If you run a business and plan to have people working for you, it is important to properly classify them as either employees or independent contractors because your decision will have payroll tax implications. For example, you must pay payroll taxes for employees, such as social security and unemployment taxes, but not for contractors.
It is very easy to determine a worker's classification. If you answer "Yes" to one or more of the following questions, it is likely that the person is an employee.
1. Do you control when and where the person works?
If you can control the person's hours and the place where the work is to be performed, then you are likely hiring an employee. Independent contractors usually set their own hours and work where they want (such as from home or at the business premises).
2. Do you specify which tools and equipment the person must use?
Usually employees use tools and equipment provided to them by their employer to complete his/her job, whereas contractors use their own. For example, a graphic designer that is responsible for purchasing his/her own software is more likely to be a contractor.
3. Does the person work only for you?
Independent contractors are free to market their services to others and to work for as many people as they want. If the person working for you is restricted from doing this, they're probably an employee.
4. Are you paying the person regular wages?
Employees are typically paid salaries or hourly wages on a regular basis, whereas most independent contractors receive a flat fee for their services. However, there are certain professionals, such as attorneys, that charge clients by the hour even though they are clearly not employees.
5. Do you provide the person with employment benefits?
Employees are more likely to receive benefits like sick pay, vacation time, health and dental insurance, and 401(k) matching.
6. Did the person agree to work for you for an indefinite length of time?
Usually employees are hired to work for the employer indefinitely until either party willfully terminates employment. On the other hand, contractors are hired for a specified time period to complete the job.
7. Is the person's job closely tied to the core operations of your company?
For example, an architecture firm that hires an architect to assist with projects is likely taking on an employee.
The above questions are guidelines to help you determine whether someone you're hiring is an employee (and will need a W-2) or an independent contractor (and will need a 1099-Misc). Like other areas of the tax code, there are a few grey areas and you will have to use your judgment to make a decision. As long as you are being reasonable and are able to substantiate your classification, the IRS is less likely to question your decision.
It's a good idea to give an Offer of Employment Letter to each person you'd like to hire as your employee and an Independent Contractor Agreement to each person who will be a contractor. These documents outline the agreement on the terms of the working relationship between you as the employer and the person you're hiring. Keep a copy of these documents in each worker's file in case the IRS ever wants to verify a worker's classification.
Jovana Jerinic is a Certified Public Accountant and Certified QuickBooks ProAdvisor providing accounting and tax services to individuals and small businesses. Jovana Jerinic CPA specializes in tax return preparation, tax planning, IRS representation, and QuickBooks setup, training and support. Our CPA firm also provides bookkeeping, payroll processing, and small business consulting. Please visit http://www.jj-cpa.com for more information.