As an owner, you’re constantly making different decisions that will benefit your business best – but especially what will support your team and elevate your company culture.
At some point, you’ll ask yourself when it’s appropriate to outsource a certain job or service. Instead of onboarding a new employee, you may opt to hire an independent contractor to accomplish the task.
For example, you may hire an accountant to handle your taxes, an electrician to rewire your office space, or an illustrator to design a logo.
At Whirks, we recognize the value of leaving certain things to the experts. It helps you avoid making a potentially expensive mistake (like your taxes), a dangerous one (like electricity), or an ineffective one (don’t DIY your logo).
In this article, we’re going to outline the differences between an independent contractor, or 1099, and an employee, or W2.
Employees vs. Independent Contractors
An employee performs work for you under your direct or indirect supervision, during hours that you specify and under conditions you control.
As an employer, you pay certain taxes on your employee’s behalf, and withhold these payroll taxes from the wages you pay them.
An independent contractor is an individual who performs a service for you, usually at a pre-arranged fee. For each service rendered, you receive an invoice from them.
Compared to an employee, you do not control the hours worked or the tools used, and they don’t have major responsibilities at your company, such as managing or supervising your team.
Additionally, they also need to possess:
- A business card
- A contract or work order with the business owner
- A business license number (issued to them by the city in which they work)
- Evidence of being licensed by the state (think doctors, lawyers)
Please note that this is only a portion of what determines a worker’s status.
Some examples of independent contractors can include:
Correctly classifying workers
It’s important to classify the people you pay correctly, otherwise, it can potentially lead to an expensive audit by state or federal agencies.
Sometimes, misclassification is an honest mistake (hey, running a business is stressful!) but other times, it’s an attempt to avoid legal requirements and expenses, such as:
- Social security and Medicare taxes
- Paid Time Off
- Workers’ compensation
While hiring employees requires more responsibility and a greater investment as a business owner, there are major consequences to misclassifying an employee as a contractor, such as:
- Paying back taxes
- Penalties for not reporting employee earnings
- Penalties for delinquent withholding payments
- Being classified as a repeat offender (OSHA and the DOL don’t like this)
The National Employment Law Project states 10 to 30 percent of employers (or more) misclassify their employees as independent contractors, indicating that several million workers nationally may be misclassified.
Because of this, the Department of Labor and the IRS have become stricter with businesses in order to ensure the rights and responsibilities of both employers and workers.
Requirements for Independent Contractors
Once you’ve hired an independent contractor, have them fill out a W-9 form prior to paying them.
If they don’t want to fill the form out, or you can’t acquire their identification number, you’re required to withhold 28% of each payment.
This is known as backup withholding. The money is forwarded to the IRS, just like payroll taxes. Once it’s withheld from the payment, you do not refund it to the contractor or pay it back in any way.
For example, let’s say you hire an electrician, and he hands you an invoice for $800. You ask him to fill out a W-9, and he says he doesn’t have the information he needs with him to do that.
At this point, you can give the electrician two choices:
- Wait to collect payment until the W-9 is filled out, or
- Pay him $576.00 immediately, with $224 sent to the IRS
We recommend taking a firmer approach with independent contractors and requiring them to fill ou the W-9 before you make any payments to them.
When you are required to submit your 1099s to the IRS at the end of the year, it protects you from the following penalties:
- $50.00 for each ID number missing from the 1099
- $50.00 for each 1099 not submitted
As an extra step, try to enter into a written agreement with the contractor and review it with your attorney.
Which is which?
The IRS outlines three factors to help you determine whether your worker is an employee (W2) or an independent contractor (1099).
- Behavorial: Do you control what the worker does and how they do it?
- Financial: Are parts of the worker’s job controlled by you, such as tools and supplies?
- Relational: Are you offering benefits? Is this job key to the success of your business?
The IRS criteria differ from the factors outlined by the Department of Labor when determining worker status for the Fair Labor Standards Act. While the IRS outlines how much the employer controls, the FLSA dives into the financial aspects of a W2 or 1099 worker.
To classify your employee under the IRS or FLSA guidelines, download our free assessment.