Are you Protected as a Contractor?
Executive Directors should protect themselves from liability and tax audits. Depending on the way a contract is written for services, the IRS may view the services provided by self-employed executive directors as employees versus contractors. The IRS is looking to make sure that companies are not abusing contract arrangements by deeming somebody a contractor to avoid paying payroll, health insurance, and offering various employee benefits.
To avoid confusion, the Academy recommends that every executive director sign a contract with each affiliate. Within that contract, a brief summary of the job responsibilities may be included. A detailed list of job responsibilities in a contract points to the position being administrative. This can cause problems if the contract is questioned by the IRS and the affiliate may be subjected to paying back taxes and penalties. Detailed explanation of roles should be saved in a second, separate document. (A contractor template is available for download.)
There are a couple of options to provide protection for executive directors and affiliates:
Executive director becomes incorporated as a business (versus self-employed). There are pros and cons to self-incorporation. Below are several of the benefits.
Limit personal liability
This is especially important as the only member/employee of the business. By incorporating, personal assets, for the most part, are off limits to satisfy judgments against the business, including any breach of contract allegations or debt.
Paying Taxes
Some businesses may gain tax benefits for the individuals by incorporating. One should contact a tax professional to determine the best course of action. For example, if incorporated as an S-Corporation, there are fees for income taxes at one’s personal tax rate. If incorporated as a C-Corporation, one may pay a flat rate of 35% on all income.
Individuals who are self-employed are subject to income taxes as well as self-employment tax. There may also be an impact to the amount of money that can be deferred for retirement by being incorporated which can reduce taxable income.
When taxes are due, the executive director would file a business tax return and pay tax on the corporation’s profits. Turbo Tax offers some useful information in several articles – “When and How to Incorporate” and “Tax Advantages to Incorporating”.
Tax Audits
Self-employed tax papers have one of the highest audit rates. Incorporating a business lowers the chances of being audited.
If the executive director decides to become self-incorporated, one of the first steps is to draw up articles of incorporation in the state where the business is headquartered. The articles declare basic facts about the company (name, purpose, etc.) This document is filed with the state (usually the Secretary of State or Department of Commerce). There will be a fee for filing that varies from state to state. The affiliate may decide to cover the initial cost of the individual’s incorporation and the executive director may cover any annual renewal cost. This should be determined by the affiliate board. Upon approval by the state the individual receives a Certificate of Incorporation.
The affiliate may hire the executive director as an employee. This means the affiliate will be subjected to paying payroll taxes, including Social Security, FICA, etc. The affiliate board should discuss and way pros and cons to make a decision.
For more information check with your tax professional and requirements in your state. The Academy recommends that any boards who currently work with an executive director have a discussion about the best course of action for the affiliate and executive director.