I recently met with the owner of a small business. He was considering whether to maintain a couple of his technicians as independent contractors or to make them employees of his business. He specifically wanted to know the costs of changing the technicians from 1099 status to W-2 employees. This question comes up a lot, probably because there is a significant amount of grey area between the two classifications. How you should identify your workers (and how the IRS would define them) will depend a lot on the facts and circumstances of your situation:
IRS employee classification rules
To help you determine whether your workers should be classified as contractors or employees, the IRS has identified three categories of questions you need to be able to answer:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
“Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
“The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”
IRS Publication 15-A (pages 7-10) is especially helpful in making the determination of whether your workers should be classified as contractors or employees. It contains definitions and several examples from different industries that can help guide you in your analysis.
Costs associated with employees vs. contractors
Many businesses prefer to use independent contractors instead of hiring employees because it lowers their overall operation costs. For example, if you hire employees, you need to worry about withholding payroll taxes and paying the employee portion of Social Security and Medicare taxes. You often need to pay unemployment insurance and workers compensation insurance as well. You also have to worry about health insurance obligations (especially if you reach the 50+ employee threshold) and/or providing the same retirement or other benefits to employees that you want to provide to yourself.
Making your choice and complying with the rules
At the end of the day, you need to decide what will work best for your business and ensure that you carefully follow the rules. This area of the law can be tricky. It is usually a good idea to consult with an employment law attorney about your particular situation so you don’t run into problems and penalties down the road. For example, should you have your independent contractors appear on your website? How are they identified? Should you give them an e-mail address for your company? How much control can/should you exercise over their schedule? Do your contractors only work for you, or do they work for other companies as well? Can or should you put a non-compete contract in place for people you want to classify as contractors? Is it possible to classify some workers as contractors and others as employees, even if they are providing more or less the same services? These and many other factors put your workers at different places along the continuum between independent contractor and employee status. Once you weigh the pros and cons of each status, make and document a plan to qualify workers under the status that fits. Follow that plan, and you shouldn’t have anything to worry about.
This article is meant to provide general information and should not be construed to contain individual tax or legal advice. Feel free to contact me at (801) 980-1290 or firstname.lastname@example.org with any questions or for more information.