As more and more of today’s work is being done by freelancers, one of the hottest topics in small business hiring involves differentiating between employees and independent contractors. While the question of classification is very much in the news as workers for companies like Lyft and Uber face legal action from drivers, small businesses need to know the difference to ensure that they are doing the right thing from a tax perspective. Here’s a quick primer on what you need to know about the difference between an employee and an independent contractor.
The first thing you need to understand is why it’s important. If the person doing work for you is an employee, then you as the employer are responsible for withholding, depositing, reporting and paying payroll taxes, as well as Social Security and Medicare taxes and unemployment tax. You also have to issue a W-2 at the end of the year. By contrast, independent contractors take care of this for themselves, and that means that you don’t have to do all that work. The only paperwork you’re required to file is a 1099 form at the end of the year, recording how much you’ve paid for the work performed.
The effective difference between the two lines in who is in charge of the worker’s schedule. If they are an employee, then they are not only paid a wage and have taxes withheld but are also told when to work and what their work consists of. By contrast, independent contractors charge a fee for their services, pay their own taxes, and dictate their own work style and schedule. It’s all a matter of who is in control.
Though the differences may feel minor, to the IRS they are a very big deal. The agency wants to make sure that employers properly classify their employees and assess significant penalties against those who don’t. To determine the difference between employees and independent contractors, the IRS reviews three factors. These factors are: who controls the worker’s behavior in terms of time, tools tasks and hours; who controls the financials in terms of wages or per-project fees; and what type of relationship exists between the company and the worker, specifically regarding the permanency of the relationship and whether the worker can also perform work for another company at the same time.
Misclassifying an employee as a contractor can leave you vulnerable to penalties and the payment of back taxes. To avoid this problem, contact us today for a review of your small business hiring practices.