Death and Taxes for Independents
The IRS could very well be the death of the freelance video and film professional this year. The tax police are arming for what promises to be the biggest assault this industry has ever seen. And if you've ever hired a freelance grip, gaffer, camera operator, or production assistant for even half a day, if you consider yourself an independent contractor, or both of the above, you could be in big tax trouble.
If you're not scared yet, you should be. Under new federal guidelines taking effect this month, what you thought was an independent could be reclassified as an employee. That relationship is then subject to payroll tax withholding, unemployment insurance, benefits, and workers' compensation premiums, not to mention some hefty penalties from the federal government.
Let's face it. If the IRS had its way—and it often does—there would be no such animal as an independent contractor. Everyone would be an employee, no matter how temporarily, of those who paid them.
It sure would make it easier for the IRS: Everyone would have taxes withheld from his or her paycheck, ensuring that Uncle Sam got his money faster. Earnings would be reported in full and on a regular basis, making it easier for the IRS to keep track of who's making what and how much they owe. And the IRS wouldn't have to give back any of those nasty scheduled deductions.
But independent producers, agencies, production companies, and in-house corporate video departments count on independent contractors to supply labor they don't need every day and otherwise could not afford. Without independent contractors, the video and film production industry would shrivel to a few rich clients and the large production houses who serve them.
The harsh reality is that everyone in video and film production must learn to do business differently. Or you won't be around come 1997.
WHERE THERE'S SMOKE...
First, a brief history of the world according to the IRS. For years, the IRS has believed that freelance production workers are not reporting their income or paying their taxes. Unfortunately, auditors have found just enough abuses, whether intentional or not, to fuel the fire.
In his book IRS vs. the Film and TV Industry, independent contractor Alan Sheffield states that the IRS is convinced that as much as 26 percent of freelance income goes unreported and untaxed. If that figure is true and is multiplied by the estimated 8 million independents in the United States, there's supposedly a big chunk of change just waiting to be collected by a fiscally desperate federal government.
Hot on the trail, the General Accounting Office of the federal government reported to Congress that 90 percent of the nearly 7,000 employment tax audits between 1989 and 1991 found employees misclassified (under IRS rules) as independent contractors. Since it was started in 1988, the Employment Tax Examination Program has reportedly reclassified hundreds of thousands of independent contractors as employees of the companies that paid them and collected more than $500,000 in tax assessments from those employers. While some of those assessments have been successfully appealed by production companies, the average bill for back taxes and penalties has come in around $68,000, driving some companies literally out of business.
Historically the conflict between the IRS and the production community has been that, on the one hand, independent production contractors and their clients had no rules to follow that applied specifically to them and, on the other hand, tax auditors didn't know how to apply the rules that did exist. Commonly known as the IRS 20 Questions, those common law factors were often ambiguous and usually difficult to apply to the non traditional business atmosphere of television production. The resulting misfit often ended in contention.
After about two years of debate, the IRS in May 1994 issued 49 pages of market segment guidelines instructing its agents in how to define an independent contractor in the video and film production industry, guidelines that will shatter the traditional image of an independent contractor.
If the new guidelines came down a year and a half ago, why be worried now? International Television Association legal counsel Mike Reed of Porter, Wright, Morris, & Arthur in Cincinnati took part in the IRS meetings and is still watching the situation closely for his industry clients. Reed reports that the IRS has held off on enforcing the guidelines until its staff could be trained. That training was completed at the end of 1995, prompting expectations of a spate of audits starting the first of the year.
ITVA's Reed points out that film and video production is not the only industry coming under the scrutiny of the IRS. "The IRS is going industry by industry," he says. "They're reportedly close to announcing guidelines for the trucking industry and several others. There are various estimates that there are between 10 and 50 other projects going on out of the Employment Tax Examination Program." Interestingly enough, Reed admits, the new production market tax guidelines do specifically exclude feature films, network television, and other portions of the entertainment industry.
To its credit, the IRS listened to industry representatives from the ITVA, the Association of Independent Commercial Producers, and the Minnesota Film and Video Association rather than arbitrarily deciding who's an employee and who's an independent. But some of the classifications will nonetheless come as a shock to many in the industry, both employers and the workers they've hired.
These new market-specific guidelines identi£y more than 100 production job functions and divide them into three categories, each with an increasing burden of proof of independent contractor status. And as far as the IRS is concerned, it's all a matter of control.
Category 1 covers those workers involved in or having control over the overall planning and production of a project. In general, this means more than just responsibilities on the shoot. According to the IRS, these positions include the director, producer, art director, director of photography, production designer, casting director, location scout, music composer, and writer. Workers in Category 1 have a high likelihood of being classified as independents by the IRS.
Category 2 is defined by the worker's control or involvement in planning and implementing specific aspects of a project or those jobs requiring problem-solving and technical skills. Once again, this often includes responsibilities outside the actual shoot. Positions in this category include costume designer, food stylist, key gaffer, key grip, hair stylist, makeup artist, lighting director, sound engineer/mixer, videographer, and wrangler/trainer. Workers in this category could be classified either way, as independents or as employees of the production company or of the corporate department producing an internal project.
Category 3 workers are defined as having little or no control over any aspect of production, and to the IRS that means just about everybody else on the crew: assistant producer, boom operator, camera assistant, camera operator (not performing director of photography functions), driver, font operator, gaffer, grip, nu rse, production assistant, production coordinator (also known as assistant producer), talent, VTR operator, and teleprompter operator. While it is not impossible to be in this category and be considered an independent contractor, the IRS has made it much more difficult.
Once properly categorized, each worker must meet various levels of proof, which the IRS terms critical factors and significant factors and which are pretty much what they sound like.
The three critical factors bear the most weight and consist of a continuous relationship in which the worker is not hired on a project-by-project basis (one exception is joint ventures in which all parties share in profits or losses), employer-paid training for the worker, and employer-paid guild or union benefit contributions. If any of these factors are present for any category of production worker, the IRS considers that work er an employee and not an independent contractor.
There are four significant factors that come into play if all the critical factors are met. However, as Reed puts it, "These become important depending on whether the position is in Category 1, 2, or 3, which wi!J determine which of these significant factors have to be met. Each indicates the degree of control to which the worker is subject."
The first significant factor is business presence or steps the worker has taken to establish a real business entity, separate from that of his employer, such as keeping a personal office either at home or elsewhere away from the employer, having a commissioned agent or advertising, being available to other clients, maintaining a separate phone line and separate business records, using preprinted invoices, stationery, and/or business cards, and having a federal employer identification number.
Next is risk of loss, which means that the worker has made a significant investment in tools or equipment, has significant business-related expenses not compensated by the employer, or is paid a fixed fee or day rate under which the worker is not compensated for significant time spent on certain aspects of the project, such as planning.
Workers from all three categories are subject to these first two significant factors. Category 2 and 3 workers must also prove that their production activities away from the shoot or production company are not controlled by their employers. "If the company has a right to exercise control over your work when you're not involved in the shoot, if they can tell you to go back to the shop and prepare the equipment for the next day or tell you how to maintain your eq ui pment, then you're an employee," says Reed.
Finally, Category 3 workers must also answer questions about their method of instruction on the job. This is something of a murky area in production, because the director reigns supreme on the set. "The IRS recognizes that production is a cooperative venture," says Reed, "and that it's important for people to coordinate the timing of their tasks with other people." Reed says it's okay if an independent contractor is given instruction only as to the desired resuLt or look. But if the worker is told specifically how to accomplish that end resuLt, h e or she is probably an employee.
SHAKEUP IN THE WORKS
If you're a little shaken up right now, you're not alone. Consider the talent industry, where most of the workers will be reclassified as employees and their agents or clients as employers. "It's very clear that if a talent is affiliated with a union, they're definitely an employee," says Carol Mosic, president of CAM Talent in Columbus and Cincinnati.
As a result of the new IRS guidelines, Mosaic is reconsidering the agency practice of collecting from clients and then paying talent. "If we write the check, we're considered the employer. And there's no agent that I know of who wants to be the employer, because there's too much paperwork."
Enter the payroll service. Traditionally, these paymasters have been used primarily by broadcast commercial talent who needed a service to track how often a spot aired in which markets and collect the appropriate residuals from the client. That's what Players for Players has been doing in St. Louis since 1989. But now President Mary Thompson finds her services expanding to handle more client needs, from serving as employer of record to helping clients budget a script.
"I think it really hangs the independent contractors, but on the other hand it's the employer who bears the brunt of it if there are any penalties and back taxes," says Thompson. And her protection doesn't come cheap. Thompson tells clients to figure on a 50 to 55 percent increase in budget to cover payroll taxes, union percentages, and the payroll service itself.
While many payroll services like Payers for Players will also handle crew payroll, there have been few services that specialize in them, until now. Art Kibby had been a partner in Kibby Rayner Productions in Cincinnati for 15 years when corporate downsizing and the IRS changed the way he does business.
"It all came about because Procter & Gamble was looking at the [freelancers] working at their corporate offices," Kibby recounts. "They did n't want any employees, and they strongly implied nobody was going to be working for them unless they came through temporary agencies."
But the alternatives at the time were not very attractive to Kibby's crews. "Some of the grips we were working with at the time looked into temp services and found that, instead of making $175 a day, they'd be making $65 a day. Those companies just aren't set u p for the video production business. When we heard that we said, 'We can do that.' And we started doing it for two or three people."
Initially, Kibby-Raynor simply directed cash flow, from the client to the freelancers. "People were still working for us as independent contractors, we were just adding a service fee for our handling payroll," says Kibby. "ln 1994, we started examining it much more closely, when i t was brought to the attention of P&G that many of these people were not independent contractors at all according to IRS rules. They were very reluctant to accept this because of the additional cost involved. But they still didn't want to have any employees, either."
Now Kibby- Raynor the produc tion company also serves as paymaster and temporary employer of record for about 100 crew members, withholding federal, state, and local taxes and paying social security and employment tax like any other employer. The company also carries workers' compensation insurance and a $2 million liability policy on all the production employees it supplies.
The main client for these services is still Procter & Gamble and its test commercial division, Red na Productions. But starting this year, Kibby Raynor is offering its services in a big way outside the Cincinnati area.
Despite the push, Kibby says, "We're not really signing up freelancers willy-nilly. We require that they have a job set up. Ideally the request to sign up should come from a production company, producer, or in-house department. There's a lot of time involved on our part to set up a separate computer fJe as well as a separate paper file on everybody."
Kibby figures those services, along with taxes and insurance, add about 21 percent to the production payroll. "The important thing to remember when you budget these things is to build that extra 20 percent into the budget."
DUCK AND COVER
If you don't want to be an employee or carry temporary employees on the payroll, how do you protect yourself from a costly reclassification? If you're an independent contractor, make sure you act like one. Incorporate or, at the very least, register your com pany with state and local governments and get a federal tax identification number.
Apply for workers' compensation and business liability insurance and pay your own premiums. Make sure you have health care coverage, either through a spouse or on your own. Maintain an office, whether at home or away. Use professionally printed business cards, stationery, and business forms. Advertise your services. And above all. report your income and pay your taxes, quarterly if necessary.
If you're an independent producer, production company, or in-house video manager who wants to hire independents, make sure the people you hire understand that. Put it in writing. Ask to see documentation of workers' compensation and liability insurance, as well as that tax ID number. And be su re to file the proper 1099 federal tax forms, reporting every dollar you paid to independents.
The best advice of all is to get your hands on the IRS guidelines for the television production industry and learn them. You will still need a lawyer and an accountant as well as a payroll service if the people you hire cannot be classified as independents. But the IRS is hoping that once everybody knows the rules, we can all get along.
Catherine Silverman is president of Silverman/Media Inc., an independent film and video production services company in Cincinnati.
Reprinted with permission of Central City Sight and Sound magazine, January / February 1996, volume 5, no. 2.