You started your business because you found a way to do what you love while making a profit. While naming, finding a logo, and a location may have seemed like the most difficult tasks you’d face, you learned that filing for and maintaining all the correct city, state, and federal required documentations is at times confusing and stressful. Making sure that you’re following all the laws and regulations is difficult, but a vital part of operating a successful business. Once you’re all set and open, it’s all smooth sailing until it’s time to hire your first employee. Knowing whether or not to classify your new hire as a true employee “W-2” or a contractor from the beginning will save you a lot of headache and from having to pay fines. Here are the basics that you need to know regarding correctly classifying your new hires:
Employees – W2
According to the IRS, “In general, something who performs services for you is your employee if you can control what will be done and how it will be done.” This means:
- They perform duties dictated or controlled by others. (i.e. you or a manager)
- They are provided training for the work that they will be doing for.
- They only work for one employer.
- Are typically offered benefits (i.e., paid sick leave, vacation, health insurance, retirement plans)
- They are on the company’s payroll and receives a W-2 form at tax time. As the employer, you are responsible for with holding both federal and state taxes as well as Social Security and Medicare tax.
Contractors – 1099
Contractors can save businesses up to 40% on labor costs, which is why many small businesses favor this type of hire. It’s important that in order for a 1099 contractor to be correctly classified unlike a W-2 employee they must:
- Have their own tools and set their own hours.
- Invoices the company for any work that they completed.
- Can be working for multiple companies at the same time.
- Are responsible for paying their own taxes to the IRS and state departments.
- Companies generally do not withhold any taxes on their behalf from their pay, and they receive a 1099-MISC form at tax time.
- They are not entitled to any additional company benefits.
The IRS estimates that between 10-60% of their employees as contactors, resulting in millions of dollars worth of fines and have recently begun a strong crackdown on the business that misclassify their employees. Misclassifying your workers could result in owing back payroll taxes, interest, and steep penalties. It is possible that you business will operate with both W-2 employees and 1099 contractors depending on the type of work being done.
As you begin to expand, don’t become liable for the consequences of misclassified workers, hire a payroll service to help you not only set up a new hire correctly, but to ensure that you’re following all state and federals regulations through out the year.