A critical decision you need to make is whether to classify a worker as an independent contractor or an employee. Making the wrong choice can lead to expensive consequences.

Why Does It Matter if I Hire an Employee vs. a Contractor?

When you hire an employee, you must:

• Withhold income taxes and payroll taxes
• Pay the your share of Social Security and Medicare taxes
• Pay unemployment taxes

For independent contractors, you don’t have these obligations. But treating an employee as a contractor can result in:

• Owing back taxes, including the employee’s share
• Penalties and interest
• Paying retroactive benefits

Imagine you hire someone as an contractor to save on payroll taxes. Later, the IRS decides that this worker should have been treated as an employee. As a result, you could owe back taxes plus penalties and interest. You may also have to pay retroactive benefits such as minimum wage and workers’ compensation. This could lead to an unexpected financial strain on your business.

How to Decide

The IRS looks at three main areas to determine if a worker is an employee or contractor:

• Behavioral Control: Who directs the work?
• Financial Control: Who controls how the worker is paid?
• Relationship: How do you and the worker view your relationship?

Remember, just because you call someone a contractor doesn’t make it so. What matters is the actual working relationship.

Common Misconceptions

Many people think remote workers are always contractors. But even if a worker is offsite or in another state, they might still be an employee. A contract alone doesn’t make them a contractor. What matters is how much control you have over their work and your relationship with them.

Imagine you hire a graphic designer who works from another state. You might think they are an independent contractor because they work remotely and have a contract. But if you control their work hours, tell them how to do their tasks, and decide their pay, the IRS might see them as an employee. This could mean you owe back taxes, penalties, and need to provide employee benefits, even though they work remotely.

Protecting Your Business

Proper documentation and guidance can save your business from costly mistakes. Look at each worker’s situation and write down why you classified them a certain way. If you need help, talk to a tax professional.

Understanding the difference between contractors and employees is important. Take time to make informed decisions and protect your business. If you need help deciding between the two, feel free reach out for a free consultation.