A Beginner's Guide to Converting Independent Contractors to Employees
Recently, the IRS and state taxing agencies have increased audits of yoga studios because they may have misclassified their workers as independent contractors rather than as employees. Regulations for the classification of workers vary from state to state, and uninformed studio owners could potentially pay a high price. Losing an audit means facing significant back taxes, penalties and fees, as well as hefty legal and accounting expenses to defend your studio in the audit process. For some studio owners this may be too great a financial burden to bear, and may ultimately cause studios to close, putting their owners and teachers out of jobs.
It is crucial that studio owners maintain an awareness and knowledge of federal rules for classifying workers, as well as those of the state where the business operates. A studio has tax responsibilities under both federal and state law and could be audited by both the IRS and the state taxing agency. The website www.workerclassification.com/State-Resources features a repository of links to all of the state laws on classifying workers.
There are a few general ways to determine how employees are classified:
- Independent contractors are self-employed and the studio signs an independent contractor agreement with the contractor. These agreements describe matters, such as the contractor’s job to be performed, payment, contract term, that reflect the intention to create an independent contractor relationship in accordance with federal and state laws. The studio does not provide benefits or vacation pay, and does not exert control over the way in which the contractors perform their jobs. Furthermore, independent contractors are not expected to align themselves with the vision or mission statement of businesses where they work because they are running businesses that are independent from those of the studios.
- Employees are almost any individual that works for a studio in expectation of compensation, if the individual does not meet the definition of an independent contractor or another exception to the definition of employee. Employees may or may not have employment agreements or formal job descriptions. They have taxes withheld from pay by the employer, are expected to receive handbooks and proper training, and may receive benefits, paid sick leave or paid vacation time. The studio has the ability to exert more control over its employees, expecting them to support and promote the business’s vision and mission statement.
Many studio owners have chosen to forego risking an audit and transition their business to an employer-employee model.
Gary Kissiah, RYT 200, attorney and author of Light on Law-A Guide to Independent Contractors and Employees For Yoga Studios and Wellness Businesses notes, “In the employer-employee model, the studio can exert control over its employees and create the job description that it wants to require its employees to perform. Although you will have a tax payment and compliance burden in making your teachers employees, you will not have to worry about liability based upon mischaracterizing your teachers, and you may build teacher loyalty by treating them as employees. Some studios have concluded that this is the right thing to do because it provides teachers with more job stability.”
If a transition to the employer-employee model is something you have decided to do for your studio, here are a few steps to take:
- Hold an all-staff meeting to discuss the conversion. Be prepared to answer questions teachers may have about the process, the new relationship and how they will be impacted.
- Create new job descriptions for employees. One of the benefits to studio owners using the employer-employee model is that they are able to ask their teachers to market for the business, do jobs to support day-to-day operations, and have control over how classes are taught. As contractors, teachers are legally free to instruct as they wish, but with the employer-employee model, the studio owner has more control over job performance through the employment agreement. Job descriptions allow studio owners to articulate their vision for the business and the terms of the employee’s relationship with that business. This provides students with a more consistent experience, and builds a stronger business.
- Adjust compensation scales for teachers. While independent contractors cannot be paid an hourly rate or fixed salary, Gary notes, “you may compensate your teachers in any way that you wish if they are employees, subject to complying with minimum wage laws. Thus, you can pay them by the hour, by the head, by a fixed base amount or any combination of those methods…Obviously, their overall compensation will decrease because you will now be withholding federal and state taxes. Because your administrative expenses and tax payments will increase after you convert your teachers into employees, you may use the conversion as an opportunity to evaluate and to streamline your business. You may want to consider your overall business model and look at ways to make your business more efficient.”
- Document all changes. Require every employee to sign an employment agreement and appropriate federal and state tax forms. In addition, there are various federal and state forms and reports that the studio owner is required by law to file. We recommend that you get expert guidance from a tax accountant or an employment lawyer to make sure that you comply with all of the tax and employment laws.
This discussion is for informational and illustrative purposes only and is not meant to impart legal or tax advice. Each studio owner’s situation may differ depending on the factual circumstances and the jurisdiction in which the studio operates.