Payroll 101: Hiring contractors vs. employees
Increasingly, more small business owners are hiring independent contractors instead of adding more staff members.
But be careful: The line between the two is not perfectly black and white, and if the IRS thinks you’ve classified wrong, it can wreak serious havoc on a small business and cost thousands of dollars.
One of the biggest payroll-related concerns small businesses wrestle with is how to classify workers, according to Eva Nazarewicz, with Intuit’s payroll division. Intuit designs financial software, including the popular QuickBooks, and offers other services to help small businesses.
The big question: Should you bring workers on with a 1099 and avoid paying taxes and offering benefits and workman’s comp? Or should you hire them as W-2 employees, with the benefits of staff loyalty and predictability?
“I spend a lot of time on this, because it’s a big decision point for small businesses,” Nazarewicz says. “Sometimes they realize how high the stakes are and sometimes they don’t.”
Nearly 30 percent of firms have misclassified workers, according to Intuit.
And often — sometimes as much as 60 percent of the time — businesses wrongfully label their employees as contractors, despite job descriptions that legally indicate otherwise.
The IRS recently has started cracking down on this — big time. So, Intuit has launched a special educational infographic, with plans for more, in hopes of helping business owners make this tricky distinction.
The truth is, it’s not really your choice, says Nazarewicz; it’s in the definition of the job duties, and not whether you want to make someone a contractor or employee.
Here are a few signs that your worker may actually be a staff employee:
- You control the work they do.
- They come into your office and use your equipment.
- They wear a uniform.
- You provide training for them.
Compare those to common characteristics of a legal contractor:
- They run their own independent business.
- They send you invoices.
- They work for multiple companies.
- They do a specialty line of work that is not regularly needed for your business, such as a web developer.
- Their projects are short-term.
It’s important to educate yourself up front, not after doing the hiring or after filing taxes, advises Nazarewicz.
“Your responsibilities to both that individual and the government are going to be different, depending on if they’re your employee or an outside contractor,” she says.
For example, for an employee, you will withhold taxes, you must post labor law information and you must offer worker’s compensation, in case someone is injured on the job.
If you wrongfully classify someone as a contractor and the government conducts an audit on your business, discovering the misclassification, you will be liable to pay back taxes and a fine. If that person happened to have been injured on the job, you may be responsible for what would have been covered by worker’s comp, too.
In the modern workforce, with increasingly more remote and freelance workers, the lines can start to blur.
“But ultimately, it’s the responsibility of the person hiring to make that classification,” Nazarewicz says.
And, from a compliance standpoint, she says it’s generally safest to classify someone as an employee, not a contractor, if you’re still uncertain about their status.
Check out the helpful Intuit infographic on the topic and read up on Intuit’s payroll articles. You also can call the IRS and check the IRS website with help making the right decision.
“It’s such an emerging issue, we’re really trying to make sure folks know the difference,” Nazarewicz says.
Regardless of whether you hire contractors or W-2 employees, she adds, Intuit has products to make payroll easier for you — and help make sure you are compliant with the IRS.
Top five reasons businesses hire contractors instead of employees:
- Need for special projects
- More flexibility
- Need specific expertise
- Less burden of taxes and benefits
- Less tax liability/risk
— Intuit study