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Sub-subcontracting question

Old 07-14-06, 11:10 AM
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Sub-subcontracting question

I am presently running my own business as a sole proprietor. So far, it's been a one-man shop -- I have a set of clients that I have steady contracts with, and I've kept pretty busy. Now I have the opportunity to grow the business somewhat and add in an additional 15-20 hours per week. Since this is probably a bit more than I can handle, I'd like to set up a friend of mine to subcontract. I'd work with the new client to make it work -- I'm not trying to do anything sneaky or duplicious -- so this isn't a question of business ethics or morality.

This is really a business question: since I am currently subcontracting with this client, my friend would be sub-subcontracting. I'd still need to handle any client meetings, review all code, etc. What I would ideally like to do is to give him a cut of the total billed amount -- if the client is paying me $70 an hour, I'd pay my friend $50-$60 an hour.

But if the client pays me directly, we'd end up paying taxes twice, right? I'd pay taxes on the total income from the client -- and then my friend would pay taxes on what I paid him. That wouldn't be any good.

Is there a way of structuring this so that I would simply subtract my friend's amount from my taxable amount? If I simply report only the extra $10-20 an hour as my "income", will the taxmen come and haul me off to jail? Would it be better to ask the client to pay x amount to me and y amount to my friend? Would it be better just to give my friend the whole kit and caboodle and just bill for my own time, even if that ended up costing the client more?

I don't want to incorporate the business -- it's still too small right now, and I don't think there are enough advantages just yet -- and yes, I know that I am an idiot when it comes to business financing. Can anyone give me some practical suggestions on how I can make the finances work out for everyone?
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Old 07-14-06, 11:16 AM
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What you are describing is illegal. The reason people are often charged $50 an hour while the guy makes $35 is because of all the employee costs. Even if he is a subcontractor, you will still have costs in paying him, so the idea that you would charge $70 an hour and give him $50 is about right, but you will be paying taxes on the $20 and he will on the $50. You do need to make sure you have a contract written up just so that there isn't ever a question that he is actually an employee and not a subcontractor.
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Old 07-14-06, 11:34 AM
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Originally Posted by kvrdave
You do need to make sure you have a contract written up just so that there isn't ever a question that he is actually an employee and not a subcontractor.
A contract won't mean squat if the state and federal government want to consider him an employee. There are many other factual conditions that determine the difference.
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Old 07-14-06, 11:43 AM
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and the client might get ticked off when they can just pay the sub-sub less for the same work
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Old 07-14-06, 12:00 PM
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Just make him a 1099 employee. This means you're not responsible for his benifits or taxes. All you do is pay him cash for full ammount. So lets say that you pay him $50/hr. He worked 5 hours so you cut him a check for $250. Now he is responcible for paying taxes and if he does not the govt comes after him, not you.
I would also recommend you limit your liability by at least forming a LLP. When you have people working for you, even as contractors, there is always a possibility if you being sued even if they did something wrong, in fact that possibility exists even if you dont have any emplyees. Tye last thing you want is give someone the ability to go after your personal assets. It's the smart thing to do.
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Old 07-14-06, 12:09 PM
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Originally Posted by X
A contract won't mean squat if the state and federal government want to consider him an employee. There are many other factual conditions that determine the difference.
Agreed. What the OP is describing sounds like an employer/employee relationship to me. The IRS uses a 20 factor test to determine whether a worker is an employee or an independent contractor. Many law firms have publications discussing the issue - just google "20 factor test."

This is NOT legal advice and should not be relied on in any way.

Persons that you hire to do the same type of work that your business and its employees do are almost always considered employees, regardless of how you designate them for tax purposes. Someone hired to do maintenence in your office or to repair a broken copier is a contractor - that person is doing work that is not typical of your enterprise, he/she brings his own tools, is free to end the relationship at any time, etc. Someone hired to handle an increased client-load is probably an employee. That might not be a bad thing.

OT: I'm sure your friend is a nice guy, but why on Earth are you paying him $50 an hour when you only get $70? Even at a modest tax rate, aren't you at best breaking even?
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Old 07-14-06, 12:10 PM
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Originally Posted by Oraphus
Just make him a 1099 employee. This means you're not responsible for his benifits or taxes. All you do is pay him cash for full ammount. So lets say that you pay him $50/hr. He worked 5 hours so you cut him a check for $250. Now he is responcible for paying taxes and if he does not the govt comes after him, not you.
I would also recommend you limit your liability by at least forming a LLP. When you have people working for you, even as contractors, there is always a possibility if you being sued even if they did something wrong, in fact that possibility exists even if you dont have any emplyees. Tye last thing you want is give someone the ability to go after your personal assets. It's the smart thing to do.
NO! A 1099 employee is an independent contractor. This guy is most likely NOt an independent contractor. He has the right to request a W-2 from the OP and the OP will be responsible for his portion of the employee tax. Trying to save a few bucks on the employee tax buy misclassifying an employee as a contractor is illegal.
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Old 07-14-06, 12:17 PM
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Contract labor is a deduction as a business expense on Schedule C, therefore, that money is not being double taxed.
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Old 07-14-06, 12:22 PM
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OK, clearly what I would envision is having my friend set himself up as a 1099 independent contractor. I reviewed the 20 factor test, and I don't think most of the factors would necessarily apply. For example, the first item states: "An employee must comply with instructions about when, where, and how to work. Even if no instructions are given, the control factor is present if the employer has the right to control how the work results are achieved." In my situation, I don't really care about the when, where and how -- only the end result. The original clients would dictate how the application would function... I would simply be responsible for backing my friend up.

In general, neither of us are interested in pursuing an employer/employee relationship... we both have full-time jobs, so all of our work would be freelance. So what would you all recommend?
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Old 07-14-06, 12:35 PM
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The IRS information you need is in
Publication 15 and Publication 15-A
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Old 07-14-06, 12:39 PM
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Originally Posted by GMan2819
Contract labor is a deduction as a business expense on Schedule C, therefore, that money is not being double taxed.


Unless you don't plan on reporting what you're paying him as an expense, the income is not double taxed.

(Speak with your accountant!)*

* If you don't have an accountant, get one!




BTW, if your business is not incorporated you are MUCH more likely to be audited and you are MUCH more likely to lose everything you have if the business gets sued. Even if it is just software, it's a stupid, stupid, stupid idea to not incorporate. Spend the $500 and do it.
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Old 07-14-06, 06:38 PM
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Originally Posted by BobDole42
NO! A 1099 employee is an independent contractor. This guy is most likely NOt an independent contractor. He has the right to request a W-2 from the OP and the OP will be responsible for his portion of the employee tax. Trying to save a few bucks on the employee tax buy misclassifying an employee as a contractor is illegal.
you can call him anything you want.. he is not an employee though. Just someone subcontracted to do a specific task. You will have no problems with the IRS in this regard.
The whole point being that a 1099 contractor is actually a sole propriator that is just doing a specific job, mush like a guy you'd hire to mow your lawn.
.. but yes to talk to an accoutnant either way.
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Old 07-14-06, 06:47 PM
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Originally Posted by Oraphus
you can call him anything you want.. he is not an employee though. Just someone subcontracted to do a specific task. You will have no problems with the IRS in this regard.
The whole point being that a 1099 contractor is actually a sole propriator that is just doing a specific job, mush like a guy you'd hire to mow your lawn.
.. but yes to talk to an accoutnant either way.
I disagree. The "specific task" he is subcontracted to do is a task normally performed by employees (or in this case the sole proprietor) of the business. If your business is making and selling widgets, you can't hire a 1099 contractor to make and sell widgets alongside your employees - that person is an employee, no matter what you call him.

My take on the OP's question is that the friend would be helping out with the business and doing essentially the same thing the OP is. It is upon this understanding that I base my analysis. If I am incorrect and the friend truly is being hired to perform discrete tasks that are not the stuff of the enterprise, then perhaps he could be lawfully classified as a contractor. At the end of the day, I don't think either of us know enough about the OP's affairs to give any real advice, other than talk to an attorney.
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Old 07-14-06, 07:22 PM
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Originally Posted by Oraphus
you can call him anything you want.. he is not an employee though. Just someone subcontracted to do a specific task. You will have no problems with the IRS in this regard.
The whole point being that a 1099 contractor is actually a sole propriator that is just doing a specific job, mush like a guy you'd hire to mow your lawn.
.. but yes to talk to an accoutnant either way.
It doesn't matter what you call him or anything else. What matters is what the IRS calls them.
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Old 07-14-06, 07:28 PM
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Originally Posted by kvrdave
It doesn't matter what you call him or anything else. What matters is what the IRS calls them.
Damn straight!!
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Old 07-14-06, 08:50 PM
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Originally Posted by Oraphus
you can call him anything you want.. he is not an employee though. Just someone subcontracted to do a specific task. You will have no problems with the IRS in this regard.
The whole point being that a 1099 contractor is actually a sole propriator that is just doing a specific job, mush like a guy you'd hire to mow your lawn.
.. but yes to talk to an accoutnant either way.
Are you trying to get NCMojo put away for tax evasion?

The advice you get on a forum like this is worth exactly as much as you paid for it. Talk to an accountant and/or lawyer. You need to look at more than just this "subcontracting" issue - liability should be a serious concern. What if the code you or your "subcontractor" provides ends up disrupting your client's business operations and they sue you?
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Old 07-14-06, 09:50 PM
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Although talking to an accountant may be helpful for getting advice about your business and its financial issues, you need to talk to an attorney to resolve the question of how to classify your friend. A good employment lawyer will be able to easily and quickly ascertain how your friend should be classified based on the situation.
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Old 07-14-06, 11:29 PM
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Not sure about the tax question, but I was wondering if you're telling your clients that their work is being subcontracted to another person and that you are not the one doing the work?

If you're doing anything where your personal skill in the matter is important to the client (opposed to a business where it's just very basic work that anyone can do equally - not likely at 70/hour) then you have an obligation to the client to let them know you're not doing the work yourself. I don't think you can just delegate your responsibilities away w/o notice when the client is paying for your level of skill.

Might want to run that issue across your attorney after he/she figures out the tax issue.
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Old 07-15-06, 06:45 AM
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Originally Posted by BobDole42
I disagree. The "specific task" he is subcontracted to do is a task normally performed by employees (or in this case the sole proprietor) of the business. If your business is making and selling widgets, you can't hire a 1099 contractor to make and sell widgets alongside your employees - that person is an employee, no matter what you call him.
That's very odd, because a lot of people selling real estate for a real estate company are paid 1099, a lot of roof shinglers working for a roof shingling company are paid 1099, etc. etc. etc. Your widget example is flawed, especially for NcMojo, who has no existing employees.
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Old 07-15-06, 06:48 AM
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Originally Posted by illini420
Not sure about the tax question, but I was wondering if you're telling your clients that their work is being subcontracted to another person and that you are not the one doing the work?

If you're doing anything where your personal skill in the matter is important to the client (opposed to a business where it's just very basic work that anyone can do equally - not likely at 70/hour) then you have an obligation to the client to let them know you're not doing the work yourself. I don't think you can just delegate your responsibilities away w/o notice when the client is paying for your level of skill.

Might want to run that issue across your attorney after he/she figures out the tax issue.
That's why Mojo needs a business license. That way he can say, "Well, Mojo Globutron Ltd." is doing the work. Then anyone he hires can do it. Remember, as the 20 test says, Mojo (as a contractor) is "free to perform services in any manner that produces desired results." That includes hiring someone else to do it.
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Old 07-15-06, 07:52 AM
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Originally Posted by The Bus
That's why Mojo needs a business license. That way he can say, "Well, Mojo Globutron Ltd." is doing the work. Then anyone he hires can do it. Remember, as the 20 test says, Mojo (as a contractor) is "free to perform services in any manner that produces desired results." That includes hiring someone else to do it.
I do have a business license... although now I'm kicking myself for not thinking up the name "Mojo Globutron".

Not sure about the tax question, but I was wondering if you're telling your clients that their work is being subcontracted to another person and that you are not the one doing the work?
As I said at the start... yes, I am going to be working with the new clients to make sure the whole process works.

Thanks everybody for your excellent advice!
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Old 07-15-06, 11:44 AM
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Originally Posted by The Bus
That's why Mojo needs a business license. That way he can say, "Well, Mojo Globutron Ltd." is doing the work. Then anyone he hires can do it. Remember, as the 20 test says, Mojo (as a contractor) is "free to perform services in any manner that produces desired results." That includes hiring someone else to do it.
Yes, that helps taxwise. And that helps the client(s) to not have to call him an employee.

However the client(s) may not be very happy about a subcontractor and should probably be told. That could be one reason they didn't hire a company of programmers. They wanted the one person they knew and trusted.
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Old 07-15-06, 12:01 PM
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Originally Posted by The Bus
That's very odd, because a lot of people selling real estate for a real estate company are paid 1099, a lot of roof shinglers working for a roof shingling company are paid 1099, etc. etc. etc. Your widget example is flawed, especially for NcMojo, who has no existing employees.
Real estate is a fairly unique example, trust me. As for the roof shinglers, etc. you will generally find that they are not just shinglers but have actual businesses themselves, though it may not always be obvious.
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