The folks at H&R Block were kind enough to share some valuable tax tips with us this week. They’re re-posted here for your education and enjoyment. Be sure to thank author Gregg Farrar for his contribution.
So, you’ve hired someone to help you out in your small business because it’s growing. Should this person be treated as an employee or a contractor?
Well, surprise! After you’ve hired and established a working relationship with a worker, you don’t get to decide whether your worker is an employee or a subcontractor. There are specific guidelines you have to follow to determine how to treat that worker. The classification of a worker depends on how much behavioral and financial control you have over the worker, which sums up the type of relationship you have.
What Does That Mean?
Having behavioral control of an employee means the employee:
- Is subject to instructions about how, when and where to work
- May be trained to perform services in a particular manner.
Having financial control of an employee means the employee:
- Is reimbursed for business expenses
- Has little financial investment, if any
- Is paid at regular intervals
- Has no capacity for making a profit or loss on the work.
On the other hand, a contractor is not subject to your control as the business owner. Contractors generally:
- Set their own work hours
- Get the job done in their own way, in other words they have no training from you to do it a certain way
- Are not reimbursed for their business expenses
- Have a financial investment
- Are paid upon completion of the work or in stages of the project
- Have the ability to realize a profit or a loss on their work.
There are some other factors to consider when deciding how to classify your worker, such as these more formal items:
- Are there any written contracts describing the relationship?
- Do you provide employee-type benefits, like insurance, pension, vacation or sick pay?
- Is the relationship permanent or short-lived?
The Bottom Line
These are all things to consider when hiring someone to help you out as your business grows. In essence, you can decide whether someone will be an employee or a contractor as long as you set the guidelines up correctly from the beginning. If you are wondering why you should care whether workers are employees or a contractors, it’s because they are treated differently for tax reporting requirements. Below is a quick explanation of what reporting is required of you, the small business owner.
Employees must fill out Form W-4 so you can withhold the proper amount from their paychecks. Then you must withhold income tax and one-half of FICA taxes from the employee’s wages. You will then have to report and pay those payroll taxes to the IRS on Form 941 or Form 944. At the end of the year, you will have to report, to the employee and to the IRS, the employee’s wages and withholdings on Form W-2.
If your worker is a contractor, then your filing requirements are different. You are no longer responsible for withholding, reporting or paying income and FICA taxes. However, you will have to issue a Form 1099-MISC to any contractor you pay $600 or more to during the year.
So while it may be tempting just to consider a worker a contractor because there are fewer requirements, if you do that without a reasonable basis, the IRS may hold you liable for employment taxes for that worker along with potential penalties for not treating the worker correctly. If you are unsure about a worker’s classification, you should seek help from a tax professional.
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