Be aware that you must classify your employees correctly. If you do not, and you are audited, you may face payment of back wages plus taxes and fines. If you are paying anyone via a 1099 form, re-evaluate and make sure they do not fall within the IRS guidelines for employees.
The IRS has 3 categories in determining whether or not someone is an employee or an independent contractor.
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his/her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies.
- Type of Relationship: Are there written contracts or employee type benefits – pension plan, insurance, vacation pay, etc. Will the relationship continue and is the work performed a key aspect of the business?
You must consider these factors in determining whether the worker is an employee (receiving a W-2) or an independent contractor (receiving a 1099).
An Employee is someone who you have hired and you specify where and when he/she works and you determine how he/she is paid. You may also offer benefits, paid vacation, 401(k) plan, pension plan, and insurance. Along with this you pay them on a regular schedule, pay all taxes both on behalf of the employee and the employer and you cut them a W-2 at the end of the year.
An Independent Contractor is one that you hire for a specific job. You usually sign a contract in agreement for the work being performed and the timeframe in which the work will be done. The independent contractor determines at what time they will arrive, you pay no benefits to them, and in most cases you do not deduct taxes from their payment. At the end of the year, you cut a 1099 form for the amount you paid them during the year (usually $600 or more in payments). Be careful even if there is no formal contract, if the person is doing work outside the employee parameters, they are considered an independent contractor and a 1099 form needs to be cut for them so they can report gross income at tax time.
Test Your Skill
Can you tell which is an employee vs. an independent contractor?
- You have an open position for receptionist and you placed a posting on one of the internet job sites. Jane Doe applies and after the interview you make an offer of employment. The position will be hourly at $11.50 per hr,; after 3 months she will be entitled to apply for health insurance; after one year, she is eligible for PTO time and eligible to participate in the 401(k) plan. Jane accepts the offer and starts work on June 5th.
- You have an IT project to install 25 computers, related software packages, printers, etc. You interviewed a few people and you feel Joe Martin would be the right fit for the project. Joe submits a contract for $7,500 and he will work on the weekends and evenings as do avoid causing problems with the staff during the day. You agree to the terms and sign the contract.
- Sue Jones comes in 3 evenings per week and cleans the office. For doing this service, you pay $15.00 per hour for 4 hours each night. From her paycheck, you deduct taxes but she is not eligible for any benefits.
- You need work done on the outside of your building, pressure cleaning, trees cut, general cleanup. You get Tom to do the work. When the job is completed Tom tells you the cost is $1,200. You write a check to him from the business account for the $1,200.
- You hired Matt Jones to head-up a new division. Upon hiring, Matt agrees to the terms of the employment contract. The length of time in the contract is 3 years with a salary of $105,000.00 per year with a 10% increase in years 2 and 3.
- Jane Doe would be an employee. You will be determining her pay, what work she will be doing and will be offering her benefits.
- Joe Martin is an independent contractor. You signed a contract, he determined the rate of payment and how and when he will work.
- Sue Jones is also an employee. Although she only works 4 hours for 3 nights per week, you are determining her pay, you are deducting taxes from her paycheck and paying both her portion of taxes as well as the employer portion, you have set the rule for the type of work she will do for this payment. Even though she does not receive benefits she is an employee receiving a company paycheck.
- Tom should be considered an independent contractor for the work he has done and a 1099 cut at the end of the year. This would be income to him for IRS purposes. Anything over $600 requires a 1099 to be issued.
- Matt is an employee. Although he has a contact, it’s an employment contact. He is being paid to perform the specific job you want done, he is receiving benefits etc. Based on the guidelines he’s an employee.