The Employee vs. Independent Contractor Issue
You’re a creative person who started your business doing what you love, but also with the hope of achieving financial success. As you continue working on your business you realize how much there is to do. Rather than wearing a multitude of “hats” doing everything yourself, you’ve decided that maybe it’s about time to hire some help.
The decision of how the helpers will be paid must be made.
The question is: Should I pay this person as a 1099 contractor or W2 employee?
Should you pay them as an independent contractor or withhold taxes from their compensation as an employee? The IRS has developed guidelines to help small business owners make the right choice between independent contractor or employee. The biggest determining factors should be what is correct in the eyes of the Internal Revenue Service not what is necessarily easiest for the owner.
In the past, the IRS gave guidelines to its agents to help determine what the status was of the “worker.” They used a list of 20 factors compiled by the IRS, sometimes called the “20-Factor Test.” This list is still used as an analytical tool, but some of the factors are no longer as relevant as they once were. IRS agents are advised to focus on the overall situation rather than to emphasise only one or two of the 20 factors.
This view allows for an easier method of collecting taxes - Direct from a single business owner rather than chasing down several independent contractors.
It seems like such a simple question - “independent contractor or employee?
The trend has been for the IRS to view all helpers
under the direct control of a business owner as their employees not as contractors.
On the one hand, an independent contractor will get full pay with no deductions. But they are liable for their own taxes. In January, the Employer (Business Owner) should provide them with an IRS Form 1099, assuming their total pay was $600 or more. The worker may be tempted to say “1099,” figuring that they’ll get a bigger check that way. In the short run, they’ll actually owe higher taxes. As an independent contractor, they not only owe income tax but self-employment tax too; totalling a whopping 15.3% rate.
In contrast, an employee will only pay one-half the Social Security tax (6.20%), plus one-half the Medicare rate (1.45%) on all wages. The Employer (Business Owner) pays the same.
Classifying workers as employees requires that the Employer (Business Owner):
* withhold federal, state, and local income taxes; * pay half of the tax mandated under the Federal Insurance Contributions Act (FICA); * pay the full tax required under the Federal Unemployment Tax Act (FUTA); * and any state unemployment insurance;
Also, may pay for:
* workers’ compensation insurance; * file a number of returns during the course of the year with the various tax authorities; * and provide W-2's by January 31.
The employee may also have rights to any employee benefits offered, such as health insurance, vacations, holidays, or retirement plans.
When considering hiring an employee, the Business Owner will incur more costs
than when paying an independent contractor.
To determine if a worker is an employee or an independent contractor we need to look at both the type of RELATIONSHIP between the worker and the business. We also need to take into consideration what is the evidence regarding CONTROL and INDEPENDENCE.
There are three (3) categories of facts that help to provide evidence as to the degree of control and independence:
Does the company control or have the right to control what the worker does and how the worker does his or her job?
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, etc.)
Type of Relationship:
- Are there written contracts or are they receiving employee-type benefits, such as a pension plan, insurance, vacation pay, etc?
- Will the relationship continue?
- Is the work performed a key aspect of the business?
So you need to be careful with your choice.
If any workers that are hired and paid as 1099
contractors are later determined by the IRS to
be W2 employees then the Trust Fund Recovery
penalty which is:
Federal income tax
Social Security and Medicare taxes
will be assessed to the business owner.
The IRS.gov website advises…..
“Factors which are relevant in one situation may not be relevant in another. There isn’t a set group of factors that would make your worker an employee or an independent contractor. You need to consider a variety of factors when you are trying to determine if a worker is an employee or an independent contractor.”