It finally happened! You worked your fanny off and your business is growing. Congratulations! In fact, it is growing so much you need to hire help. You are a service professional who could greatly benefit from an administrative assistant. You are a photographer and need the help of hair and make-up artists. You offer delivery service and could use another driver.
In today’s complex world, striking an employment agreement with someone is not the final step; not even close! Among other things, you must determine whether your helper is going to be an independent contractor or an employee. Why is this important? The IRS and the ever-powerful dollar say so! Make the right choice (and stay out of trouble!) by reading on.
- Independent Contractor: An independent contractor is their own boss and you are essentially hiring out their services. They call their own shots and decide when, where, and how the work will be done. They pay their own payroll taxes. At the end of the year you issue a 1099 tax form to them.
- Employee: An employee plays by your–the boss’s–rules. You set their times to work and stipulate how the work will be done. You often give them added benefits such as insurance, retirement plans, and vacation time. You split the cost of payroll taxes with them by paying half and withholding the other half from their paychecks. At the end of the year you issue a W-2 tax form to them.
So why is the correct classification of a worker so important? Well, it is important because, as I said, the IRS says so. Payroll/employment taxes–no small amount when all is paid–are on the line. If you incorrectly classify an employee as a contractor, you may be liable for that workers payroll/employment taxes. Also, you just don’t want to make the IRS mad.
How do you decide which category the worker’s position will fall into? Unsurprisingly complicated, the IRS has devised a 3 part test by which to weigh the position: Behavioral, Financial, and Type of Relationship.
- Behavioral: Does the boss/company get to say when and how work will be done?
- Financial: Does the boss/company make financial decisions on behalf of the worker such as tools and supplies purchased and how the worker is paid?
- Type of Relationship: Are benefits part of the relationships? Does the working relationship continue after the project is finished?
It is common that a position will not clearly meet all 3 parts of the test one way or the other. Not all factors will be relevant to every case, either. The IRS suggests weighing the options against each other, to “look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.” (So keep a good paper trail, just in case.)
Still feeling unsure and cautious? You can bring the IRS directly into the game by filling out and submitting a Form SS-8. But only if you can wait at least 6 months to hear back!