Labor laws specifically define who is an employee and who is considered an independent contractor. If you don’t understand the classifications, or you are unsure about the status of your workforce, it can result in costly fines and penalties for your business.
Determining the classification of the people who work for you also impacts collecting and paying income tax on monies paid to your workers, payments for workers’ compensation insurance, social security payments, and thresholds for liability and health insurance expenses among other responsibilities.
Independent Contractor: An individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.
What this means for you as a small business owner - If you hire someone to provide a specific service or services for which they invoice you, they are a contractor, and you need to be ready to issue their completed 1099.
The first step in the process is collecting each contractor’s W-9. If you do not have an updated W-9 on hand for every contractor you paid in 2020, now is the time to request that from them.
Employee: An individual is an employee if they perform work under the direction and control of their employer and work fixed hours, although casual employees might work variable hours. Employees usually have an expectation of ongoing work, the right to paid leave and sick leave, and have income tax deducted by their employer.
What this means for you as a small business owner – Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year, for services performed by an employee must file a Form W-2 for each employee (even if the employee is related to the employer) from whom:
- Income, Social Security, or Medicare tax was withheld.
- Income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4, Employee's Withholding Allowance Certificate.
The distinction between employees and independent contractors is highly scrutinized by the governmental agencies that regulate and protect the state’s labor force. It is essential that you know the exact business relationship between you and your workers in order to determine their proper classification.