compensation: 1099 vs. 'Under the Table'

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angelat

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Hi.

I have the following problem. I have a small picture framing shop in glendale, california and about this time last year decided to take on some help. After many interviews, I decided on what I thought would be the most promising and motivated person. Being a new business, I wasn't really set up at the time to do the 'proper paperwork' - but figured that as long as that was done by the end of the tax year, then it would be okay...

at any rate - sit tight - there are a few parts to this problem:

PART 1: Definition of Employment
I took this person on casually - telling them I could give them no more than 10-15 hours a week and that they should give me invoices to pay them. They were resistant to the idea of invoicing - but I try to be easygoing... so I just paid what was owed when I could. One of the reasons I took this person on is that they stated they were flexible with pay (meaning - when they get paid) and I have a tiny business - so that was definitely a plus for me. ANYWAY - cut to the chase. I'd been giving them chunks of $$ as it came in paid out against what they supplied to me as their hours (just an excel spreadsheet). I was forever behind in paying them - but not horribly so. They seemed to tolerate it fine and it was workable.

PART 2: Then the Crisis Came
About six months after this 15 hour a week gig (at this point I'd paid around $2000 on maybe $3500 owing) things were looking pretty bleak. We were making nearly zero sales and I had to start relying heavily on my family to help me make rent payments etc... I told the erstwhle employee/contractor (unsure how to categorize - though they set their own hours and were free to pursue employment on their own, etc) that I couldn't afford to keep them on... and that we'd have to pick things up later somehow and that I was sorry...

Their response to this was that they would be happy to 'volunteer' for the time being until I got back on my feet. It was definitely a very nice offer - but I told them that I couldn't accept that since I didn't think it was fair to them. So I told them this: that if they wanted to do that - well, that I would compensate them when and if I got enough money 'an equivalent amount' - The point to saying this, for me, was that I would be able to fall back on the fact that they were simply offering to 'help out as a friend' at this point - IN CASE we were making zero money and then I wouldnt' be stuck. That was an attempt at creating a loophole for myself. But it was never my intent NOT to pay this person some sort of compensation for time spent. I want first and foremost to be fair - and this person was fairly devoted to the 'job'.

PART 3: The Falling Out
After a year of knowing this person and having them do work for me under such an fuzzy definition of compensation, and having racked up another $3K in obligatory debt to this person under my own definition (see previous paragraph) the financial and other stresses came to a head and they quit on me (understandable). I am deeply thankful for their help - and want to get them fully paid at what was (I think) a fairly generous hourly compensation rate. But there are problems - since I don't fully understand the tax system and law...

MY QUESTIONS
Can I (retroactively) file a 1099 form for them and get this all legit somehow - so that it's properly filed with the IRS etc... my taxes haven't been filed yet and I"m a sole proprietor. I thought it would be smart to do that to cover myself in case the situation with them turned nasty somehow... as it stands I owe them money but I'm wondering if I'm screwing myself by giving them the cash they insist on...(?)

Sorry to be so verbose - it's about the simplest way I can think of putting it.
 
1. Incorrect. The number of hours or the amount you pay a worker has no bearing on their employment status.
http://www.irs.gov/pub/irs-pdf/p1779.pdf

2. Employees cannot "volunteer" their time to a for-profit company.

You need to see your tax accountant pronto. You have a number of violations of IRS and state tax law, plus possibly minimum wage, overtime and wage payment violations.
 
Not to mention state law violations, and California is very hungry these days.


Sent from my iPhone using Tapatalk
 
Depending on whether you need the expense deduction, you may consider to treat the payment to this individual as a personal gift (non-business expense). This individual would have to agree to the situation and not be the type of person to run to the authorities.

Is the aggravation of correcting your errors and all the red tape involved worth it versus accepting the loss of a business expense deduction for the $6,500 wages? You may gift up to $13,000 in 2009 without having to pay a gift tax.

If you are continuing your business, you need to learn the difference between an independent contractor and an employee. You need to learn your responsibilities related to both.

Based on the details you have provided, the individual most likely would be considered an employee. Thus, as the others have pointed out you could be in serious hot water!! You never collected withholding taxes or FICA.

That is why I made my suggestion above, though perhaps not ethical, it may be your best bet. You didn't hear that from me.
 
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