Hired Help: Employee vs Contractor
As a small business owner, you may hire people to help you with your business Whether these people are classified as employees or independent contractors affects a number of things, including how much you pay in taxes, whether you need to withhold taxes, and what documents you need to retain and reports you need to file. It can also affect your risk exposure with workers compensation and general liability insurance. Improper classification can result in fines and penalties, exposure to liability claims and lawsuits, and back taxes assessed against the business for failure to pay when required. It is worth more than a little of your time to make sure you have the proper classification and required documents for all of the workers you hire before any work is started.
The IRS uses three main criteria to determine the relationship between businesses and workers:
- Behavorial Control - how/when/where the work is to be done, what tools are required, who should assist, and where to purchase supplies and services
- Financial Control - who controls the financial aspects of the worker's job
- Type of Relationship - how the business owner and worker perceive their relationship
Aspects of a typical employee are:
- Receives extensive instructions and/or training on how the work is to be done
- Required to work specific hours or a specific schedule as determined by the employer
- Eligible to have business expenses reimbursed
- Eligible for company-provided benefits, such as insurance, pension, or paid leave
- Employer must withhold income taxes and employee's share of Social Security and Medicare
- Employer must pay their share of Social Security and Medicare, as well as federal and state unemployment taxes, and carry the required workers compensation and other insurances required by state law
- Employer must provide a W-2 to employee by Jan 31 of the following year
- Forms W-4 and I-9 must be filled out by employee and kept on file at business office
Aspects of a typical independent contractor are:
- Does not receive extensive training or instruction on how work is to be done
- Has a significant investment in their work, such as providing their own tools and equipment
- Is not typically reimbursed for business expenses
- Can realize a profit or loss from the work being performed
- Is not eligible for employer-paid benefits
- Has a written contract showing that an independent relationship is intended
- Must have a Form 1099 issued if paid over $600 during the calendar year
- Is responsible for paying their own income tax and self-employment tax
- Form W-9 must be filled out by contractor and kept on file at the business office
Both employers and workers can ask the IRS to make a determination of a worker's status by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The form can be obtained on the IRS's web site - it may also be helpful to review this form to see the types of questions the IRS uses to determine status so you can better classify your workers.
In addition to the IRS forms, you should also make sure to retain the proper insurance documents for independent contractors. Your insurance carrier may require that you obtain proof of insurance for any contractor you hire. This proof of insurance, called a Certificate of Insurance, proves that the contractor has adequate insurance that will cover any potential claims that may arise from the work being performed.
For more information on Employee vs Independent Contractor, you can visit www.irs.gov and refer to Publications #15-A, #1779 and #1976. Or you may call the IRS directly at 1.800.829.3676.
The following article from the US Small Business Administration also provides helpful information on hiring employees: Hire Your First Employee.