Running a small business typically means that you, as the business owner, must wear a lot of hats.
For some companies, this arrangement works out well, but for others, there comes a time when bringing on additional people becomes a necessity.
Traditionally, small business hiring has meant that hired workers would be classified as employees for tax purposes.
These days, more options to partner with professionals exist largely due to the Internet, and business owners are utilizing independent contractors in place of hiring full-time employees more and more.
This can sometimes cause confusion among workers as well as business owners regarding the classification of someone who does work for a place of business.
How Hiring Choice Affects Worker Classification
Employee classification, at least on paper, comes down to the agreement you have with your workers and the tax documents you file.
A person whom your business hires as an employee is considered a W2 employee since your business will need to provide a tax form W2 to each of these types of workers at the end of the year.
When hiring an employee, your business will need to fill out and file a form W4 for each worker who is considered an employee of your business.
An independent contractor will usually be classified as such and will need to be provided with a 1099-MISC tax form at the end of the year.
For this reason, most business owners will refer to contractors as 1099 employees. An independent contractor will need to fill out and turn in a W9 form to your business.
This form contains the information your company will need to provide a 1099-MISC form to each contractor.
On the tax filing end, you will usually need to file form 1099-NEC. This form is for non-employee compensation that your business paid out to people who did work for your company but are not classified as employees of your business.
Tips For Small Business Owners Hiring An Employee Or Independent Contractor
Before hiring either an employee or a contractor, you need to know how the worker is classified. For some types of work, this may be straightforward, but in other cases, worker classification may not be so clear.
The Internal Revenue Service (IRS) allows employers to file form SS-8 in these situations. This form gives the IRS a chance to review the employee’s duties to make a determination regarding classification.
Before filing form SS-8, you may also consider looking over the guidelines for a 1099 vs. W2 employee provided by the United States Department of Labor (DOL).
The DOL provides classification guidelines that can help you determine the right way to classify people you pay for work so that you can ensure your business is adhering to federal requirements.
According to DOL guidelines, an employee can be considered someone who usually works for one employer and has an ongoing relationship with that employer.
Additionally, an employee is someone who is paid hourly or by salary, is not working for themselves and the person’s employer assigns roles and duties.
Conversely, DOL guidelines explain that a contractor is someone who works for themselves, works with multiple clients and decides when and how work will be performed.
You’re also encouraged to have an actual contract in place with any contractor you hire. This contract should expressly state that the contractor is not an employee of your business and is completing a work for hire.
This not only provides the contractor with a full understanding of their role in the company, but it also helps to protect your business in the event that the contractor tries to invoke litigation for things like unpaid benefits or wages.
What Is Employee Misclassification?
If you find that you have misclassified a worker, it’s important to correct the issue as soon as possible. Misclassification occurs when you label an employee as a contractor or a contractor as an employee.
This can happen with contractors who don’t have a contract in place, but it can also happen when you hire an employee and do not provide things like a schedule, a regular paycheck or the right tax withholding status.
It is believed that somewhere around 90 million Americans will consider themselves contract workers by 2025.
Currently, it is estimated that there are over 50 million contract workers in the United States. This makes it all the more important for employers to clarify the role of each person they pay for work.
Misclassification can come along with some challenging consequences that may be costly.
The IRS is likely to penalize any business that fails to file proper documentation. For employers that fail to file the right W2 forms, there is currently a $50 IRS penalty per employee in addition to a 1.4% penalty of the employee’s total wages for the tax year.
You may also need to pay 40% of the FICA taxes that did not end up getting withheld along with 100% of the FICA taxes your business was supposed to contribute.