The two-sided coin of misclassifying your workers is troubling. There are significant fines and consequences for labeling an independent contractor an employee, but hiring an employee when an independent contractor is better can lead to significantly increased costs. With that said, even an experienced business owner should pause to double-check how they have identified who receives 1099s (contractors) and who gets a W2 (employees).
To be upfront, there is no single document that you can turn to that will give you a definitive answer. There are guidelines and factors that go into making this determination. However, it is up to you (and your attorney) to correctly identify how your workers should be classified.
An Understandable Mistake
The life of an entrepreneur can be a difficult one. To maximize profits and gain traction, they live on very tight budgets. Many of the jobs and positions that employees or contractors will later hold are being fulfilled by the same person building the business to save on overhead.
Although human capital is a high cost, taxes are another. To save money on taxes (and money leaving the business), many people incorrectly take the shortcut of calling an employee a contractor to save on taxes. Short-term gains like these can potentially lead to business-ending disasters. When it comes to misclassification, you could face hefty fines in addition to the IRS requiring you to pay back taxes plus interest. Depending on the circumstances, this could potentially bankrupt you.
Classifying Employees & Contractors
Going over each factor the IRS uses to determine whether someone is an employee or a contractor is beyond the scope of this blog. However, what it comes down to is control. The IRS even refers to it as the “right-to-control test.”
To what extent are you, the employer, able to control how the work is completed? If you have an employee, you can dictate what work will be completed and how it will be done. Imagine that you want to hire someone to make a cake. If you choose to use an independent contractor, you can tell them what kind of cake you want. But they will use their own tools, and they may have their own methods for delivering the product you asked for.
With an employee, you can create a strict process for making it. Your influence extends beyond the final product and into how it is done.
Brandon Stanko, PA
As a business owner, you need to protect your company from external threats, including litigation and financial penalties from the IRS. Brandon Stanko, PA, can help businesses mitigate these risks. For additional questions, contact us to schedule your consultation.