If you’ve been managing your business solo up until now, it can feel overwhelming and scary to start working with someone else. It’s always scary to try something new, but when you’re looking to recruit quality help for your business, usually the support you gain outweighs the feelings of fear.
Since 2021 we’ve seen millions leave their jobs in pursuit of more flexibility, happiness and ultimately more freedom. The “Great Resignation” has caused many business owners and workers alike to wonder if the traditional working relationships of employee and employer is sustainable long term.
With more and more people leaning towards entrepreneurship you may be wondering what’s the best move for your company. Should you look into hiring a full time employee or start working with an independent contractor? In this post we’ll get into what constitutes an employee vs an independent contractor, as well as what option will suit you and your business needs the best.
An employee is a worker that an employer has added to its payroll. When an employer adds a person to its payroll they are then responsible for withholding a portion of the employees pay. This is known as a payroll tax, something that an employer needs to register for so that they can give those funds to the appropriate government agencies.
When you hire an employee you are in charge of their hours, the tools they use, their work location, and where they should make work related purchases. If you also tell your worker how they should perform their deliverables then the IRS is more likely to classify that worker as an employee.
Another thing to take into consideration is that if you give your worker training or evaluations then the IRS would probably classify that worker as an employee.
An independent contractor is a self employed worker who enters into a working relationship with a client via a written or verbal agreement. The client is then pays the contractor for their services rendered.
Independent contractors are typically in charge of how and when they work. They are usually in charge of providing the tools and equipment that they need to complete their assignments. While the client or business owner is in charge of certain areas of the agreement, such as deadlines, projects and campaigns, the contractor decides how the assignment is done.
Contractors are not considered to be employees, since they are self employed. For that reason they are not on their clients payroll. They are totally responsible for reporting and remitting their taxes to the IRS, state and local government tax authorities. Since they are not considered to be employees contractors are not given benefits or paid time off.
Independent contractors will give their clients invoices as a means of collecting payment for their services rendered. These contracts ideally should have a start and end date.
Tax Considerations: W-2s and 1099s
Let’s go over the differences in record keeping and employer responsibilities when it comes to employees vs independent contractors.
It doesn’t matter if they are full or part time, there are various taxes that employees are subjected to by the federal and state government tax authorities - and sometimes the county or city where they work.
When they’re hired employees are required to fill out a W-4 (Employees Withholding Certificate). The document will ask for the employees name, address, social security number, their filing status, their dependants, withholding adjustments as well as any income coming in from their spouse if they have one.
Employers are no longer required to turn in the W-4 to the IRS unless they’re asked for it. The document stays with the employer as an official record used for determining tax withholding.
Employee taxes are subjected to a number of payroll taxes. This includes federal and state income taxes as well as an FICA tax (social security and medicare). Employers are also legally obligated to make a matching employer contribution to their employees FICA tax. Some cities also require employees, and sometimes employers, to pay a local tax as well. Lately, SUTA (unemployment) taxes are paid usually just by the employer. Only employees in Alaska, New Jersey and Pennsylvania are subjected to their state’s unemployment tax.
Every quarter employers are required to report the income tax and social security taxes they withhold from their employees using form 941. Employers are also required to pay their portion of FICA taxes quarterly.
Every year by January 31st, employers are required to report employees wages and payroll taxes to the SSA (Social Security Administration) as well as to the appropriate tax departments. You do so by using the W-2 (wage and tax statement) form. After the SSA processes the W-2 they send the federal tax information to the IRS. When employers send in the W-2 to the SSA they are also required to fill out and send a W-3 (Transmittal of Wage and Tax statement) along with it.
Employers are also required to send a copy of the W-2 to each employee. They also keep a copy for their records.
1099: Independent Contractors
Contractors need to fill out a W-9 (Request for Taxpayer Identification Number), that then the business who hires the contractor will send to the IRS. This document either captures the contractor's social security number or their federal tax ID number.
Contractors pay their taxes quarterly and self employment taxes on their personal taxes, which typically is due April 15th. Business are not responsible for withholding taxes from payments to the independent contractors that they hire.
Businesses are responsible for reporting all payments made to an independent contractor if the total payments exceed $600 in a given tax year. Any payments made to contractors are reported on the form 1099-NEC (nonemployee compensation).
Up until 2020, the for 1099-MISC (miscellaneous income) was used by businesses to report payments made to independent contractors. Since the shift happened so recently, there are many business owners who are still unaware of the change, but not you! Still, it’s good to spread the word because you never know who is still unaware.
1099-NECs are due by January 31st, and if the date falls on a holiday or weekend then the form is due the following business day. Businesses are also required to submit form 1096 (Annual Summary and Transmittal of U.S. Information Returns) alongside the 1099-NEC by January 31st.
California’s Assembly Bill no. 5 - AB5
AB5 tightened the IRS’s worker classification rules. This law only affects businesses and workers based in California, it requires three points to be true of any worker for them to be considered an independent contractor.
This was put into action in 2020, so it’s still fresh. More legislation like this is expected to pop up in various states in the coming years so make sure you keep up to date on any news like this in your State.
When You Should Opt for Hiring an Employee
Here are some circumstances where it would make more sense to hire an employee over an independent contractor.
When You Should Opt for Hiring an Independent Contractor
Alternatively, here are a few circumstances where it would make more sense to hire an independent contractor over an employee.
There are a myriad of differences between hiring an employee as opposed to hiring an independent contractor. Hopefully through this post you’ve gained some clarity as to which option is better suited for you and your business at this time.
If you are considering working with an independent contractor to help you with administrative duties, social media management or personal assistance consider getting a virtual assistant! Schedule a consultation call with us today so we can start talking about how we can elevate your life and your business.