Thinking of hiring someone to help you out with your new or small business? Here are some important things you should know about the tax classification of your workers:
Independent Contractor versus Employee Classification
The way you classify your worker is very important. There are two categories: Independent Contractor and Employee.
Independent Contractor:
You pay them a fixed fee for their work. They take care of their own taxes. Your only responsibility is reporting basic information (name, amount paid, etc.) to the appropriate federal and local regulatory agencies.
Employee:
In addition to their wage, you are responsible for payroll taxes. Payroll taxes consist of withholding for income tax, withholding for the employee’s contribution to social security and Medicare, contributing to social security and Medicare on behalf of the employee, paying for unemployment insurance (federal and state), and paying for worker’s compensation insurance. These last three items are all expenses to the employer.
Costs Associated with Employee Classification
From an employer’s perspective, classifying the worker as an independent contractor is attractive from both budgetary and administrative perspectives. Expect total costs for an employee to be around 20-30% higher than independent contractor costs because of those extra payroll taxes. Additionally, managing employees means extra time and effort associated with calculating how much to withhold, remembering to make timely payments to the regulatory agencies and paying penalties when you miss a filing deadline.
What Should You Do?
While it is tempting to simply categorize your worker as an independent contractor to avoid the cost and administrative burden, regulatory authorities (IRS, state/local taxing agencies, Worker’s Comp Board, etc.) can be very strict when it comes to improper classification. The cost and administrative savings by classifying your worker as an independent contractor is significantly outweighed by the costs and penalties resulting from improper classification. In the long run, it is best to play it safe. Where a worker is clearly an employee, treat them as an employee. Where a worker is clearly an independent contractor, treat them as an independent contractor. When you’re not sure, speak with an experienced business or employment law attorney.
The IRS has posted a page here that summarizes its perspective on this issue.
Information from California’s Employment Development Department about independent contractor misconceptions can be found here.
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