Salon Owners: Practice Safe Credit Card Processing to Avoid an IRS Audit

Does Your Salon Accept Credit Cards?

By Eric Shasha, Stylists Alliance, LLC

Imagine the following scenario: It's January of 2012… as a salon owner, you submit your tax return, as you do every year.

You take your proper deductions and are transparent with all expenses, but you do not report some of the credit card charges because you have processed them for the independent contractors who rent spaces in your salon.

However, when the IRS receives the 1099 from the credit card processing company [due to the recent federal legislative ammendment - see article above] they will match it to your return. Remember, you did not account for your independent contractors and this will red flag your return and automatically trigger an audit.

When you explain, "Those are my independent contractor's charges," you may be guilty of not only misclassifying employees but also aggregating merchants on your credit card processing account. Aggregating merchants is a direct violation of Visa and MasterCard rules and regulations.

The penalty for aggregation is placement on the terminated merchant file, which means that the merchant may never be able to take a credit card again. The IRS will then reclassify your independent contractors as employees and you will owe FICA and FUTA for up to seven years back taxes and will notify the State of California.

With California Senate Bill 459 now signed into law, [see separate article] the impact of this bill in the beauty industry will be significant, since common business practices now result in misclassifying employees as "independent contractors" when in fact they should have been classified as employees.

In the salon owner tax return scenario above, it is entirely possible to unleash a State audit for misclassification of employees as well as a federal investigation of your tax return and business practices. These investigations will likely include going through your business and employees with a fine tooth comb, interviewing your employees and disrupting your business as a whole.

One instance of misclassification and you are in violation. The aspect of this SB 459 that makes it particularly deadly for the salon industry is that if you have "established a pattern" of misclassifying employees, the salon owner may be fined up to $25,000 for each occurrence. Salons are unique among other industries because they provide an environment in which the salon has multiple independent contractors under one roof.

Other common salon owner practices must also be re- considered in this new legal environment:

226.8. (a) It is unlawful for any person or employer to engage in any of the following activities: ...Charging an employee individual who has been willfully misclassified as an independent contractor a fee, or making any deductions from compensation, for any purpose, including for goods, materials, space rental, services, government licenses, repairs, equipment maintenance, or fines arising from the employee's individual's employment where the employer would have been in violation of the law if the employee individual had not been misclassified.

The practice of misclassifying employees is just not worth the risk. If a salon owner has 10 independent contractors and even the smallest infraction is found, the total liability may be upwards of $300,000 in fines and back employer taxes owed. In the salon owners defense they may state "…my accountant said it was ok!" or "My accountant never warned me." This has also been addressed in SB 459:

2753.(a) A person who, for money or other valuable consideration, knowingly advises an employer to treat an individual as an independent contractor to avoid employee status for that individual shall be jointly and severally liable with the employer if the individual is found not to be an independent contractor.

If an infraction is suspected, the State could then approach the CPA and ask them a very simple question "Did you advise your client to do business in this matter or neglect to advise them of the consequences of employee misclassification?" If the CPA answers yes they are subject to loss of license and must share in the fines with the salon owner.

If the CPA answers "No", the salon owner is left out in the cold to deal with the fines individually. The question here is "Do you think that your CPA will be willing to take the hit with you?" The reality is that the CPA will not risk loss of license and the fines associate to protect an individual salon.

Lastly, to add insult to injury, the following caveat was added for businesses that violate SB 459. A so-called "scarlet letter" must be placed on your website and within your business for a period of one year to let everyone know publicly "I have broken the law."

These potential misfortunes for your business are avoidable. Every salon owner should educate themselves on these new legislative developments and seek guidance and counseling from industry experts before you unknowingly set events in motion that will destroy what you have spent so many years building.

Do not be afraid if you are not in compliance. There are a few solutions which will help you avoid having your business practices picked apart. Technically each stylist who assumes an independent contractor status should have their own separate credit card processing account. This can be handled with a few solutions that are readily available and very inexpensive.

First, with the proliferation of mobile processing, for no cost a stylist can set up their smart phone to accept credit cards in a matter of hours.

This holds many benefits to the stylist, (as well as for the salon owner/landlord) including, faster receipt of funds, reduced rates, and the ability to accept credit cards during appointments in the field. Additionally, credit card terminals can be purchased and enabled to accept credit cards over many different merchant accounts. Though this is a widely accepted form of work-around to this mounting problem, the machine must technically be purchased by the stylists as a group.

Remember, employee misclassification can cost an individual salon owner hundreds of thousands of dollars. Practice caution and seek advice whenever a question should arise in regards to this is topic.

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