In addition, the Internal Revenue Service requires a far more restrictive arrangement to allow separation of the salon owner from the tax obligations of the booth renter. This article is written to assist the salon owner in meeting these various requirements. In addition, the Internal Revenue regulations are described and explained so the reader can understand what to do and how to carry out these rules.
Independent Contractor or Employee
The underlying issue in the salon industry relates to the independence of the stylist. The stylist is mostly concerned with two personal goals. First is the greater increase in income via separation from the salon as an employee. The secondary goal is more independence in setting their personal schedule e.g. what days to work and hours of operation.
For the owner of the salon you must realize that you have two governing bodies that must recognize the stylist as an independent contractor in order for this to work. The first is your respective state law and court case history related to the contractor/ subcontractor relationship. The second body that must recognize the relationship is the Internal Revenue Service.
The one mutual requirement that exists in law and in the tax code is a ‘Contract’ between the parties. This contract should include the following elements:
- Control over the End Result – effectively the booth renter must have the right to control the style of the hair for the customer. The salon can have no rights to how the style is rendered.
- Govern by the Board of Cosmetology/Professional Regulation – each state is different, for example in New Jersey, booth renting to independents is against the law. For those states that do allow booth renting, there are compliance issues. Some states require the booth renter to obtain a salon license. In New York, the booth renter must have their own ‘Appearance Enhancement Business’ license to provide services. Typically these licenses require bonds and insurance to protect the patron from medical issues and illegal activities.
- Separate Insurance Compliance – the renter should carry insurance to protect the customer, the property and the shop owner from accidents.
- Collection of Customer Payments – the renter should collect the customer payments and not have the payments processed through the front register.
- Separate Supplies – in this industry the back bar includes supplies for the stylists. In the contract, the salon should require the stylist to carry their own supplies including color.
- Hours of Operation – booth renter sets their own hours of operation, can be restricted slightly to correspond to the general salon hours.
- Separate Business License – the renter must carry their own business license issued by the local government or by the state or both.
Rents can be fixed or have a fixed component and a percentage of the sales the renter collects. The key here is that renter provides an accounting of some sort to validate the sales volume in which a rental percentage is paid. The preponderance of the total rent should be fixed in nature so as to maintain a true appearance of independence for the stylist. Identify in the contract what the rents covers, such as their particular spot in the salon, utilities, access and costs for receptionist to receive all customers and for scheduling.
I urge you to have a written contract and a compliance program in your salon. The contract is signed by both parties and should have a life of one year with automatic renewals unless terminated with proper notice (time and statement). For compliance issues, I encourage you to have the stylists insurance binders copied to your business address. Their binders should have the salon listed as additional insured and have you as an individual listed as an additional insured. Monitor the business license and the corresponding Board documents as identified above.
In addition to the above requirements, the IRS has an additional set. For the independent contractor, they must prepare a Form 1099 identifying the rents paid to the salon. This is often confusing as in many salons, the customer payments are collected up front and the salon issues a 1099 to the booth renter identifying their respective earnings. YOU CAN’T DO THIS.
The IRS is adamant in making sure the independent contractor collects their own fees for the services they render. Look at the outcome of this particular Revenue Ruling:
Revenue Ruling 73-591, 1973-2 C.B. 337
Facts: Salon agrees to furnish, repair, and maintain all equipment; hair stylist is paid on a percentage of gross receipts; no credit work or free work can be done without the approval of the salon owner; working hours are set; hair stylist furnished a report each day to the owner reflecting the day’s receipts. Determination: Employee
Here’s another with a slightly different variance from 73-591:
Wolfe v. United States, 77-1 U.S.T.C ¶ 9346 (D.N.D. 1977)
Facts: Hair stylists are paid on a percentage of gross receipts; hair stylists handle own clients; hair stylists provide own supplies; appointments are made through one receptionist; hair stylists set their own hours and have their own keys to the shop; money from services is paid to the salon; hair stylist decides what prices to charge; hair stylists are responsible for bounced checks; and hair stylist are not required to work on salon’s customers. Decision: Employee
Based on many rulings and court cases, it is obvious that the requirement for collection of payments has to be done at the booth and not up front. The stylist must control their income just like any other business. If the salon fails to comply then the salon owner opens their business up to employment tax consequences. This can be extremely expensive given the fact that you did not collect the money or have control over the money to pay the respective taxes. You must maintain a preponderance of the evidence that the booth renter controls their own destiny.
Suggestions – Booth Rental Legal and IRS Compliance
In general, I don’t encourage the booth renting format in a salon. Nor do I recommend any combination of renters and employees. I strongly encourage owners to use a pure employer employee relationship. A really good model for compensation is illustrated in this article: Hair Stylist Compensation Model . My primary concern is that the salon owner exposes their business to a lawsuit by not only the stylist, but by the stylist’s customers. The customers are generally not aware that their stylist is a booth renter. In addition, the IRS strongly encourages the employer employee relationship and will use any form of discovery to negate an independent contractor status.
However, if you are going to use this tool as a revenue source, then make sure that it is only available to your more experienced and mature stylists. Generate a contract, require insurance, mandate licensing compliance and vouch the documents (make sure they exist on the premises). Finally, the renter must issue you a 1099 for the rents the stylist paid to the salon. Act on Knowledge.