hospital & Medical Service Plans
7338 - Court Reporting & Secretarial Services
7338 - Secretarial Services & Court Reporting
7338A - Secretarial Services
7338B - Stenographic Services
7338C - Resume Services
7338D - Word Processing Services
7338E - Editorial & Proofreading Services
7338E - Proofreading & Editorial Services
7389 - Business Services

I have a phone directory on CD-ROM, "Select Phone," which also includes the SIC numbers of the businesses listed. It seems the medical transcription services use one or a combination of those numbers above. Many use 6234, 7338A or 6234, 7389. Guess we'll have to do the same until MT is recognized as a unique service.

Five disks cover the entire U.S. It cost somewhere around $140 but has paid for itself many times over insofar as referencing referring physician names, hospital names, addresses, and sometimes even patient surnames my doctors forget to spell. For a while there I was considering changing my name to Clair Voyant. Did I say forget to spell? Last week one doctor dictated, "Next patient, Betty, uh . . . something or other." Well, no help there . . . but in general, no more wasting time "letting my fingers do the walking."

Here's a few more codes that might be worthy of consideration or just a laugh until someone decides we're worthy of a code of our own. I especially like 7389R and 9223.

7334C - Duplicating Services
7366M - Chart Services
7381 - Detective Agencies
7382 - Fire Protection Services
7389R - Interpreters & Translators
8099 - Health & Allied Services
9223 - Correctional Institutions

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