Employee or Self-Employed

Hiring Employees

It’s nice to do things your own way, isn’t it? Surely. But, after awhile, you may find that the dirty details add up and you could find yourself needing some extra help. There are some considerations to make when bringing on your first employee. Family is first. Consider a spouse, cousin or nephew. There are several intangible benefits to hiring someone you already have an established relationship with and some tax advantages as well. Wages to kids under 18 aren’t taxed, for example, and are fully deductible to your business. As another example, money paid to your spouse or child can go into an IRA instead of their wallet, and you’re likely to avoid paying any taxes on it while reducing your own personal taxes. Just something to think about…

In lesson seven we’ll touch on the paperwork you need to complete to bring someone on-board. So we’ll skip the W-4 and I-9 for now, but remember that you can’t work an employee until he or she is verified and on payroll. “But what about independent contractors?” you say. Well, that brings us to our first point of discussion.

Calling a rose a rose: Why misclassification hurts!

I’d like to start here because I can’t stress enough how really, very important it is to establish your relationship with those working for you. As an employer, you pay employment and payroll taxes including 50% of medicare and social security benefits. But since independent contracts are considered self-employed by the IRS, you’re not responsible for their employment taxes. Shoot, that sounds great for you as an employer doesn’t it?! No worries about setting up a payroll if everyone’s self-employed! Not so fast. There’s a pretty big penalty if you choose to bring someone on as a contractor and you’re wrong.

If the IRS finds that you have no reasonable basis for bringing someone on as a contractor, consultant, expert or advisor instead of as an employee, you’ll be held responsible for his or her employment taxes. Notice how I never used the word “employee” to describe her. You should do the same. Unless you’ve mailed in someone’s W-4, she’s not your employee. Just consider this a dirty word in conversation and in writing until which point. You’ll also be responsible for the fees when the IRS takes it upon itself to set-up payroll for you. And of course there’s penalties and interest associated with that, too.

And it doesn’t end there. Even if you afford these costs, you’ve essentially cheated your should-be “employee” out of Social Security and Medicare benefits. Susie may file an 8919 form stating that you’ve misclassified her as an independent contract and collect. If the IRS determines she’s right, they’ll refuse to match your contribution, and now you’ll be responsible for 100% of what’s owed. If you’re not in this proverbial creek without a paddle, you can skip the next paragraph and continue on to our checklist.

So here’s your paddle: if you feel like you’ve been treated unjustly or were just misinformed, you may still have options. In 1978, Congress passed Section 530 of the Revenue Act of 1978. This essentially protects employers from false contractor claims. So, say you brought on Susie as a contractor and she claimed disability after ditching your shop; now the IRS wants to know why no one’s paid her taxes (we’ll touch on how they determine who is and isn’t an employee in a bit).

You’re in the clear as long as you can prove that your decision was A) based on a ruling, precedent or letter of advice B) informed by a past IRS audit that did not find any discrepancy with your employees status or C) informed by standard industry practice. But say the damage is done; you may at least qualify to pay back a fraction of those back taxes (10{1b681eef93263380d38aeb37b03801f661225c1c465364ff74e7686b7dc27ec8}) if your non-employee has had that same status for at least three years. Using the Voluntary Classification Settlement Plan (form 8952) the employer will not have to worry about interest or the fear of an employment audit.

Well is she or isn’t she?

So now that I’ve put the fear into your heart, let’s talk about how you can make the informed decision to hire your worker as an employee or an independent contractor. Hopefully you’re doing this before submitting any paperwork to the IRS. But as I mentioned in a previous lesson, you can always update a W-4.

So let’s figure what Susie is by determining what she’s not. Here is a list of things that can commonly be said about independent contractors:

  • She doesn’t take instruction from you
  • She’s won’t receive on-the-job training
  • She makes her own staffing decisions
  • The work is nonessential to the company. That is, she’s not running Operations.
  • She sets her own hours and priorities
  • She has no continuing relationship with you or your business; once her job is done, it’s done. Likewise, the right of discharge is limited by a contract.
  • She’s free to pursue outside employment
  • She pays for her own tools, equipment and additional expenses
  • She’s usually paid by assignment
  • You don’t call her your employee. Have I stressed this enough, yet?

If she meets all of these criteria, Susie should not be considered an employee and will not have to be put on payroll. If you feel like yours is a special case, and you want to consult with a real professional, call one of our tax consultants. Our guys love special cases.

Free eBook

Tax Settlement Options

Download Now
Having a tax debt is stressful. We can help.