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How a Tax Law Helps Insure a Scarcity of Programmers (1998)
- Psyonic 17y agoThanks for posting this. It provided the best explanation so far (for me, at least) of the law that so pissed off Joe Stack.
- retro 17y agoDoes this mean if you're a freelance programmer, you're at risk of running afoul of this law - as Joe Stack did - if you're trying to negotiate programming contracts directly with the client rather than through an agency? My understanding is that you can protect yourself from this law by working through employment agencies as a W2 or Corp-Corp contractor? Is that correct? Is so, then perhaps the programmers I've met who said they were "independent consultants" were likely working through agencies since the risks of being truly independent are too high?
- maurycy 17y agoThe article says that if you're incorporated, and the only person hired, it changes nothing.
- seiji 17y agoNot just the article, but the senate directly referenced such no-nos: "For example, an engineer retained by a technical services firm to provide services to a manufacturer cannot avoid the effect of this provision by organizing a corporation that he or she controls and then claiming to provide services as an employee of that corporation." http://www.synergistech.com/1706.shtml http://www.synergistech.com/1706.shtml
- jhancock 17y agoSome clients, usually larger ones, can be risk adverse to working directly with an independent contractor. Its not hard for an independent contractor to be "independent" per these tax rules. However, many clients don't want to take the risk that the contractor is doing their end right. Whether this is real or perceived risk on the part of the client is not clear to me. The bottom line is if you are an independent contractor, you should do all your work through an LLC or S/C-Corp and manage your tax filings well. Some clients may still not accept dealing with your LLC directly and hand you a list of "approved contractors" to bill through. The only way you may get in trouble past this is if all you work is for one client and the IRS feels your really acting as an employee.
- SriniK 17y agoOn the tax side, there is W2 or 1099. When you get W2(salary), taxes are usually withheld. In case of 1099 no taxes are withheld. So, you(as the contractor or LLC owner or Corp owner) have to estimate taxes every quarter. LLC and Single person corps were treated badly 10yrs ago. Now pretty much every state recognizes LLCs/S-Corps and yes, one can be owner and single employee.
- tedunangst 17y agonit: It's risk averse. A risk can have adverse effects, though.
- jfager 17y agoI understand it to be the opposite: if you're drumming up your own business, you should be fine, but if you're getting work from an intermediary, you have to be treated as an employee of that intermediary for tax purposes. IANAL, and I could be completely wrong on that; anybody who knows better, please correct me. EDIT: nevermind me, read grellas comment.
- lsc 17y agoor they are individuals with a high risk tolerance.
- artanis0 17y agoAnyone know if any laws like this exist for Canada?
- 3pt14159 17y agoThey do not. Anyone is free to create a sole proprietorship/partnership/corporation provided that there is not national security implications ("Pam and Tom's Atomic Weapons" - Disallowed "Pam and Tom's Fighter Craft Displays" - Allowed) or confusion in the marketplace or depletion of nation resource (fishing companies, dairy companies, logging, etc). Actually, small business law in Canada is extremely well thought out. There is rarely a tax reason to incorporate, unlike other companies. For example, incorporating and paying out dividends will run you just as much tax as running as a sole proprietor. Usually. There are tricks you can pull, Turks and Caicos QA companies that reduce your profit to nearly 0 but reinvest the profits overseas. Plus IRAP funding is intense if you are large enough to float a couple salaries and you can handle mountains of paperwork.
- scotty79 17y agoCan you as us citizen register company in Canada and provide your services in US? Is there anything against it? Import tax on services?
- bjelkeman-again 17y agoThere are similar rules to the US rules in the UK, but what we do instead is that we hire people cross border in the EU as there is no real coordination on these things between the countries. If there was they would open up a can of worms around where the tax money goes and who gets what for the services. In fact the only sensible way to work for a Dutch company whilst living in Sweden is to have your own company or be a sole trader, even if you work 100% for the same company in the Netherlands and invoice only them.
- cperciva 17y agoYou can do that, but it won't help. My understanding (as a non-US tax expert) is that if you're providing a service in the US you have to pay taxes in the US -- at least, last time I did consulting for a US company I had to fill out paperwork confirming that I was Canadian and doing all of the work from Canada in order to avoid all sorts of US tax paperwork.
- jbooth 17y agoFor those who didn't read all the way down, this law was passed in order to pass a tax cut on overseas operations that IBM was lobbying for. PAYGO rules and all that. Your congress at work -- raise taxes on the little guy in order to give tax breaks to the wealthiest.
- CulturalNgineer 17y agoAbsolutely right! This is the problem... Which is also why we've developed such an imbalance in wealth! We've got a serious problem with an imbalance in INFLUENCE!!! Actually that's my own focus for technological innovation... Realtime Networked Citizen Lobbying and distributed credit creation... (no pitches here, see my blog if interested) Fortunately I don't fly planes and still have a sense of humor.
- tpyo 17y ago[1-6] Is this an ironic joke? [6] Are you jealous?
- CulturalNgineer 17y agoNope, I'm an anthropologist. Extremes in wealth are not compatible with a stable free society. Though I'm open to contrary evidence.
- adharmad 17y agoSo was the soviet society stable and free?
- ynniv 17y agoYour statement attempts to show evidence that a society with no wealth diversity is unstable. That has no bearing on the original hypothesis that high diversity is unstable. Still it fails in this attempt because the historical instability in Communism has always been due to high wealth diversity that arises from political corruption, which ironically supports the original hypothesis. So... try again?
- deleted 17y ago[deleted]
- CoryMathews 17y agoWow.. just wow. what a load of crap, I cannot even imagine how many people are working "illegally". Most every programmer I know does some work on the side as a 1 person operation.
- crpatino 17y agoFor what I understand, if you are doing work on the side, you should not be reclassified as employee. You do not work exclusively for the customer, nor with their hardware, neither full time, and probably not even on site.
- tedunangst 17y agoHave things changed? I had no trouble working as a 1099 for a while, nor did any friends. HN and reddit are filled with posts by people claiming to be independent contractors. How is that one guy with plane is affected by this law, but nobody I've ever talked to is?
- jfager 17y agoIANAL, and I might be misreading the law (http://www.synergistech.com/1706.shtml http://www.synergistech.com/1706.shtml), but the way I understand it is that if non-tech company A needs some tech work done, and they hire tech service company B to get it done for them, company B is not allowed to farm out that work to individual contractor C without treating C as an employee for tax purposes. So if you're an independent contractor and you get your own business, you should be fine. If someone knows this to be incorrect, please let me know. EDIT: nevermind me, read grellas comment.
- ssanders82 17y agoI am individual contractor C, and company B pays me hourly as a contractor. I do most (95%) of my work for various clients of company B, but they are mainly concerned with my results, not every detail of my work. If I have questions, I usually ask the A's directly. I believe I am operating properly here.
- pauljonas 17y agoWhen I started my career, back in the 80s, the independent contractor was the "rock star" of software development career field. Would work at $MajorCorporation and bill directly, and make $100-$250 per hour or more. This tax code change, as well as some other regulations and tax issues mostly eliminated such direct consultants. Instead, a corporation like American Express would select several approved vendors and consultants would have to work for these firms in order to get work as a consultant. The shift meant a reduction in rates and another middleman to carve up the billable amount. It didn't totally eliminate the independent contractor but it certainly put the kibosh on it as most of the corporate world (big employers) funneled those positions to a set of preferred vendors. And which was exacerbated further with the rise of offshore vendors (who supplanted domestic bodyshops) and NIV workers.
- fnid2 17y ago''This is Catch-22,'' he said. ''If you are not legitimate because you start out as a one-person corporation and you haven't been in business for a year, then how do you ever start your business? It is nonsensical.'' Save up at least a year's living expenses, get rid of everything you own, travel the world for a year. You'll save money over keeping it, see the world, write some code on your laptop at hotels. Get one of those netbooks that will fit in a backpack. Charge it up at the coffee shop. You can get good wireless cheap overseas. Room and board is cheap. Make arrangements to work with companies while you are away. Start getting paid the next tax year. ''Basically the I.R.S. is saying it would rather collect less revenue with less cheating than collect more revenue with more cheating. Does that make economic sense?'' It is interesting that what is proposed here as more profitable government policy encourages cheating, something we don't appreciate in our species.
- barrkel 17y agoIn my experience traveling with a laptop, a lot of coffee shops will cut off power to their sockets to avoid giving you free electricity.
- fnid2 17y agoHotels, Hostels, solar panels. There is plenty of energy in the world for a laptop and you don't have to write code every day, only when you have enough electricity to sit in the park write or check emails. Use a notepad. Write stuff down. Draw diagrams. Think more, code less. You have a guaranteed income when you get back just don't run out of money that's all. If you do run out of money, go back to employment and start over. Find a job while you are away. The world outside employment is full of green pasture and sun for programmers as individuals and the future of the world alike.
- bestes 17y agoI'm not sure wasting a year of my life is really the right solution to this problem. Or, any of the other "solutions." My wife falls into this category. First (years ago), she just worked as a consultant via her sole proprietorship. Then, she had to start getting insurance policies. Then, she incorporated. Now, her corporation does work for another corporation that has a contract with the corporation she actually works for. It's a bad law and it should be removed.
- ww520 17y agoHere's my experience working as an independent status. Once a megacorp wanted to hire me as a consultant. The problem was that this megacorp had a list of "approved-vendors" to do consulting work for them. To get into the list was a time consuming and expensive hurdle. What did the hiring manager do? He asked me to join one of these approved vendors temporarily and billed through them. And this vendor got a cut out of it. Apparently it's a common problem that they did it alot. When I told the consulting firm my agreed rate was $200/hr, the guy said their contracting rates were never even close to that. Sweet time.
- euroclydon 17y agoThat's not really a complete story.
- ajross 17y agoThis is confusing. The clear text of the article says that programmers can't do individual contracting, which is insane and clearly wrong. The examples (e.g the contracting company with 50 "workers", none of whom were technically "employees" of anyone but themselves) don't seem nearly so clear cut. I mean, if this is really an important law to understand, wouldn't the idea of good journalism be to tell me how to avoid breaking it? I don't see that at all here. It reads like just another "tax is bad" screed. A pointer to the text of the law, or a less sensationalist presentation would be very appreciated.
- lsc 17y agotext of the law: http://www.synergistech.com/1706.shtml http://www.synergistech.com/1706.shtml the problem is that it's pretty unclear how to avoid violating it.
- CoryMathews 17y agoanyone got a link to the actual law itself?
- jfager 17y agohttp://www.synergistech.com/1706.shtml http://www.synergistech.com/1706.shtml
- dnsworks 17y agoReading through that article a couple of times was like a high school student attempting to write in the spirit of Kafka. It almost feels like an urban legend amongst geeks.
- grellas 17y agoI have dealt with this law in depth, from every angle, from its inception in 1986 and have a few observations to make about it: 1. The technical issue concerns the tax risk to an employer whether someone functioning as an independent contractor might be reclassified as an employee via an IRS audit that finds that the person is in fact functioning as an employee and not as someone who runs his own business. This risk exists for every business, large or small, that hires contractors. And the rules by which the outcome is determined are positively byzantine and pretty hostile to employers (and to contractors). They are set forth in IRS Revenue Ruling 87-41 and are summarized here (http://www.morebusiness.com/running_your_business/taxtalk/indvsemp.brc http://www.morebusiness.com/running_your_business/taxtalk/in...). In general, they state that if an employer has the right to control the means and manner by which someone performs his duties, as opposed to being concerned strictly with the result, then the person is functioning as an employee. They also set forth a list of 20 factors that auditors are to use to help to decide the issue, making this legal determination a very detailed facts-and-circumstances determination that can easily turn one way or the other depending on how an auditor chooses to apply a range of detailed factors. In the background, the law also has cases, precedents, administrative decisions and rulings, etc. that boggle the mind in their complexity concerning how the "rules" work. Moreover, the penalties associated with having a group of contractors reclassified as employees can be extreme. The employer must not only pay employment taxes (Social Security, etc.) for all such persons but also associated penalties and interest. The kicker in the case of a major audit covering several years is even worse because, if the employer can no longer locate the persons involved to get them to sign affidavits attesting that they in fact paid income tax on the income received, the employer also gets stuck having to pay the estimated income taxes for each such reclassified person. In practice, this can amount to a penalty that amounts to nearly half of the wage base involved in the dispute. 2. As one might imagine, this is a horrible landscape for companies to try to traverse without something that eliminates or sharply limits the above risks when they deal with contractors. And, to what should be nobody's surprise, such limits have historically existed to enable companies to have some rational means of dealing with the contractor issue. The limits appear in what are called "safe harbor" classifications. This means that a company hiring contractors can know with reasonable certainty that there will be no reclassification of the contractors as employees as long as the company complies with the safe harbor rules. These rules in turn vary from industry to industry but every industry has them. This is how companies hire sales people as contractors, for example, without incurring major risks of tax liabilities. 3. The 1986 law referred to in this article repealed the "safe harbor" provisions for providers of high-tech services. Thus, there was no law passed that said, "You are barred from hiring tech service providers as contractors." Companies can hire such contractors as much as they like. The repeal of the safe harbor for this type of service provider (and for no other) had the practical effect of making such service providers unmarketable to companies that had no interest whatever in taking on major tax risks just to be dealing with contractors as opposed to employees. 4. Just a background note on this repeal. Before the 1986 repeal, it was true that companies throughout Silicon Valley would hire "contractors" who would literally do, e.g., a 3-year stint working full-time at one desk for one supervisor on one project. Whatever else these persons were, they were clearly functioning as employees. They had to report for work at designated times and in a designated place. They took direct orders from supervisors on when, how, and where to perform specific duties throughout the course of a project or series of projects. There was nothing in such relationships remotely resembling a situation of a company dealing with a person who was in his "own business." In essence, what the companies were doing was hiring employees, calling them contractors, and saving the trouble of having to pay them employee benefits and employment taxes for their services. These were clearly abuses, and they prevailed at all sorts of Valley companies (Intel, HP, all the biggies). Thus, by 1986, this was an area ripe for attack. How did this happen in Congress? Well, 1986 was the great bipartisan coming-together for the lowering of individual tax rates in exchange for closing a variety of tax loopholes and tightening of tax requirements. In the midst of this bipartisan compromise, Congress took note of the abuses happening in Silicon Valley and repealed the safe-harbor classifications for high-tech service providers as a means of eliminating what was perceived as an abusive loophole. 5. While the above explains why the tech industry happened to get singled out as it did in 1986, it does not eliminate the fact that this safe-harbor repeal was in fact a highly discriminatory act in that every industry in American had safe-harbor rules available to it so that it could reasonably hire contractors while the tech industry was suddenly left without any such rules at all. Thus, from 1986 forward, tech companies became terrorized at the thought of hiring contractors under any circumstances (by the way, one of the last holdouts, Microsoft, continued to use large numbers of contractors and got slammed for this in major rulings that came out by the early 1990s, if I recall, though that case involved much more than tax issues). 6. Almost instantly from 1986 and on, a cottage industry sprang up of "placement agents" who would, in effect, assume the employee risk by hiring the tech-service providers directly and, in turn, contracting with companies to place them there as contractors. This worked for the tech companies because, from their perspective, they simply signed a contractor agreement with the placement firm and paid for the work as contract work. The placement firm, for its part, would then hire the tech-service providers mostly as W-2 employees and occasionally (if they were adventuresome) as contractors. If they retained individuals as contractors, though, they ran the risk of having those persons reclassified as employees and so faced the risk at their level that the tech companies once had directly. Because of this risk, most placement firms would not take on tech people as contractors unless they could have what they perceived as a strong case of calling them true contractors. The practical result of this was that, if a tech-service provider wanted to hire on to a placement firm as a contractor, he would first have to incorporate himself and then the placement firm would take on his company. The irony here is that the tax regulations behind the 1986 repeal specifically provided that it was irrelevant whether or not a sole contractor had incorporated himself and that this fact was to be disregarded in making the tax determination. Thus, though the fact of incorporation was technically irrelevant, most placement firms were happy to take people on as contractors once they had become incorporated. Go figure. (This article, by the way, discusses how the IRS would target such incorporated individuals in search of audit opportunities). 7. After 1986, it became virtually impossible for a tech service provider to hire himself out directly to a company as a contractor. Every one of the large Valley companies adopted strict rules forbidding this. In rare cases, someone might get through the rules if the person was incorporated but even then most times the answer from the company was no. Companies simply re-did their hiring practices and thereafter took on contractors pretty much strictly through placement firms and no longer directly. 8. For a tech service provider looking to go into business, this essentially put up an impregnable practical wall to finding reasonable opportunities to work independently in the tech world, at least in terms of providing services to the larger companies. This remains the case today as well, since the law has not changed in the decade following publication of this article. 9. By the way, this is not just a "big company" issue. Even little businesses can get into trouble without the benefit of safe-harbor protections. If you as a founder hire an early-stage contractor (which is often done) and later terminate the relationship, that person can go file for unemployment on the theory that he was in fact an employee of your company and had functioned as such. This in turn can easily trigger an audit of your entire company's history in this area (1099s you have issued are an easy way for the auditors to focus on key areas). Should this happen to you, you find yourself going down a rabbit hole that is likely to be unpleasant. (An aside: one reason to incorporate as a startup is that reclassification penalties/taxes apply only to the entity and not to the founders directly). 10. To sum up, then: there is no law forbidding tech people from offering their services as independent contractors but such persons face serious practical barriers in building a service business because employers will not hire them as contractors for fear of having their status reclassified in a later audit. This is pure discrimination against tech people. No one else is burdened in this particular way in wanting to set up a service business. The fix is an easy one for Congress to make but I have seen no movement on this whatever. For the near future, I am afraid tech service providers are stuck and have no real remedy for this problem.
- andrewljohnson 17y agoInsure -> Ensure As an ex-college-newspaper editor, this error always stands out to me. And the NYT should know better.... even in 1998. YC's headine is the same as the Times.
- liamkf 17y agoHmm, it seems like they're pretty much interchangeable at this point: http://dictionary.reference.com/browse/Insure http://dictionary.reference.com/browse/Insure
- andrewljohnson 17y agoIt's true you can be lenient about this, but the Associated Press style is to distinguish: http://www.wsu.edu/~brians/errors/assure.html http://www.wsu.edu/~brians/errors/assure.html. I would have thought the Times would follow suit. They really are two different words.
- prgmatic 17y agoThis is rediculous, I'm just glad to see that this has resurfaced and people are taking notice.
- scotty79 17y agoIn my country there is a problem with employers forcing their employees to fictionally incorporate, so employer can save on social security (in case of 1 person companies social security is not associated with actual income, but can be paid in low minimal monthly amount, of course lower monthly social security payments means lower retirement benefits which is not good for fictionally incorporated employees). Our IRS equivalent decides that incorporation was fictional if former employee has 1 person company, has only one client and this client is his former employer. If you have multiple clients and none of them hired you before you started your own company then you are safe.
- kevinpet 17y agoIs this the reason Joseph Stack flew his plane in the IRS building?
- araneae 17y agoWell, probably not the reason (I would say some sort of mental disorder was primary.) But yes, is was one of the reasons stated on his website.
- huherto 17y agoIsn't the root cause of all of this, the high cost of employing people(as opposed to just contracting them). I don't know if it is the situation elsewhere but here in Mexico; the benefits than a low income employee gets are worth the extra employments cost; but for higher income, you just get too many taxes and little benefits, so it is costly for companies without the employees getting much. So people hire contractors to avoid paying so much in benefits that are not worth much.
- petercooper 17y agoThere's a similar law in the UK. It was passed in the early 2000s, I believe - it's called IR35: http://www.contractoruk.com/ir35/what_is.html http://www.contractoruk.com/ir35/what_is.html
- sown 17y agoWait. Does this mean that my dream of starting a side business of writing kernel code for hire in SV is DoA?
- lsc 17y agoNo. It just means that it will be quite difficult to find people who will hire you without going through a headhunting firm that will take half your pay, and that if you do manage to find a small corp that will hire you directly as an independent contractor, and you write off business expenses against that income, there is a chance the IRS will invalidate those writeoffs, which often results in big debit that can't be discharged by bankruptcy.
- fexl 17y agoThe movie "Brazil" premiered in 1985, the year before strutting beasts wrote this statute in defiance of common law. Many wilt helplessly at the sound of such braying -- but not Tuttle, who embraces the dangerous life of peaceful production.