This is illegal. It’s not something that the US government has been regularly enforcing. But if the trend continues and ends up on the public’s radar, that will change.
To get started as self-employed is a bit difficult. You need to bootstrap yourself with at least two customers. You need to show offers, orders, payments, advertisement for your service, and so on. They want to make sure that what you do is not circumvention of factually being an employee. A workaround could be to ask two friends if they could create an order for you, then you are free to offer yourself to a company and switch every three to five years.
What's illegal here exactly?
1. US Business Entity conducts business with EU Business Entity.
2. The person (let's call them a contractor) is employed as a full-time employee for the EU Business Entity. They also function as the owner of the EU Business Entity.
3. US Business Entity, EU Business Entity and the contractor - all pay their respective taxes as required by the laws in their jurisdictions.
This is the very foundation of how consultancies operate, for example:
1. The consultancy is the employer, the consultant the employee.
2. The consultant gets hired out to different clients, to work on different projects.
3. The consultant's salary gets paid by the consultancy, not the client.
4. The client only ever conducts business with the consultancy.
What does "wrapping people in shell companies" mean? As a person, you're either employed for a "shell company", in which case you've signed a contract and you get paid a salary - or you're the owner of a "shell company", in which case you get to choose how to manage the company's funds. You can also be both, simultaneously. You'll be paying taxes either way. Paying yourself a salary is a taxable event.
I'm still not sure what's illegal here?
Could you kindly explain how this definition of "false self-employment" is in any way relevant to the situation I just described in my original comment? I'm struggling to see it myself.
What about the specific situation I described implies circumvention of social welfare, or employment legislation, for example?
So they hire a contractor instead and pay them as a 1099 contractor, or the contractor sets up an LLC and they pay the LLC, or an S-corp.
Doesn’t matter how they pay them, if they treat them as an employee (there’s a 20 part test) they are a de facto employee and it’s false self-employment.
It's a standard case of one company (a third-party) purchasing the services of another (a company you simultaneously both own, and are employed at).
And if that's a fiction, a judge will see straight through it. Ask a lawyer if you don't believe us. I can think of several examples in the news lately in my country of residence.
I never claimed that "pro forma" contracts used for laundering illegitimate business relationships are somehow legal. This feels to me like an entirely separate issue, and I'm not sure how it's related to anything we've discussed so-far?
You can own a company, and simultaneously be the only employee in that company. Your client enters into a contractual agreement to purchase services from your company. Your company must comply with all local laws and regulations as part of your employment in that company. Your company charges the client a fee which, down the line, covers all of the business expenses associated with the work being done (including any taxes that need to be paid, overtime, insurances, pension, social security, etc). I'm still, to this moment, not sure what makes any of this illegal or illegitimate?
Whether the engaging company pays you directly or pays an LLC you own is not part of that test.
If the IRS or a local government decides that you are being treated as an employee of the company, they will ignore the intermediate LLC.
Think about your argument for a second. If it holds true, employment laws are useless.
Single owner LLCs are pass through entities and they have no obligations to pay minimum wage, overtime, unemployment insurance etc…
If your interpretation of the law stood, every company would simply require each employee to form an LLC and pay each employee as an independent contractor.
In fact many companies do try this, and the IRS and state departments of labor go after them for it regularly.
Perhaps an LLC (which is a pass-through entity) is the wrong structure to use here then. Perhaps a C-Corp would be more suitable?
Here's one example of what I'm referring to: https://www.altinn.no/en/start-and-run-business/planning-sta...
> "If your interpretation of the law stood, every company would simply require each employee to form an LLC and pay each employee as an independent contractor."
But that's exactly how companies hire external contractors today, so I'm not sure why you're suggesting there's anything wrong here?
The reason companies don't require each and every employee to form an LLC is because it makes things more difficult for everybody - not because it's illegal. Direct employment is much easier to manage, hence it's more popular. I don't see your point?
>much easier manage
This is patently false. Contractors are much much easier to manage.
It is perfectly legal to hire contractors. There is nothing wrong with this. What you can’t do is hire a contractor and treat them as an employee.
There is a legal difference. The IRS has a 20 part test.
The IRS will look at this situation and determine either the owner of the LLC is a de facto employee or not.
Whether they are billing though an LLC or not is not one of the factors.
Here’s a quick read about the topic: https://www.trimprulaw.com/an-individual-who-has-an-llc-is-a...
“Just because an individual which is engaged by a business has an LLC, does not mean that the DoL will classify that person as an independent contractor.”
e.g., the owner of an LLC who bills through the LLC can still be found to be a de facto employee.
It doesn’t matter that you pay income taxes, what matters is that the employer isn’t paying payroll taxes, withholding income taxes, paying unemployment insurance etc.
I think we're talking past eachother here.
The employer, in this case, is you (a company you own). You're also the only employee (a private person employed by that same company you own).
If your company decides to pay you a salary, your company must also deduct taxes, social security, benefits, payroll taxes, income taxes, pension, etc.
Your company must ensure the terms of your employment are compliant with all laws and regulations.
Your client enters into a contractual agreement to buy a service from your company. They're not responsible for your company's compliance with local laws and regulations. Your company will be charging the client a certain rate (gross), which is usually worked backwards from the "net salary" you as an employee want to make.
The vast majority of single person corporations are pass through entities. There’s no income tax withholding , no salary, no corporate tax etc…
However even in the very rare case where you setup a non pass through entity, if your company only has one source of income and that is you the owner operating as a de facto employee of another corporation, in most jurisdictions that is false self employment.
What you’re describing is an often attempted loophole, and there’s plenty of precedent that it doesn’t hold up.
I strongly disagree, it's not a loophole, it's literally one of the most used incorporation methods in Norway ("aksjeselskap", or "AS"): https://www.altinn.no/en/start-and-run-business/planning-sta...
This model isn't unique to Norway. Plenty of other countries offer similar incorporation methods.
But isn't that exactly how consultancies work though? The client enters into a contractual agreement with the consultancy, asking for specific consultants to help the client get certain tasks done. The consultants are "treated as employees" in the sense that they often have to physically work with the client, on the client's projects, during the client's schedules, having lunch in the client's canteen, working with the client's team, reporting to the client directly, using the client's tools and processes, creating IP for the client, etc.
That their company receives income from multiple clients, and the engagement is for limited duration is evidence for them being contractors.
The IRS and local governments make the final determination.
https://www.everee.com/blog/irs-independent-contractor-test/
If there's a subjective test involved, where some things are left to interpretation and circumstantial evidence, my take here is that it would be wisest to work with a lawyer/accountant on setting up the correct structure for each engagement.
It's also good to remember that this is the IRS, and that other jurisdictions may have entirely different practices here.
The loophole you’re talking about is alas probably tax fraud, if you are paying from multiple companies that you own to make it look like your “contractor” had multiple clients.
It has been popular, at least in NL for decades now: people invoicing eachother and moving money around just to make the threshold.
You keep applying laws for companies operating in NL to any arbitrary company operating elsewhere.
Timezones are a major hassle. You will end up with a lot of weird late afternoon, early evening meetings, which isn't great for family life. That might not matter if you're end up in the top 3% earners and your partner doesn't need to work as a result.
For some countries also be aware of things like on call. A US employer might not be ready to deal with the legal requirements in your country.
If you are treating the contractor as an employee, they are a de facto employee and you should be withholding income tax, paying payroll tax etc..