MLMIA – Legal Mentoring Bulletin One
The Critically Important Independent Contractor Status
Direct selling companies are not an “industry” in the traditional sense of being grouped together because they market similar products like cosmetics or vitamins. What unites direct selling companies for discussion purposes, for industry association purposes, and for regulatory purposes is their selection of their channel of distribution—independent contractor representatives.
This channel of distribution selection (by direct sellers and qualified real estate agents) is specifically recognized in the Internal Revenue Service Code, at Title 26, Section 3508. The existence of this regulation, 99 percent of the time, resolves any doubt whatsoever that payments to a direct seller are NOT subject to the IRS withholding rules and W2 issuance, but rather are free from withholding and ARE subject to the IRS 1099 reporting rules. Parts of the regulation are quoted and commented upon:
For purposes of this title, in the case of services performed as a . . . a direct seller -
(1) the individual performing such services shall not be treated as an employee, and
(2) the person for whom such services are performed shall not be treated as an employer.
For purposes of this section -
(2) Direct seller
The term ''direct seller'' means any person if –
(A) such person-
(ii) is engaged in the trade or business of selling (or soliciting the sale of) consumer products in the home or otherwise than in a permanent retail establishment, or
(B) substantially all the remuneration (whether or not paid in cash) for the performance of the services described in subparagraph (A) is directly related to sales or other output (including the performance of services) rather than to the number of hours worked, and
(C) the services performed by the person are performed pursuant to a written contract between such person and the person for whom the services are performed and such contract provides that the person will not be treated as an employee with respect to such services for Federal tax purposes.
Just two comments: First the obvious one: “. . . selling . . . consumer products in the home or otherwise than in a permanent retail establishment . . . .” A person making sales from the corporate offices of the company will not fit this independent contractor definition. And the not so obvious comment: “. . . pursuant to a written contract . . . .” A written contract is ESSENTIAL. Distributors take note of this very important point. You cannot, without risk, become an independent contractor on a handshake. And companies take note that counsel of a direct selling skilled attorney should be sought about the existence of, and the contents of, this legally required written contract between the direct selling company and its independent contractors.
The above is provided as general information, and although written by MLMIA Board Member and Direct Selling Specialist Attorney, Gerald Nehra, is NOT provided as the rendering of legal advice. Readers are urged to seek the counsel of attorneys or firms with special knowledge of direct selling laws. The four firms that devote their practice exclusively to counseling corporations about direct selling legal issues are, in alphabetical order: Babener & Associates, Jeffrey A. Babener, 503-226-6600, [email protected]; Grimes & Reese, PLLC, Kevin D. Grimes and Spencer Reese, 208-522-2600, [email protected]; Nehra & Waak, Attorneys at Law, Gerald Nehra and Richard Waak, 231-755-3800, [email protected]; and D. Jack Smith Law Firm, D. Jack Smith, 901-292-5225, [email protected].