Most people don’t know whether to classify lawyers as contractors or employees. In certain instances, the distinction is quite clear. For example, when a lawyer is hired for consulting services and paid a flat fee or contingent fee, then it is obviously an independent contract engagement. The distinction between a contracted lawyer and one that is engaged as an employee counts a lot in matters to do with taxation.
A lawyer that independently offers his/ her services on a contractual basis is exposed to the following benefits:
· No income tax is withheld.
· No employment taxes are levied.
· No agency liability is incurred for acts committed by employees of the law firm; the employer is exempted from any liability arising out of his or her employees’ legal malpractice.
· There are no Federal or State laws imposed to discriminate against the lawyer and protect employees only.
· There are no retirement, pension, fringe benefits, and such related systems.
Given the disadvantages that accompany employee lawyers, many people question why they even seek formal employment in the first place. In most instances, it is not a matter of choice.
For all intents and purposes, all state organizations and related agencies/ agents, assume all people working in a firm to be employees unless proven otherwise. This statement holds true for the IRS, state labor commissioner, employment development department, insurance companies, and the unemployment insurance authority.
There are various screening tests that can be done in order to identify the employment status of a worker. Most of the tests center on the level of control exercised over the worker. With cases of fraud on the rise, the IRS is doing everything in its wake to ensure that lawyers become liable for their taxation dues. The IRS is doing this by actively cooperating with different State departments and Federal agencies.
Lawyers are usually prime targets in this IRS venture and in certain instances, they get caught. There are precedent laws, developed over time, to bring out the distinction between a contractual engagement and a formal employee engagement.
When in catch 22 situations, most lawyers invoke Section 530 relief. This provision is a get-out-of-jail- free card that can be used when issues to do with employment tax liabilities pop up. However, for Section 530 relief to apply, there are certain requirements that the lawyer must have fulfilled:
· Consistent treatment of workers as independent contractors.
· Filing all forms 1099 for the workers.
· Have sufficient reason for not engaging the workers as employees. The degree of reasonableness is tied to judicial precedents, IRS rulings, past IRS audits, or a long – standing practice adopted by a significant portion of the relevant industry.
In order to successfully win a legal dispute touching on employment status, a practicing law firm must issue good and clear work contracts and be consistent in all it work ventures. This is the only sure way of avoiding income tax problems with the IRS.