PAPER TRAIL Deciding whether salespeople should be full-time employees or independent contractors should not be taken lightly. Industry consultant and REPLACEMENT CONTRACTOR columnist Dave Yoho recommends that companies at that crossroads do a “pro forma” to determine which employment situation works best for them financially and operationally. “If a company has only a few sellers, it might not be worth it to hire them as full-timers,” he says. “But for companies with 20 or more salespeople it probably would be.”
Regardless of what they choose, it is imperative that companies protect themselves with paperwork that clearly defines the salesperson’s relationship with the company. “Documentation is critical,” says Bob Birner, general manager for Amazing Siding’s Houston office, which requires its sellers (who are independents) to sign a notarized statement declaring that they understand their tax obligations. (Birner says that several of his sellers have established themselves as corporations.)
At the very least, contractors must “build a brick wall” around their companies, says attorney D.S. Berenson, by structuring their employment relationships in compliance with state and federal tax laws. Berenson also cautions contractors about turning down a former seller’s unemployment claim because “it might trigger a reclassification” that, he notes, can be time-consuming and costly because states might go as far back as five years for payroll taxes and penalties.
PUSHING BACK Last fall, the California Unemployment Insurance Appeals Board ruled in favor of U.S. Home Systems, the Lewis-town, Texas-based decking contractor, in a dispute between the company and the state over unemployment insurance liability. That decision was the first time California had recognized a safe harbor provision in the U.S. tax code that allows contractors to treat full-time workers as non-employees for tax purposes, according to D.S. Berenson, whose Washington, D.C.-based law firm, Johanson Berenson LLC, convinced U.S. Home Systems to make a stand and establish a precedent that could benefit all contractors in that state.
For the past three years, U.S. Home Systems’ 200 sales reps have been full-time employees, a switch the company made because of its installation relationship with The Home Depot, which requires sales reps to be company employees if they are in Depot stores more than 10% of their time. But in 2002 and 2003, U.S. Home Systems classified its sellers under section 3508 of the IRS Code, which Berenson says creates a “carve out” for real estate agents and contractor sellers to be treated as non-employees for tax purposes.
When a former salesperson filed an unemployment insurance claim, California’s Employment Development Department asserted that U.S. Home Systems was liable for taxes and penalties totaling $20,000. The company lost the case — Berenson says an administrative judge simply chose to “ignore” the safe harbor provision in his July 1, 2005 ruling—and Murray Gross, the company’s CEO, paid the assessment and was ready to move on. “But D.S. convinced us to appeal, and agreed to work for free if we lost,” Gross says.
“We thought we could make law for our industry,” Berenson says. “At least our clients are protected because we have this judgment.” Gross says that his company got all of its money back from the state because “our documentation was good.” In reversing the administrative judge’s decision, the Appeals Board found that the employee in question was a “direct salesperson,” and therefore “the statute [Section 650 of California’s Unemployment Insurance Code] should be interpreted to effect the intent of the legislature, that is, to exclude direct salespersons [from withholding tax].”
By the time it could savor its victory, however, U.S. Home Systems had already become leery of relying on the tax code as a shield, and let its sellers decide whether they wanted to be classified under 3508; about half did.