Salon Owners Need to Carefully Structure Their Independent Contractor Relationships
By: Nancy E. Joerg, Esq.
The Issue: Some salon owners may not want to hire a fixed number of employee hairstylists, cosmetologists, nail designers, etc. Salon owners may prefer to classify these workers as independent contractors.
Will agencies such as the Illinois Department of Employment Security (IDES) and the Internal Revenue Service (IRS) agree with the classification of these workers as independent contractors for tax purposes?
Illinois Department of Employment Security: Let us look at the Illinois Department of Employment Security (IDES) situation first:
If the IDES decides that certain stylists ARE employees, rather than independent contractors, salon owners can be hit with big assessments. Some of these assessments for larger salons can be financially devastating.
Unfortunately, even though you consider your stylists to be independent contractors, and even though they AGREE IN WRITING that they are independent contractors, the IDES can still suddenly slap an audit on you, the unsuspecting salon owner, and reclassify your stylists as employees. (The facts of your case will govern – not the formal agreement.)
The IDES Test: For an Illinois salon owner to prove to the IDES that an independent contractor should not be reclassified as an employee, the salon owner must pass all three parts of a three-part test as set out in Section 212 of the Illinois Unemployment Insurance Act. The Illinois Unemployment Insurance Act was written in 1937, and the essentials of this very tough test have never been changed.
The three-part test demands that the Illinois salon owner prove:
• The worker (i.e., hairstylist) is not subject to the control or direction of the employer when providing the service; AND
• The service is provided either outside the usual course of business or outside all the places of business; AND
• The worker is engaged in an independently-established trade, occupation, profession or business.
If salon owners cannot pass ALL three parts of this test, as much as four years of back taxes, penalties and interest can descend on them.
The Department makes no blanket determination as to certain occupations or professions. A hairstylist in one setting may be considered an employee by the IDES. Another stylist down the street who works under slightly different circumstances may be considered an independent contractor by the IDES.
What the IDES Auditor Asks: The IDES auditor will want to look at all written independent contractor and/or lease/booth rental agreements. Then, the auditor will look beyond the words of the agreement and investigate exactly how you interact with your stylist, esthetician, et al.
Every aspect of the relationship is held under a microscope. The IDES auditor will ask, for example:
• Does the hairstylist have an agreement with the salon owner whereby he/she rents his/her own booth in the salon?
• Does the hairstylist pay a fixed or “variable” booth rental to the salon owner?
• Is the salon owner solely a “landlord”, or is the salon owner also in the business of providing hairstyling services?
• Does the hairstylist have his/her own business cards? In whose business name?
• Does the hairstylist advertise? In whose business name?
• Does the hairstylist work only for this particular salon?
• If the hairstylist makes a mistake, who pays for his/her error?
• Does the hairstylist have his/her own assistants? Who hires, disciplines and/or fires them?
• Who pays for the hairstylist’s insurance? Whose pays for his/her assistant’s insurance?
• Does the hairstylist or the salon select the clients?
• Does the salon have the right to fire the hairstylist or terminate the agreement for booth rental “at will”?
• Does the salon owner receive some guaranteed amount of the hairstylists’ fees?
• Is there a dress code or required uniform that the salon owner insists upon for the hairstylist?
• Does the salon owner decide upon the scope of services to be offered by the hairstylist?
• Does the salon owner establish the hairstylist’s days and hours of work, minimum hours for work, schedule of customers, etc.?
• Does the salon owner furnish the supplies, equipment, etc., to the hairstylist (or specify which supplies or equipment are to be used)?
• Is the hairstylist an entrepreneur, i.e., does he/she have risk and reward connected with his/her job duties?
Determination Results: After the auditor collects these facts, and a great many more, the auditor decides whether the independent contractors at issue should be reclassified to employee status. Often, the auditor will find that the hairstylist is an employee. The auditor will then assess unemployment insurance taxes for a stated period of time (up to 4 years!) onto the salon owner.
Right of Protest: The salon owner then has two options. The salon owner can (1) accept the results of the IDES audit and pay the back unemployment insurance taxes, or (2) decide to protest to the IDES and demand a hearing on the matter.
A note of caution here: If you should decide to protest, you must do it within the stated 20 day time frame. The IDES is very strict and unforgiving about its time regulations. If you miss the proper period in which to protest, you will lose all rights of protest! Even good excuses fall on deaf ears at the IDES.
IRS Standard: Many business owners are more familiar with the famous ” Twenty Questions” test of the Internal Revenue Service regarding independent contractor status. The IRS uses the common law “control test” to determine whether a worker is in fact an independent contractor. The 20 questions look into the nature of the working relationship (for example, training, uniforms, hours of work, method of payment, payment of expenses, advertising, etc.).
The IRS makes a determination after considering all of the factors involved. The Illinois Department of Employment Security, on the other hand, puts the employer through a much more rigorous test.
Salon Owner as Landlord: Where the salon owner is merely the landlord of the worker in the salon under a carefully drafted lease agreement, the worker has been declared the “lessee” (and not the employee) of the salon owner. In other words, the audit issue becomes lessee status versus employee status (rather than independent contractor status versus employee status).
One noted legal authority recently stated that, in the cosmetology industry, it is better to try to establish the landlord/lessee relationship than the salon/independent contractor relationship, for purposes of withstanding an employment tax audit.
Need for Self-Audit: If you currently use independent contractors, it is vital that you do a self-audit. Look at each and every aspect of the working relationship, in light of Section 212 of the Illinois Unemployment Insurance Act. Refer to IRS Form SS-8, which has a good checklist of questions for a self-audit under the IRS test. Scrutinize any booth rental agreements.
Salon owners who choose to use the services of independent contractors or lessee-workers should obtain legal advice when putting together an independent contractor agreement, or a lease for booth rental, etc. Involving an attorney and/or other employment tax professional in the overall self-audit process is highly recommended.
Warning: If you are audited by the IRS, do not forget to see if your salon could claim “safe haven” under Section 530 of the Internal Revenue Act – a powerful defense.
For assistance with IDES audits, hearings, and independent contractor agreements (or for consultations on limiting your liability in the use of independent contractors), contact Attorney Nancy E. Joerg, who enjoys a nationwide reputation in working with companies who use Independent Contractors of all types. Nancy Joerg can be reached at Wessels Sherman’s St. Charles, Illinois office: 630-377-1554 or email her at firstname.lastname@example.org.