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Posted by on Feb 4, 2014 in Small Business Tips | 0 comments

Employee vs. Contractor: What You Don’t Know Can Hurt You

Employee vs. Contractor: What You Don’t Know Can Hurt You

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Did you know there’s a huge difference between a freelancer/contractor and an employee? As a business owner you most likely knew that; one is someone you bring in for a temp job and the other is someone who comes in every day (or at least a lot of them) to do regular, daily work. Who doesn’t know that?

Strangely, some business owners don’t know, at least when it comes to taxes. It’s been such an issue that the IRS is cracking down on businesses that confuse the two when it comes to tax collection and filing. Are you sure you’ve correctly categorized your workers? The lines are a little more complicated than you might think.

What the IRS Has to Say

There are actually several differences between an employee and a freelancer, and they’re not all what you would expect. Some of them seem a little picky and arbitrary but they exist for perfectly good reasons.

For example, did you know the IRS might consider a freelancer an employee if they come into your office every day? While you hired them as a contractor, their presence every single day could make them appear as an employee. However, that’s just one of several criteria they must meet to be considered a freelancer.

Another caveat is they have to have their own “business identity:” business cards, an office, their own business line… something to differentiate them as a separate entity. Also, they should require a contract for every single job, even if it’s a repeat job.

Payment is a particularly big deal when comparing the two. Do you pay your freelancer on a regular basis, like every two weeks or every month? This isn’t a good idea – pay them per job or whatever is in the contract you signed with them. Regular payments make them look like an employee.

One last criterion is that the freelancer should come with their own training – you hired them because of their specialty, not to shape them yourself. A little bit of training in your own business processes is okay, but too much may land you in hot water.

Why the Difference?

The IRS is in the business of collecting income tax on every penny of income earned. Whether you intend it that way or not, they consider shenanigans when it comes to classifying workers a potential way around paying all the income tax you (or your employee/contractor) owe.

Employees and freelancers don’t get treated the same when it comes to taxes. Basically, you help your employees figure out taxes by taking it out of their paycheck every period. On the other hand, you pay freelancers a lump sum and then they figure out their own taxes.  For example, you would send an employee form W-2 at the end of the year while you’d send a contractor form 1099-MISC.

As mentioned, some businesses were skating the rules by claiming employees as freelancers and vice versa. This gave them an advantage with their own taxes for one reason or another. This is why the rules are now more enforced than ever before and why you need to be careful.

So what happens if you goof or intentionally misreport this info? Look forward to a lengthy audit of everything else on your taxes, not to mention big fines and penalties if the mistake is bad enough. Just get it right in the first place and you won’t have to worry about it!