If you have hired a contractor to help you with your small business, you are not alone. There are many reasons hiring a contractor can be a great way to grow your business. But did you know that the IRS has special classifications for hiring independent contractors verses employees? If you don’t know the difference, you risk hiring a worker under the incorrect category, which could lead to penalties and unexpected employment taxes. Below is a brief breakdown of the categories used by the IRS to determine contractors vs. employees.
Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. An example would be training the worker how to do the job using your methods. Employees are typically trained on the job whereas an independent contractor would need little to no training and uses their own methods.
Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker’s job? Did the worker significantly invest in the equipment being used to work for someone else? Typically, a contractor would provide his or her own equipment.
Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. Are the services provided a key activity of the business? Generally, this would be classified as an employee-employer situation.
There are more examples of each category here. The IRS looks at the facts relating to these 3 categories for each situation. If you are located in Washington state, the WA Labor & Industries has a 6-point test for determining contractors vs employees, which can be found here. If you are audited by L&I and have misclassified your contractors, you could be liable for workers compensation on their hours. If you are located outside of Washington state, we encourage you to research your state’s employment laws or get in contact with an HR professional that can provide the information for you for your area.
If you review the IRS rules and determine your contractors qualify, be sure you obtain a W9 form from each contractor as early as possible for your records. The W9 form will provide you (or your accountant!) with information necessary to issue a 1099 at year-end. The Joy Accounting team members are experts at tracking contractor payments during the year so there is no scramble come January. Feel free to reach out to us if you need help with contractor payments!