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W-2 vs. 1099: don’t misclassify!

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How do you decide how to employ someone? Are they an employee or contractor? And, importantly, as a business owner, do you get to chose?

The short answer to that last question is NO. You do not get to  decide if the person you hire is an employee or contractor. The IRS has already decided for you and, as is typical for anything bureaucratic, they have 20 questions to determine how to classify people in your workforce. These questions generally fall into 3 categories: Behavioral, Financial, and Relational.

Behavioral:

This is all about how the work gets done and how much influence you have over it while it is being done. Whether you are reviewing and making changes to work while it is in progress or simply approving the final work product makes a difference. As you think about how you are managing your workforce, here are the key questions that the IRS takes into consideration for the behavioral aspects of the working relationship.

  1. Do you give instructions on when, where, and how the work gets done?
  2. Have you provided training related to the assigned work or your workplace practices and policies?
  3. Do you specify the person who performs the services?
  4. Have you assigned or hired other people to assist the person in completing the assigned work?
  5. Have you set their work schedule or hours?
  6. Do they have to work full time for you?
  7. Where is the work performed? At your offices or your job site?
  8. Do you require that they do the work in a specific way?
  9. Does the person have to give you a report on the progress of their work?

Financial:

Financial considerations not only include how you are paying the individual and whether they have access to benefits and perquisites what are offered to employees. They also include things like whether you provide materials or tools that they need to produce work, and reimbursements for work related expenses. The following questions are what the IRS looks at in terms of financial aspects of the working relationship.

  1. Do you pay the person for their time – either by hour, week or month?
  2. Is the person being reimbursed for their expenses (i.e. travel)?
  3. Do you supply them with any tools or materials needed to do the job?
  4. Have you invested in facilities or offices used by the person to do the job?
  5. Is the person protected from making a loss (or profit) from the results of the work performed?

Relational:

Lastly, the Relational considerations. This takes into account how close the relationship is between you and the worker as well as how critical you each are to the others success. As you think about how you are managing your workforce, here are the key questions that the IRS takes into consideration for the relational aspects of the working relationship.

These questions address the nature of your relationship with the person you’ve hired. This means: how closely are you working together and how hard is it to change the nature of your relationship.

  1. Is this person critical to the success of your business?
  2. Does the person only work for you?
  3. Do you limit what services the person can offer to other customers?
  4. Is the relationship ongoing (as opposed to having a fixed end date)?
  5. Is the individual restricted in how and when they can terminate services?
  6. Are you limited in terms of how you can terminate services, either through procedures or notice periods?

If you answered yes to more that half of these questions, chances are you have an employee not a contractor.

So now what?

Becoming an employer (as opposed to a customer of someone else’s services) is not as daunting as it seems and in fact, can be a richly rewarding experience with employees often feeling a greater sense of commitment to the company and a vested interest in its success. Here’s a quick checklist of things to put on your to-do list if this is your first step to becoming an employer.

  • Draft a job description that clearly explains the essential functions of the job as well as the knowledge, skills and experience required to perform successfully.
  • Decide terms and conditions of employment and draft an offer letter that outlines the job and maintains your at-will employment status, if applicable. Set a compensation budget range for the job and stick with it.
  • Identify your support requirements, including a payroll system, workers compensation insurance and employment practices liability insurance, physical space and IT requirements. You’ll also need labor law posters if you have a physical workspace.
  • Define a recruiting and on boarding process to differentiate you on the talent market and recruit people who fit your values and culture.
  • Start thinking about performance development, goal setting and how you will measure results so you are ready for those conversations later.

If you are ready to move forward, but don’t have the time or expertise to do it alone, please reach out. We can help. 

Additional reading

IRS Guidelines outline the rules for determining whether a worker is an employee or contractor (1099 v W-2).

QuickBooks has an online quiz with interactive questions.  The results will help you decide whether to hire someone as an employee or contractor.