By: Steven Masur and Danika Johnson
Recently, we wrote an article about Loan-Out companies in which we discussed the advantages for established and early-stage artists alike. However, our clients are reporting trouble getting gigs and getting paid through their loan-out companies. It seems some agencies now want them to be employees — the same agencies that had previously required them to form loan-outs. Why the sudden change? The reasons include: 1) the fact that IRS requires employers to pay back withholding taxes for individuals they believe should have been classified as employees, 2) the growing argument regarding who is an employee and who is an independent contractor, and 3) new tax rules that may reclassify who should pay employment taxes. Loan-out company owners are getting whipsawed by their clients, and are struggling to work out how best to get paid.
The IRS Cracks Down
As we discussed in our previous article, agencies and other employers had encouraged the idea of paying their workers through loan-out companies as independent contractors. Employers believed that by hiring people as independent contractors, they could avoid paying their share of social security and medical taxes, overtime pay, and other employee benefits such as vacation and sick pay, as well as avoiding workers’ compensation insurance and unemployment compensation taxes. The 2017 Tax Cuts and Jobs Act provided many advantages to classifying workers as independent contractors – it cut labor costs, made the workers’ checks look bigger because no taxes withheld, and even gave the workers a slew of pass-through deductions on their own taxes, for everything from equipment and supplies needed for work, to home offices, travel and entertainment costs, and even car repairs. Many employers looking to avoid paying employment taxes got wind of these advantages and began labeling workers as independent contractors. The IRS saw both situations that amounted to potential tax fraud, and an opportunity to collect more taxes so it began to crack down on and re-classifying the same workers as employees, enabling it to collect the back taxes and levy fines and interest for the misclassification of these workers. Facing these potential liabilities, many employers rushed to reclassify their workers as employees rather than independent contractors in order to avoid repercussions.
Because of the change, loan-out company owners are finding it more difficult to get new gigs, get paid by long term clients through their loan-out company, and are now encountering problems with their health insurance. If they accept a gig as an employee, the loan-out company owner may no longer be able to use their loan-out company’s insurance, and instead, have to rely on the agency for which they now work to provide medical insurance (if they even qualify). Furthermore, the benefits are often not as good, and to add insult to injury, these expenses may no longer be deductible. If the worker does not work enough union hours in the entertainment industry through their loan-out company, they can claim COBRA benefits. However, if they work for an agency that classifies them as employee, they will not qualify for COBRA.
Deductions are also withheld differently, drastically affecting creative workers’ income. If the creative worker has multiple clients, they are stuck in a situation where they have to file a W-2 for some clients, and a 1099 for others, making it very difficult to accurately keep track of which expenses can be deducted, and which cannot. This could also trigger an IRS audit. Even without the audit, this leads to increased accounting costs, as the owner will need a good accountant to keep track of the various nuances.
Uber, Amazon, and the Studios
The state of California has been very vocal about employee rights. In its fight with Uber, California has shown an interest in classifying Uber drivers as employees instead of independent contractors. If Uber is ultimately required to classify its drivers as employees, Uber will be subject to health care, pension, workers compensation, and unemployment insurance obligations.
Here we see a situation where drivers can set their own hours and use their own car, but in order to classify as an independent contractor, they must pass the ABC test in Assembly Bill 5 (a simplified version of the 20 part IRS test qualifying a worker as an independent contractor or an employee): A) the worker is free from the control and direction of the company in connection with performing the work, both in reality and under the terms of the contract; B) the worker performs work that is outside the usual course of the company’s business; and C) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work being performed for the company.
It is likely that in California, the studios, as well as such companies as Amazon, or Disney may be scrutinized by tax authorities to evaluate where their workers are employees, or independent contractors.
So what’s our advice if you are a creative worker? We believe that if you have multiple clients in a single year, it is best to insist that a client pay you through your loan-out company unless the client makes clear that they will not hire you unless you become their employee. If they do insist that you become their employee, do your best to document that they insisted it, so you can defend yourself if the IRS or state tax officials raise any questions. Ultimately, it is you being caught in the middle, and it is an instance in which you really should push the problem to the people responsible.