ENTERTAINMENT PAYROLL FAQ'S
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Think Twice before you hire your crew as "Independent Contractors"
As a Director of Payroll for over thirty years, I have seen and heard many stories from Producers that should make you think twice before you decide to hire your crew members as independent contractors. Many producers say "I just can't afford to put the crew on payroll - there's no money for it".
The real fact of the matter is this - are you willing to break the law and put yourself and your company at risk because you think you can save money? Many independent filmmakers just don't understand the reality of what the law requires with regards to hiring independent contractors (IC's) and that is the reason for this article - to make sure that you are well informed before making a catastrophic decision that could cost you (and possibly your investors) dearly.
Although it has been common practice for decades, the hiring of individuals (particularly below-the-line crew members) as "independent contractors" on a "1099" basis is a dangerous decision that can get the principal owners/officers of the production companies or project into trouble - not only with the government but also with their investors. After all, your investors are under the impression that you are operating "legally" with their money and would not be too happy to find out down the road that you made a tactical error that could put their funds in jeopardy.
Frequently, newer independent filmmakers will get advice from veterans who will tell them "In order to save lots of money on your payroll taxes, just pay your crew as independent contractors. Just 1099 them - I've been doing it that way for 20 years!" Unfortunately, while this may in fact save the producer some money, it's really bad (and in most cases) incorrect advice.
The IRS as well as most states has determined that in the entertainment industry, most "crew" below-the-line positions are, in fact, "employee" positions. The IRS has a Market Segmentation Specialization Program (MSSP) which specifically targets and examines companies within the entertainment industry.
Production companies (particularly low-budget filmmakers) will typically pay their crew as independent contractors based solely on the fact that it will save them money in payroll taxes (and sometimes in Workers Compensation Insurance as well). Their thought process in doing this is that "all my producer friends have done it this way so it must be okay - and think of how much money I'll save."
When this occurs, in most instances, the individual making that decision has just opened their production company up for many legal issues including significant fines and penalties at both the Federal and State levels. In many cases, there has even been criminal prosecution.
The problem and confusion over this issue lies in misconception. Just because a friend tells you he paid individuals as IC's for twenty years does not make it legal. The real issue is a matter of "classification" of employees as determined by Federal and State regulations. Unfortunately, to make things more confusing, there is no one set guideline that regulates this. There are Federal rules and state rules - sometimes conflicting with each other.
However, for the most part, under the Federal regulations (and most states including California), a crew member on a film or other similar type production should never be categorized as an independent contractor - they are really "employees" and are subject to federal and state withholding (from their paychecks) as well as the employer making the required "employers" payroll tax payments to the government (referred to as payroll "fringes").
One exception to this would be if the crew member had his or her own "loan-out corporation" in which case, that individual is an employee of the loan-out corporation. Typically, the only crew members who usually do this are UPM's, Line Producers, Directors of Photography and other high paid individuals.
What is the Determining Factor?
There are many factors which determine how an individual is classified. However, the IRS guidelines state:
"The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result".
"Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed."
Some of the other factors include:
- Who has control over hours of work
- Who has control over the location/place of work
- Who has control over the sequence of work
- Who furnishes the tools, equipment and materials
- Whether the worker has a risk of profit AND loss
- Whether the employer has the right to fire without breach of contract liability
- Whether the worker has the right to quit without breach of contract liability
With the main determining factor being that an employer has "the right" to control how the job will be performed; this puts almost all below-the-line employees into the "employee" category.
Many producers will argue that it is the "length of time" that will qualify their selected individual to be an independent contractor - "after all, it's only a two day shoot". Whether that individual is on the clock for ten days or ten minutes - it doesn't alter the fact that they are an "employee" - not an IC.
Other producers are under the impression that having a written "independent contractor agreement" with the individual will protect them (or make it legal). They believe that by having an individual sign a document that says that they (the individual) are independent contractors, and, as such, are responsible for their own tax, that relieves them of any tax liabilities. Such an agreement is not valid and would be disallowed in a payroll tax audit. Under the law, the contract is not controlling as to the definition of independent contractor or employee.
If a producer or production company is unable to determine if an individual they want to hire should be paid as an employee or an independent contractor, it is always best to let the IRS make the final determination for you. If you make the wrong choice, you will be liable for penalties, interest plus the amount of applicable taxes that should have been withheld and paid to the government. Use the IRS Determination of Worker Status SS-8 form to assist you.
How do I (or my company) get into trouble?
Many producers are sometimes aware of the fact that they might be breaking the law when they make the decision to categorize their crew as IC's. They justify this by saying that they will "1099" the individual and the government will eventually get their money. They believe that by simply 1099'ing the individual at the end of the year absolves them of any tax liability - it doesn't!
Another problem is that many production companies will pay the individuals cash and then NEVER submit their earnings (1099 data) to the government. So, the government loses payroll tax revenue from both the employee and the employer. Under this scenario, this is out and out tax evasion - a criminal offense.
When an employee works for an employer, the employer contributes an "employers" share of payroll tax dollars to the government. This is not to be confused with the "employee" portion that comes out of the employees check. When the employer pays into the state unemployment fund, the state receives a record that that employee "worked" for that employer (the production company). The state sees that the production company "paid in" to the unemployment fund and everything is okay. That means that the state received the proper payroll taxes from both the employee and the employer. That is the way it should work.
If you've paid your crew as an IC (with no taxes taken out) the problem starts when a crew member files an unemployment claim after your shoot is finished listing you as their last employer. The unemployment office that examines the claim will eventually note that there is no record of his supposed employer (your production company) ever registering with them or paying payroll taxes into the system on behalf of this individual.
This will immediately cause a red flag at the unemployment office (who are always on the lookout - especially for entertainment companies). They will eventually contact the individual and ask further questions - more specifically "give us a copies of your check stubs for examination".
When the documents are examined, the unemployment office will take note that there were no employee taxes taken out the individuals check. This will in most instances always result in a state investigator showing up at the door of your production company with a subpoena to examine your payroll records, bank accounts, and other books.
After the extensive audit, the State will determine that your production company failed to pay the proper employers payroll taxes and you will be subject to paying not only the original taxes, but now additional fines and penalties. The State may also have agreements with the IRS which will allow them to notify them as well which can then result in a Federal audit.
Should an audit occur and the auditors find that the officers/owners were negligent in paying the proper taxes, the results can be catastrophic. The entity type of your organization (such as an LLC or corporation) will be of no protection or defense. The government will want their money and they will come after ANYONE that they think that they can collect it from - the "deep pocket" individuals.
They will (and have) put liens on peoples bank accounts, garnished wages and even taken persons homes in an attempt to collect their payroll tax debt. Their attitude is that you are a "criminal" for "defrauding" them and they will stop short of nothing in order to get what is due to them.
How can I protect myself?
If you are a filmmaker and are budgeting a production, take the time to budget in the necessary amount of money it takes for your payroll "fringes". It is not worth the extra risk to yourself, your associates, or your investors for the sake of trying to save money. If you can't afford to do the production legally, then postpone it until you have the necessary funds.
Since most productions are funded by investors, ask yourself this question: would you be willing to go to your investor and state - "I'm trying to save your money by not paying the required taxes. Even though it's really illegal, are you okay with it? Will you be willing to pay the fines and penalties later if we get caught?"
Chances are you would NOT be willing to make that statement to your investors. They would think that you are unprofessional and you don't know what you're doing. Are you willing to take the risk and explain it to them down the road if you fail to tell them now? Are you willing to put your own security on the line?
Don't make the mistake that I've heard from other producers over the years - "if only I'd done it by the book". They will tell you that it's just not worth it!
By Kevin King, CEO of ABS Payroll and Production Accounting Services