Teaching Tips

It seems like an ideal arrangement: Teachers working as independent contractors gain flexibility over their schedules and improve their cash flow. Studio owners add expertise and variety to class schedules as interest and enrollment warrant, by hiring ICs. The owners also reduce their costs significantly, since they don’t pay Social Security, Medicare, federal or state payroll taxes, unemployment insurance, worker’s compensation, health insurance, or for vacation and sick leave, as they would with employees.

This is a good thing all around, right? Not exactly, according to the IRS, state revenue authorities, workers’ comp boards and the Department of Labor. Like most things that sound too good to be true, the use of ICs isn’t always what it seems. In fact, quite often incorrect use of ICs is a direct violation of federal and state tax and federal labor laws.

How can an arrangement between two consenting parties be wrong? The difference between tax abuse and a winning arrangement is a matter of definition. If found on the wrong side, parties run the risk of being assessed back taxes and the studio owner may pay additional fines.

For studio owners, the tax savings can blind them to the disadvantages of using ICs. Because they are independent, these workers are free to come and go. By definition, they are not under the business owner’s control, and by law, they shouldn’t be. How they teach isn’t up to you. They can’t be fired. And because you aren’t paying workers’ comp, you bear the sole liability for any work-related injury. This is because workers’ comp is offered to employees in exchange for their right to sue their employer. But to an IC, you are the sole source for restitution. Also, an audit flag goes up for government agencies that target this area for review.

The key advantage to being an IC for teachers is flexibility. But this is possible through part-time employment as well. When you are an IC, job security and protection against unfair practices or discrimination disappear. Health insurance, unemployment benefits, workers’ comp and the opportunity for paid leave (for illness, vacation or even jury duty) are forfeited. If injured on the job, your only recourse for lost income is to sue the studio owner/client for negligence. You bear full responsibility for state and federal taxes—not to mention Social Security and Medicare, which are subsidized by employers, and therefore higher for the self-employed (this is known as the self-employment tax). While you can deduct business-related expenses, keep in mind that these are primarily expenses that your employer would cover. The only real tax break that the self-employed receive is being able to put away substantially more tax-deferred money for retirement than employees can.

Defining Your Identity
Just because a studio owner identifies a teacher as an IC doesn’t mean this definition is correct, even if it’s in writing. The key determinant is how “independent” the contractor really is. ICs who only work for one studio, for instance, might actually be employees—full- or part-time, depending on how the studio defines a full-time schedule (typically, anything over 32 hours a week, in a 52-week year, is considered full-time).

The IRS takes a rigorous approach to maintaining its distinctions. Though it doesn’t use a precise formula to determine when exactly one crosses the line between being an IC and an employee, it questions how a relationship is structured. (For a clearer understanding of IRS expectations, see the Q&A below.)

But even the IRS doesn’t expect perfect compliance with its guidelines. They are most focused on the issue of control, which is the hardest for many studios and teachers to overcome, as Angela Floyd, owner of Angela Floyd School for the Dancer in Knoxville, Tennessee, has discovered. “In a ballet school, the owner makes the schedule. My understanding, at least in Tennessee, is that once I set the schedule for teachers to adhere to, they are my employees,” says Floyd. To avoid the risk of being caught on the wrong side of the definition, Floyd hires her teachers as part-time employees.

However, if teachers are visiting—teaching workshops or involved in a short-term project, and their primary draw is their expertise—then IC status is defensible. In such visiting-artist situations, the content of the class would be determined independently of the studio and that guest artist’s reputation would be the main attraction of the class. However, independence would be hard to defend with a substitute teacher who follows the curriculum guidelines determined by the studio.

Which One Are You?
Before pursuing the IC route, consult your tax advisors for guidance on your state’s requirements and about how best to structure these relationships. Understand that since agencies may not share these definitions, owners may need to treat the same worker as an IC for one government agency, and as an employee for another in order to be in compliance. If the studio, for instance, withholds federal taxes as though the teacher were an employee, but not state taxes, the teacher should be sure to pay the estimated taxes due the state. For the teacher, the main responsibility is making sure taxes are being paid on time.

Studio owners should consider requiring ICs to fill out an Independent Contractor Form, detailing their place of business, other client relationships, credentials and insurance coverage. For the owner, this helps document a legitimate IC arrangement. Owners should never let ICs fill out the same job application that prospective employees fill out. That would create evidence that the owner actually considered the IC an employee.

Create a written contract that describes what services will be provided, the hours of availability, the cost and what compensation will be due to the owner should the IC fail to perform satisfactorily. Include beginning and ending dates to avoid the appearance of employment and list what, if any, expenses will be reimbursed. The greater the responsibility an IC has for business (and travel) expenses, the more independent he or she appears and the greater the evidence he or she has personal money at risk. The following websites offer useful guidance for the structure and content of such a form:

  • www.allbusiness.com
  • www.toolkit.cch.com

Sticking to Status Quo
To maintain IC status, teachers should abide by the following rules:

  • Do not ask for supervision or instructions on how to run your class.
  • Hire and pay any assistants yourself.
  • Invoice for your services using your own stationery, and keep records of payment.
  • Have business cards and a business phone line as proof that your services are available to multiple studios. Offer this information to each studio for their records.
  • Keep your business expenses separate from your personal expenses.
  • Avoid being deemed a part-time employee by one studio and offering yourself as an IC performing the same duties elsewhere. It could lead the IRS to reclassify you.
  • Pay taxes quarterly. Also, if you equate IC status with pocketing tax-free pay, rethink your strategy. If your client is tax compliant, and paying you more than $600 annually, they will be filing that information with the IRS, where it can be crosschecked.

Confusing an IC status with that of an employee can lead to government penalties. Make sure that you take
the time to sit down with teachers and owners (and ideally with their respective tax advisors) and clearly define the distinction and weigh the risks. A careful assessment now will save you time and energy later. DT

Q & A

The IRS uses these distinctions to evaluate the status of an IC:

Q: Does the worker receive instruction in how, when or where to do work, what materials should be used, which assistants to hire to help with the work or where to purchase supplies or supporting services?
A: ICs should set their own hours, have their own places of business and determine independently how they will get the job done. Note that in practice, the IRS seems to focus more on “how” than “when,” “where” or “with what.”

Q:Does the worker receive training or need to do the work in a certain way?
A: ICs use their own methods to accomplish the agreed-upon results.

Q: Does the worker’s involvement in the business impact its success or
A: The services a specific IC provides should be separate (i.e., the business can use them or not and still thrive).

Q: Does the worker have a continuous or exclusive relationship with
the business?
A: An IC is hired to do a project. There is no assumption of a continuous
relationship, nor should the relationship be exclusive—the IC is free to take on assignments from other clients.

Q: Do the workers have an investment in the work being done?
A: ICs need to have something at risk, like a reputation, that ties the work to them and not to the studio. The IC would also retain the copyright to his or her work (e.g., choreography) unless otherwise sold.

Q: Do workers bear the responsibility for all or most of their business expenses, or are they reimbursed?
A: ICs should not expect reimbursement.

Q: Has the worker executed a written contract that specifies the nature of the results expected by the client and the cost?
A: ICs operate under contract, a written document specifying the results
the client expects, timeframe and cost. Generally, payment by the hour is appropriate for employees; ICs are expected to price by the project.

Q: Can the worker realize a loss from the contract?
A: ICs bear the risk of doing business. This means they could theoretically
lose money dealing with a particular client due to poor decision making or nonpayment, for instance.

Q: Does the worker receive any benefits, such as insurance, pension or
paid leave?
A: ICs do not receive any benefits. Keep in mind, though, that simply
withholding benefits from workers who would otherwise be classified as employees doesn’t change their employment status.

Q: Can the worker be fired or have the right to quit?
A: ICs can’t be fired without financial consequence as long as they are
providing the results specified in their contracts, nor can they quit without
financial consequence, the way an employee can. The contract specifies the
liability attached to a job that isn’t well done.

Chicago-based freelance writer Gayle B. Ronan has written financial, investment, business management and tax-related articles for Bloomberg WealthManager, TICKER Magazine and www.CNBC.com.

Do you think health insurance is beyond your means? Think again. In 2003, Congress passed legislation to create health savings accounts. These policies are directly available to self-insured teachers or to studio owners, especially those not currently offering health coverage to their full- or part-time employees.

If you haven’t heard of HSAs, listen up. These plans were legislated specifically for small businesses that simply can’t afford to cover their employees. While the wave of marketing would have you believe that HSAs are the cure-all to your insurance problem, the decision to offer or alter your insurance coverage hangs on a number of issues. Read on for the pros and cons of this new approach to managing medical expenses.

HSA Basics
An HSA is comprised of two parts: a savings account and an insurance policy administered by a traditional insurance company. To understand how HSAs work, it helps to think about IRAs or 401ks. HSAs are designed to do for health care spending what IRAs and 401ks do for retirement savings—relieve employers of some of their financial burden and provide individuals with a tax-advantaged incentive to assume more responsibility and control over how much money they save for future expenses—in this case, exactly how and when that money is spent during their lifetimes.

The first component is a tax-advantaged savings account similar to an IRA, to which pre-tax dollars may be contributed regardless of your earned income (during 2005, up to $2,650 may be contributed for individual accounts; $5,250 for family coverage). This money may be withdrawn tax-free as needed throughout the year to pay for medical expenses. The unspent amount is rolled into the following year. Because this account builds tax-free balances over one’s lifetime, there is an advantage to keeping medical expenses low in order to accumulate a nest egg for use later in life, when most medical expenses are incurred.

The second part of the HSA is the insurance policy itself. Basically, this is an insurance plan, and some HSAs are even HMOs or PPOs. The difference is HSAs have deductibles of at least $1,000 for single coverage and $2,000 for family coverage. This means the insured is responsible for paying the first $1,000 ($2,000 for a family policy) of medical expenses incurred each year before the insurance begins to pick up the tab.

These deductibles are substantially higher than what most people are used to. The Kaiser Family Foundation estimates the average deductible for a conventional employer-provided insurance plan at roughly $400 for individual coverage, $894 for families. So, if you are currently covered by a traditional policy through your or your spouse’s employer, shifting to an HSA can significantly raise out-of-pocket costs if you incur higher medical services needs—like a broken leg or pregnancy for example—in any given year. Keep in mind that many plans will cover all or most preventive services before the high deductible is met. These covered services may include annual exams, immunizations, screening tests and routine prenatal and well-child care.

For Studio Owners
If you’re a studio owner who offers traditional insurance and is considering the switch to HSAs, you may want to contribute an amount to your employees’ HSA to make the switch more palatable. This would help offset what your employees potentially face in the form of the higher deductible. Also, all of your contributions to the HSA are deductible and free of payroll taxes.

The downside is that this amount becomes your employees’ money. If they leave, they leave with the cash contribution. The insurance policy portion of the HSA may be extended, but the savings portion is entirely a personal asset.

Yet you will exchange added responsibility and potentially higher expenses for a drastically lower annual premium, or the actual cost of the insurance policy. According to Gary Oslowski, a vice president at Aetna Insurance, the studio owner can expect to cut premiums in half by offering HSAs. That low annual cost is an attention grabber for employers and the working uninsured because it makes offering or extending coverage to part-time employees more affordable.

How excited should you get? Evaluating HSA plans should be a relatively easy calculation for employers to make: you need to compare current costs, or available budget for a new policy, to an HSA plan’s projected costs. Then, consider the utilization rates, that is, how much employees actually use medical services—which are the other key component of an employer’s health insurance cost. By shifting more responsibility for the expense of health services to the consumers, these rates will drop, resulting in further cost savings for employers.

Under the HSA scenario, employees must pay the first $1,000 or so of bills. They are more likely to spend their dollars with greater care, because they have the incentive of seeing their savings account balances grow. So far, studies indicate, employees do spend less with HSAs. And to ensure that happens, firms like Aetna provide their clients with tools to help them comparison shop for their prescriptions and other medical services.

For Teachers
While switching to or instituting an HSA plan can make economic sense for employers, what about part-timers, independent contractors or anyone else who may want to self-insure?

If you are self-insured and have a high-deductible health care policy, you would gain access to the tax-advantaged savings plan and be able to use pre-tax dollars to pay for medical expenses and stash away extra dollars toward future expenses. If you are also self-insured, you will benefit from lower premiums.

If you are uninsured, this option has the potential to raise your out-of-pocket expenses, especially if you never spend money on health care. But if you do have medical expenses, you are always paying full price for services. By accessing an HSA, no matter where or how much you work, you will be covered by insurance and limit the amount you are responsible for in a single year. Having access to the savings portion of the HSA would also make it that much easier to pay future expenses.

The Bottom Line
The actual cost of an HSA is hard to predict. Despite the low premiums, there is the potential responsibility for co-payments and expenses incurred before the deductible is met. And each plan has a variety of features and is structured differently, so shop around before you commit.

The younger and healthier you are, the more attractive the HSA is—low premiums plus a low probability that you will spend much on your medical care makes it look like a good bet. It is certainly a better bet than remaining uninsured.

And though they are far from a panacea for what ails the U.S. health care system, HSAs may offer significant relief over other plans and make health care more affordable for both studio owners and teachers. DT

Gayle B. Ronan is a Chicago-based freelance writer of financial, investment, business management and tax-related articles. Her work has appeared in
Bloomberg WealthManager, TICKER Magazine and on CNBC.com.

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