ASSIGNMENT: "Beach Gear Gripes"
Facts
You are a certified public accountantproviding tax and general business advice to your client Cynthia Bradley. Cynthiais considering purchasing a "beach gear" store from the existing owner, Jared Eddy.Jared is a sole proprietor (i.e. the sole owner of the business).
The business is located on the public beach in Malibu, California. The beach gear consists of towels, sun tan lotion, beach toys, and other items commonly purchased by the beach crowd.
The beach gear is sold by individuals solely on a "commission" basis on an area staked-out by Jared Eddy. Salespersons keep a fixed percentage of each sale as full payment for their services, and return the balance of the sales price to Jared. They are paid strictly in cash by Jared, with no withholdings and no annual wage statements-and, as Jared puts it "no paper trail."For whatever reason, Jared refers to these payments as "rent."
Purchasers consist of the every-varying beach crowd that swims, relaxes, and otherwise visits the beach in their spare time. Business is outstanding-in fact, phenomenal--and several competitors would like to sell similar items on that portion of the beach. However, they are prevented from doing so by Jared and his "people," namely to individuals named Dan and Elaine. Dan and Elaine are former gold-metal professional kickboxers who were banned forever from the sport because of their especially aggressive behaviors, which led to many injuries and lawsuits. Anyone except Eddy's salespersons who try to sell similar beach gear are "taught a tough lesson" by Dan and/or Elaine, and never return after they are treated in a local hospital for their injuries.
Although there have been several complaints made to the local police, nothing has been done to remove Jared, Dan and Elaine due to the risk of harm that will likely occur to those who try to do so, and becausethe local police are more interested in keeping an eye out for an opportunity to appear in the next Hawaii Five-0 episode on TV if the film crew happens to arrive.
Every morning, Jared gets up early and "stakes out" a large portion of the public beach for his business in order to keep out competitors. He pays extra cash (all in "small bills"--no checks) to Danand Elaine to patrol the perimeter of the staked-out area and make sure that no one tries to "trespass" on his (i.e. Phil's) staked-out space by selling toys or any other items. Jared hardly knowsDan and Elane because he has never inquired about their past personal or employment history, but can always depend on them to keep competitorsout.
Each day, the beach-gear sellersshow up and pay rent to Jared. Rent is twenty-five percent (25%) of daily gross earnings, and must be paid or Jaredwill collect it by gunpoint or have Dane and Elane do so. Each of the beach-gear salespersons makes upwards of one-hundredseventy-five thousand dollars per year in annual gross income because the beach attracts many people. Everyone involved is quite happy with this amount, and business is booming.
However, no one gets along with Dan and Elane because they constantly "micro manage" the salespersons. This includes setting their hours of operation, telling them how they dress, how to great customers, and even how they should perform their sales jobs. In addition, besides paying rent to Jared,each beach-gear seller is required to pay Jareda "commission" (this is what Jared calls the payment) consisting of a percentage of the charge and tips received for made in connection with the sales.
However, income is great, and the salespersons do whateverJaredtells them to do. Besides, Jared does provide all of the equipment, supplies, security, and advertising for the business. In addition, Jared pays for all other expenses such those for Dan and Elaine, who make sure that no one interferes with the salespersons' work and customers.
All of the salespersons work exclusively for Jared. They have no other customers.
Jaredhas always told the salespersonsthat they are independent contractors and that he (Jared) is not their employer. Until recently, this worked fine for everyone because no one wanted taxes and other withholdings deducted from their income because it resulted in additional disposable income. However, one of the salespersonswho had no health insurance was recently injured by a volleyball that sailed into the grooming area, and was told by Jared that there was no workers' compensation insurance available because the groomers were, in Jared's words, "not employees."
Jared has told Susan that she must buy the business "as is" and assume all liability associated with the business, including that created by any "employment relationship" existing between the groomersand Jared. Jared has never paid a salary to any of the groomers, and consequently has never withheld payment for state or federal income taxes, paid the employer's share of social security taxes, paid for workers' compensation insurance or unemployment insurance, or any other tax or fee normally required to be paid by an employer.
Initial Questions
Susan asks your advice. What is the probable status of the relationship between Phil and the groomers? Why?
What is the potential liability of Phil regarding his relationship with Dan and Elane and that of Susan, of course, if she assumes Phil's liability by purchasing the business?
What should Phil have done differently to avoid any liability? How can he fix the problem if there is one?
Response
Please address the issues, considerations, questions for further inquiry (e.g. assumptions based on facts not known); probable outcome, and ultimate advice to your client. What factors indicate an independent contractor relationship? What factors indicate an employment relationship?
What is the "worst case" for Jared and the groomers if a court were to determine that they were employees and not independent contractors? The answer to this question may require some internet research. Suggestion: Check the IRS web site!
If Cynthia insists on purchasing the business and assuming all liability, what should she insist that Phil do to fix any problems first?
A typical,concisely-written response should take three to five double-spaced, typewritten pages.