When does a contractor need to become an employee?

When does a contractor need to become an employee?

At Expex, we see a variety of businesses that work in many different vertical markets. Some of our clients hire independent contractors to perform work for them, others hire employees, and some have employees and contractors. We have also seen businesses paying employees as contractors when they should be hiring them as employees. The ramifications of not making the correct decision can have a significant impact on your business. Let’s take a look…

What is the Fair Labor Standards Act (FLSA)?

According to the Department of Labor, The Fair Labor Standards Act (FLSA) provides minimum wage and overtime pay protections to nearly all workers in the U.S. Unfortunately, some employers incorrectly treat workers who are employees under this federal law as independent contractors. We call that “misclassification.”

  • Receiving 1099 does not make you an independent contractor under the FLSA.
  • Signing an independent contractor agreement does not make you an independent contractor under the FLSA.
  • Employers may not misclassify an employee for any reason, even if the employee agrees.
  • You are not an independent contractor under the FLSA merely because you work offsite or from home with some flexibility over work hours.
  • Whether you are paid by cash or by check, on the books, or off, you may still be an employee under the FLSA.

What is the difference between a W-2 and a 1099?

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We are asked this question quite often, so here are the simple definitions:

  • What is 1099? 1099 is the form from an entity or individual you have done work and have paid you directly. This is usually in the capacity of a vendor, independent, or subcontractor. It is not a form from your employer.
  • What is W-2? An employer generates a W-2. The W-2 details the money you earned from your employer in a given year, in addition to showing your state and federal tax withholdings.

Please note:  Individuals can receive both a W-2 and 1099 in the same tax year, depending on the type of work they do.

How do I know if a contractor should be an employee?

The U.S. Department of Health and Human Services explains the difference between an Independent Contractor and an Employee: A business may pay an independent contractor and an employee for the same or similar work, but there are important legal differences between the two.  For the employee, the company withholds income tax, Social Security, and Medicare from wages paid. For the independent contractor, the company does not withhold taxes. Employment and labor laws also do not apply to independent contractors.

To determine whether a person is an employee or an independent contractor, the company weighs factors to identify the degree of control it has in the relationship with the person.

  • Does the company control or have the right to control what the worker does and how the worker does the job?
  • Does the company control the business aspects of the worker’s job? These include arrangements like how the worker is paid, whether expenses are reimbursed, and who provides tools and supplies.
  • Is there a written contract or employee benefits such as a pension plan, insurance, or vacation pay?
  • Will the relationship continue, and is the work a key aspect of the business?

The Internal Revenue Service uses a right-to-control test to assess a business’s tax liability. Visit the IRS website and Visit disclaimer page for more information.

Each state also has tests to determine a person’s status under workers’ compensation and unemployment insurance laws. The economic realities test used in most states makes it harder to classify a worker as an independent contractor because, in addition to the degree of control test, it considers the degree the worker is economically dependent upon the business. State-specific information is available from state workforce agencies. Visit the disclaimer page.

What is an employee, and how are they paid?

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Employees are paid via a W-2. An employee’s pay period must remain the same unless formally changed. Pay periods vary from one week to one month and must be paid regularly.

The employer must withhold income tax and the employee portion of social security and Medicare taxes. Also, the employer is responsible for paying social security, Medicare, and unemployment (FUTA) taxes on your wages. The employer must provide a Form W-2, Wage, and Tax Statement, showing the amount of taxes withheld from the employee’s pay.

What is a contractor, and how are they paid?

Contractors are non-employees. Employers will report payments to the contractor of $600 or more in a calendar year. The business may be required to give you Form 1099- MISC, Miscellaneous Income, to report what it has paid to the contractor.

Accounts Payable pays a contractor after receiving an invoice. The terms of the contract or Statement of Work dictate when payments are made, such as upon completion of a task or by periodic amounts.

Contractors are responsible for paying their own income tax and self-employment tax (Self-Employment Contributions Act – SECA). The business does not withhold taxes from their pay. Therefore, contractors may need to make estimated tax payments during the year to cover the tax liabilities.

What is the advantage of hiring a contractor vs. an employee?

The decision to hire a contractor vs. an employee depends on the nature of your business. Other factors include a budget for headcount and the desired skills and flexibility you are looking for in the open position.

Contractors can be less expensive overall because you are not paying the fully burdened costs of wages, benefits, employment tax, income and unemployment tax withholdings, workers’ compensation insurance, overtime pay, and training expenses.

Employees provide a consistent, long-term commitment to the company. They are a component in the composition of your company culture and may positively impact recruiting.

Contractor or employee, know the tax implications and comply with IRS standards.

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You know your business and what it takes to get the job done. As a business owner, you can hire both employees and independent contractors so long as you pay them correctly. That does not include paying them cash. Payments must be tracked (under $600.00) and reported to the IRS.

Paying your payroll taxes does not have to be stressful or difficult. With Expex, you have us handle your payroll through one of our approved payroll partners, who will ensure that your payroll taxes and other payroll-related services are done for you. It’s one more thing that Expex does for you, so you can focus on growing our business. 

About Expex

Expex is based in Schenectady, NY, offering convenient and innovative bookkeeping services to help your business succeed. Our application, Carly, can do everything a traditional bookkeeper does and more. This financial management program expertly fulfills services such as bill payments, bank and credit card reconciliation, and financial records consolidation. Call (518) 389-2305 today to get started, or contact us to learn more about Carly.

Special thanks to the resources from the U.S. Department of Health and Human Services and the IRS.