Hiring In Your Business: Does They Need To Be W2 or 1099?

As you grow your small business, you’re almost guaranteed to need help. You may decide to contract or hire this additional help. Let me help you understand the difference between contracting someone vs hiring them as an employee.

Most are familiar with the fact that payroll will involve withholding payroll taxes and remitting employer taxes to taxing authorities. Only employees exist on a payroll. Contractors do not. 

Contractors are responsible for reporting and remitting their own taxes. It is nearly always cheaper to contract labor than it is to outright hire it assuming that the pay rates are close to the same.

You may be asking yourself, why would anyone hire an employee if contractors are cheaper?

Well, the decision to hire or contract is not arbitrary. There are rules that determine whether someone should be classified as an employee or a contractor.

Let’s go over them:

• Control: One of the primary factors is the degree of control exercised by the employer over the worker. Employees typically work under the direct control and supervision of the employer, who dictates how, when, and where the work is performed. Contractors, on the other hand, usually have more autonomy in how they perform their work.

• Behavioral Control: This includes instructions, training, and integration into the business. Employees often receive extensive training and guidance from the employer, while contractors are expected to possess the necessary skills and expertise to complete the work independently.

• Financial Control: This involves factors such as how the worker is paid, who provides the tools and equipment, and whether the worker has the opportunity for profit or loss. Employees are usually paid a regular wage or salary and do not typically invest in the tools or materials needed for their work. Contractors, on the other hand, are often paid based on project milestones or on a per-job basis and are responsible for their own expenses.

• Relationship Duration: The length of the working relationship can also be a factor. Employees often have ongoing, long-term relationships with the employer, while contractors are typically engaged for a specific project or period and may work for multiple clients simultaneously.

There is no perfect formula to determine which bucket a person will fall into. As the business owner, you must weigh each of the factors and come to a good faith determination if there is doubt. 

Document this process of coming to a determination. 

So what happens if you come to the wrong conclusion - classifying an employee as a contractor?

Typically a business will be required to reclassify the person as an employee. From there, they will be required to pay back taxes, as well as penalties and interest based on those taxes. They may be fined for failing to submit W-2s, as well. This is true when the taxing authority determines the misclassification was an honest error.

In a more extreme case, where the classification was intentionally incorrect, they could face criminal penalties. This opens the company up to lawsuits from the worker. 

You definitely want to get this right.