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Before Payroll Part 7: Employee or Independent Contractor?

Last week I shared with you how to set up employees in QuickBooks, but what if you have 1099 independent contractors? (1099 refers to the IRS filing at the end of the year, similar to a W-2 for employees) How do you determine if a worker is an employee or independent contractor? Today I would like help you answer that question and obtain the documentation you need to back up the right working relationship. This question is a confusing one for many business owners because there is no cut and dry answer, but a mix of gray that encompasses many working relationships. I hope to provide you some clear questions to help you with this decision.

Employee or Independent Contractor?

There are 2 factors that determine whether a worker is considered an employee or an independent contractor: Control and Independence. The more control and more independence the worker has in the working relationship, the more likely the relationship falls under an independent contractor. The less control and less independence the worker has in relation to your business, the closer the relationship is to being an employee/employer relationship.

Control and Independence are measured in the 3 categories of behavior, finances, and the type of relationship. These break down as follows (if the answer is the worker, then it is closer to an independent contractor, if it is the company, it is closer to an employee/employer):

  • Behavioral
    • Does the worker control what they do and how they do it to get the overall job done, or does the company control the work assignments and methods for the completion of the work being done?
    • Is the worker trained already and proficient at the job, or does the company provide training and instruction?
    • Does the worker determine his/her daily routine and schedule, or does the company control the schedule and routine?
    • Does the worker perform the majority of work away from the company site, or does the job require the majority of time be spent on-site?
    • Can the worker delegate work to others he/she hires and pays, or does the company require that the worker complete the work or will hire the additional help themselves?
  • Financial
    • Are supplies, equipment, materials, and property provided by the worker or the company?
    • Does the worker lease space and equipment from the company or third parties to complete the work or does the company provide these?
    • Are expenses incurred during the course of the work paid by the worker, or paid/reimbursed by the company?
    • Is the worker paid under contract, lump sum, piece work, or commission, or does the company pay a salary or hourly wage set by the company?
    • Does the worker invoice for work being completed and establish the level of payment for the services provided or products sold, or is this set and controlled by the company?
  • Type of Relationship
    • Does the worker control benefits personally, or are paid vacations, sick pay, paid holidays, personal days, pensions, insurance benefits, or bonuses controlled by the company?
    • Can either the worker or company terminate the relationship without incurring liability or penalty? (Yes is closer to contractor, No is closer to employee)
    • Is the worker free to provide similar services or products to others, or only to the company?
    • Is the worker bound by any non-compete agreements at the present or into the future? (Yes is closer to employee, No is closer to contractor)
    • Is the worker a member of a union? (Yes is closer to employee, No is closer to contractor)
    • Does the worker advertise him/herself? (Yes is closer to contractor, No is closer to employee)
    • Does the worker represent themselves to customers or does the company require they perform work under the company business name?

No one item is cut and dry to determine whether or not a worker is an employee or an independent contractor, but answers to all of these questions will help you determine which direction the work relationship is leaning. When in doubt, you should consider the worker as an employee. This is because as an employee, you are required to withhold taxes on their behalf, which is of particular interest to the IRS. On the other hand, if the relationship is an independent contractor, the individual is responsible for paying their own taxes out of the money that is earned, which is better for the company as they aren’t responsible for those taxes – ergo the tension over this issue.

Resources and Documentation for 1099 Contractors

Lucky for you, if you can’t decide, the IRS has a free way to help you determine the correct working relationship. Some people will recoil at this idea, but to others it may come as a relief. One way or another, this option is available and you should at least look into it:

IRS From SS-8 - Determination of Worker Status

This can be filed by either the worker or the company – so you may find this document helpful if you are a worker and feel unjustly treated as an independent contractor instead of an employee, or as a business owner, you my find yourself on the receiving end of an IRS determination letter that requires you to treat an independent contractor as an employee or appeal the decision.

So you know you have an independent contractor relationship, what next? Here are 3 documents that you need to have in your records of all working relationships with independent contractors:

  • IRS Form W-9 - have every contractor fill this form out for your records before you pay them. You will need this information to send them a 1099 at the end of the year.
  • Written Contracts – write up a contract using some of the language above detailing the working relationship and outlining how the contractor has control and independence enough to justify this kind of relationship.
  • Invoices from the independent contractor to your business – make a copy of the contractors first invoice to you and keep it in their file. If the worker isn’t invoicing you, then maybe they don’t understand the relationship and consider themselves an employee – which could get sticky if they wind up at the unemployment office asking for a check through your account.

An important note on the W-9 – if a contractor doesn’t provide or refuses to provide you  with a W-9, then the IRS requires that you withhold 28% of any payments to them and submit the withholding to the IRS. When contractors hear this, they are usually more than happy to give you their information!

If you do pay independent contractors, just know that in January you are required to file 1099s to the contractor, State, and IRS – so keep this in mind as you start the new year (I am more than willing to help out if you need this done!)

Finally, another helpful website that gives an overview of this information and much more is http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-(Self-Employed)-or-Employee%3F

Wrapping up!

I hope I have helped you gain a decent understanding of the distinction between an employee and an independent contractor. If so, then you are ahead of most business owners out there, and I have done what I have set out to do! If not, leave a comment or connect with me to let me know if you have any questions! Also, check in next week to learn about setting up independent contractors in QuickBooks.

Keep Reaching!

Mark

 

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