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MLMers: Employees or Independent Contractors?

Figure our your tax classification.
March 1, 2001
URL: http://www.entrepreneur.com/article/38448

This time last year our economy was thriving. We heard stories about bonuses and promotions, not layoffs and bankruptcies. But figuring whether you earned money as an employee or independent contractor has taken on a dramatically new meaning in Tax Time 2000 and beyond. The combination of workforce layoffs, a spiraling growth of homebased businesses, industry's increasing reliance on temporary and contract workers, and the insecurity of those who are "traditional employees" have made more of us into entrepreneurs and contract workers than ever before.

While the variety of homebased businesses is vast, this article focuses on one form-multilevel-marketing programs. While much attention has focused on legally questionable marketing practices by some of these firms, we hear little about a much more important question facing anyone participating in an MLM at tax time-MLM associates' employment classification or "status" when it comes to calculating our taxes. The question of "Who's the boss at tax time?" becomes extremely important for the IRS and, therefore, for you. The right answer can determine whether you'll check the "refund" or "payment due" box on your tax form this year. Not knowing the answer to this question can have costly consequences for anyone involved with an MLM or other homebased business.

Employee Vs. Independent Contractor

The issue became important after a recent legal case holding that anyone signing on as an associate or distributor with a MLM organization is a contractor, not an employee of that organization. If you joined an MLM during the past few years, your contract most likely states that you signed up as an independent contractor and aren't an employee of that particular MLM program.

Therefore, if you're among the thousands of folks who became used to the traditional working world of receiving and filing W-2 forms to calculate and report your taxes, you need to be extra careful. Don't be surprised if you received a 1099 Form from an MLM you may have been associated with in the past. Many of these firms have changed their accounting systems to comply with the law-and are sending all their current and prior associates and distributors 1099's.

Misclassification Can Pose Costly Risks

Risks of employee misclassification face employers in all sectors, from corporate giants like Microsoft which paid $97 million to settle a class action lawsuits with misclassified "permatemps" last year to public municipalities like King County, Washington, which paid $23 million to misclassified workers.

A recent study by The Independent Contractor Report of the businesses and industries most often involved in IRS-related worker status or misclassification disputes confirmed the diversity of the problem. It included professionals and small-business owners, clerical workers, doctors and nurses, personal care assistants, truck drivers, newspaper delivery messengers and many more in hundreds of workforce categories. Surprisingly (to some), lawyers and accountants were at the top of the list.

Questions To Ask

As you do your taxes this year, ask yourself two simple questions: 1) Did I spend all or part of the year as an independent contractor, temporary, contract, part-time or other "nontraditional" worker?, and 2) Did I spend any part of the year operating a small business of any size? This includes participation in any multilevel or network marketing firm as an associate, distributor or other label.

If you answer "yes" to either question, you may want to consider seeking professional advice from a knowledgeable attorney and/or accountant to help you in your calculations and avoid the high price of filing your tax forms incorrectly.

The IRS and our courts continue to use the "20 Common Law Factors Test" to decide if you're an employee or independent contractor. You can also find it, along with other useful information to help you determine your tax status at the IRS Web site.

Author's Note: This article is intended to inform and educate you, but not answer your specific questions or deal with your particular situation. Bring it with you to your accountant, lawyer or other professional tax or financial advisor and ask how to avoid potential pitfalls of employee-contractor misclassification.


Ron Wainrib is a law and business consultant and educator, and principal of REW Associates Inc., based in Franklin, Massachusetts. His Web site, Temp Law On Line, is an online information resource for workforce managers and employees. Ron can be reached by e-mail at Needtokno@mediaone.net.