Episode 20: Who Are You Hiring? Employee vs Independent Contractor

Michelle: Hey, everyone. Michelle and Shawn here. Are you a small business owner looking to bring on new people? Well, this is the podcast for you. We’re going to talk about employees versus independent contractors. 

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Michelle: Welcome everybody to Profit Points, where we talk to businesses, industry leaders and other professionals about being in the world of business. And today we are going to talk about employees versus independent contractors. And we have had instances where we’ve had small business owners come to us with questions about wanting to add people to their business. So they have gone out and created a business of their own, working as basically a sole proprietor, even if it’s a separate entity there. They’re just working independently on their own, and they have gotten to the point where their work is beyond their capacity. They have gotten too much work, which is a good thing, but they have too much work and they’re not able to fulfill all the work that is coming to them. And they may have a really good reputation and they really want to help people, but they just don’t have the capacity within their time in order to do all of that work. And so they sit back and they’re like, Well, I think it’s time now for me to bring on somebody to help me with this workload. And the questions that we get every time is, should this person be an employee or should this person be an independent contractor? And that is where the dilemma lies. And we’re going to talk a little bit about what both of those are and some of the rules around those so that you can make a proper guess. Not necessarily guess, but a proper distinction between what you’re a person that you’re looking to bring on should be and how they should be classified. 

Shawn: Yeah, this is a topic that we get asked a lot. It’s something that businesses need to kind of understand the rules around and not just kind of go into this hodgepodge and just kind of dive into it without, you know, considering the rules and the different aspects of this. You know, in some industries, it’s a lot easier to determine employee versus independent contractor. Others, it’s much more difficult. And so, you know, you just want to know, understand the rules and kind of help make that decision. 

Michelle: Yeah. And some of the things that the IRS gives as far as determining whether or not somebody is an employee versus independent contractor, there is a set of rules. But they also mention that none of this is set in stone. It really all the facts and circumstances have to be looked at. And you cannot just base your determination on one factor. So it’s not as easy as just saying, okay, if this person is this, then then they’re an employee or they’re an independent contractor. 

Shawn: And, you know, the federal government has its own set of rules. States have, you know, also have their sets of rules as well. So they can be more strict than the federal rules as well. So we kind of have to be cautious or conscious of where you’re doing business and what those rules are, especially if you’re a business that is operating or have these workers in multiple states. Each state is going to look at it a little differently. 

Michelle: Yes. And that has become very complicated in of itself. And it’s involved with the workers. Yeah. Remote access and people working remotely now have their pool of employees as or potential employees is that much greater than maybe historically. And it does open a different set of issues and problems. 

Shawn: So, yeah, exactly. 

Michelle: So let’s get into some of the Common Law rules that the IRS lists as being indications or ways to determine whether somebody is an employee versus an independent contractor. 

Shawn: So these common law rules have come out of court cases that have looked at the term, trying to determine what things should be looked at in determining whether it’s a you treat someone as an employee or an independent contractor and they’re categorized in three separate categories. The first one is behavioral. 

Michelle: Mm hmm. 

Shawn: So basically, when you’re looking at behavioral control, it’s, you know, whether there is a right to direct or control how the worker does their work. 

Michelle: So, for instance, it’s like, do you have control of how they’re doing their work, when they’re doing their work, where they’re doing the work and who does the work for them? 

Shawn: Yeah, exactly. So, you know, obviously, the more control that the worker has over what they do and how they do it when they do, it leads more to an independent contractor than an employee. 

Michelle: Right. So a great example is even us as accountants. We are considered independent contractors even if we’re doing a certain service for a company within their business. We have a firm that we are able to have other people work for us to do the work that we’re providing. It’s not necessarily us all the time going into a client’s place of business or touching their records. You know, we have complete direction ourselves over what we’re doing. Instead of the client being the one to say, okay, they might have stipulation, say, okay, you have to have this done by a certain deadline or a certain date, but they don’t tell us exactly when that has to be done and in what capacity. 

Shawn: Yeah, exactly. Or how we’re doing it. They may want to see certain things within their financials if we’re doing their bookkeeping or accounting or you know, they may want to track certain things, but we kind of control how we do that work. 

Michelle: And to give an example, another type of example is a, I know a lot of massage therapist practices have multiple masseuses that work for one organization, but they all dictate their own schedule. They all hold themselves out in business on their own, and they all are providing their own tools and supplies. So, you know, the person who’s place that they’re kind of working out of doesn’t provide all of those things. This person really is truly an independent contractor. 

Shawn: Yeah. So you mentioned tools and that gets us into the next category of common law rules is financial control. So really this refers to the facts that show whether or not a business has a right to control the economic aspects of the worker’s job. So, you know, how much is charged, tools, who’s providing the tools? When you’re you know, we see where employees or workers have expenses that they incur. If that company is reimbursing them for those expenses, then that kind of leads more into an employee relationship then that independent contractor. When you’re an independent contractor, you want to look at it as you have a profit motive. So you have certain expenses that you need to incur, whether they’re fixed or variable costs to earn that money that you’re going to get from the company that you’re working for. And that’s really kind of your financial burden, not the company’s financial burden. 

Michelle: Right. So you have a you are the one making the decision on what kind of overhead costs you’re incurring. You know, are you maintaining your own website? Do you want a certain level of supply of tools or supplies that you use within your business? A great example might be a therapist that has a certain platform that they prefer to use over another platform. They’re making the decision on what they want to use in their business to help them do their job. 

Shawn: Right. Exactly. 

Michelle: And typically, an employer is the one who dictates that they provide the software. They may provide a computer. They may provide your web or email address or provide the website. That kind of stuff. 

Shawn: Yeah, exactly. And in most cases, I would say in almost all cases, if you’re an independent contractor, you’re going to be expected to have your own business liability insurance. So and you know, I know, you know, in a lot of states in order to get your license or you may have to get a license to be a contractor or in a certain field of study that you have to have business liability insurance. 

Michelle: That’s a great point, because I had a client who came to us that was in an examination for unemployment compensation with their state and their state was asking for a list of people who worked as vendors for that person. And then they also needed the business license liability insurance proof, proof of insurance. And for everyone that and I’m not saying this is going to be the case for everybody, but for everyone that had business liability insurance and had proof of that along with providing invoices on a regular basis to the business owner, was classified as a true independent contractor. Those that did not have the business insurance or proof of business insurance was looked at a little bit harder and then was later determined. I’m sure it’s not the only reason, but was later determined that they were in fact should have been employees and so ended up having quite hefty unemployment compensation, taxes assigned to them and penalties of course because they were misclassified. 

Shawn: Yeah you know there’s you know we can get into a little bit of that leaders what happens when when they’re misclassified but yeah there’s there’s a lot of kind of I would say more paperwork and I don’t know if it’s more paperwork, but there’s different type of paperwork that you want to have for an independent contractor versus an employee. So we could talk about some of that as well. 

Michelle: Okay. So the next common law rule is the type of relationship that you have with that business. And let’s talk about what that means. 

Shawn: Yeah. So that, you know, the type of relationship really it’s, you know, refers to the facts that show how workers and business perceive their relationship to each other. 

Michelle: What does that mean?

Shawn: So you know, if I’m hiring Michelle, and you think you’re an employee, but I think you’re an independent contractor. That’s a different conflicting perception. Right. But if you know, some of this is when you go into these relationships, there are some documents that you may provide to establish that relationship. So whether it’s a written contract, independent contractor agreement, a an employee agreement. Um, you know, usually you have some sort of offer sheet of what this is.

Michelle: The relationship is. Yeah. 

Shawn: Kind of list some of the aspects of the relationship. And yeah, that paperwork is pretty important to kind of establish those roles and that relationship. So getting those, if you’re wanting to treat these workers as independent contractors, definitely have an independent contractor agreement drawn up by an attorney review that with the attorney to make sure you’re establishing all of these different factors within that agreement to make sure that it is an independent contractor relationship, not an employee relationship. 

Michelle: So, again, the IRS has kind of created these common law rules, but they’re not the only ones that dictate when a person should be an employee versus independent contractor. There’s some other safe harbor rules in addition to it, like these are the absolute must. Right. And then there’s some other ones that say, okay, well, you still may have you still may fall into these kinds of sub roles that can still qualify you either way. 

Shawn: Yeah, exactly. So, you know, the Safe Harbor rules are really kind of to help businesses that really don’t fit into the common law rules. But if you follow these safe harbor rules, you can, you know, be able to treat these workers as independent contractors. I think that’s it’s these rules are driven at least the safe harbor rules is to establish an independent contractor relationship. 

Michelle: Okay. So one of those may be a great example is a contractor who is a construction contractor who is working in the industry and they sub out certain parts of their job to another company or another person. And in many instances, these subs are truly independent contractors and that is common practice within the industry of construction contractors. 

Shawn: Right. That falls into the first part of the safe harbor rules. You really have to establish three sets. There are three sets of standards that you have to meet all three of these, of which the first one is Reasonable Basis. So under the reasonable basis, you’re looking at industry standards. You’re looking at whether you’ve relied on some ruling or judicial precedent. There was a prior audit by the IRS that established them as independent contractors. So some kind of reasonable basis that you’re able to follow in order to treat these people as independent contractors. The other two steps are you must have reporting consistency. So you have to have issued 1099 every year for these people. You can’t flip flop between payroll and 1099 or not filing anything at all for these people if they’re required to file the tax forms. And then the subsitant consistency means that you’re treating all contractors the same. 

Michelle: Everyone is in that same situation treated the same way. 

Shawn: Yeah. So once you meet all three of those factors, then you fall into these safe harbor rules that allow you to treat these workers as independent contractors. 

Michelle: Okay. So again, it’s a lot of facts and circumstances that are going to dictate whether or not a person is an employee versus an independent contractor. And every fact within the situation should be examined with the lens of is this person employee versus is a contractor, but what are some of the let’s talk about some of the pros and cons of both. Right. What would you like to start with? 

Shawn: Let’s start with an employee. 

Michelle: So okay. 

Shawn: So the pro of having an employee is, you know, you’re you kind of you can control and direct what they do, how they do it when they do it. You. Have. You can offer them benefits that, you know, could help lure people to work for you. Well, when you have independent contractors, you can’t give them benefits like health insurance and stuff like that because that’ll get you out. 

Michelle: Definitely look like an employee then. Yeah. 

Shawn: Exactly. You know, you may have more of a permanent need for somebody as opposed to just a short term need. So having an employee helps with that permanent need or that more ongoing consistency. 

Michelle: Right. And sometimes when you have an employee, you know, having an employee makes it easier for the person who is working for you to file their taxes because they get a W-2, the taxes are being withheld on an ongoing basis for them. As the employer, you’re paying half the Medicare and Social Security taxes. So that’s less money out of the person that you’re hiring. It can be more attractive to some people. It can become a little overwhelming to be an independent contractor having to pay in your own taxes, having to file separate returns like separate types of forms within your return or separate returns, it can be more complicated. And so an employee can be the easiest and simplest way for the person you’re trying to attract to come work for you. 

Shawn: Right. And some of those are all would be cons to the employer. So it would have. Yeah, it would be more costly for you to hire an employee because you’re paying half of the Social Security, Medicare tax, unemployment compensation, taxes, worker’s compensation. 

Michelle: Federal unemployment taxes.

Shawn: You have if you are offering benefits, then that employee, you may be required to provide those benefits to those employees. So it could become more costly for you. Mm hmm. 

Michelle: So let’s talk about the independent contractor, then. An independent contractor simply gets paid for the invoice that they or the contract that they are in agreement with you. So there is no withholding of taxes, there’s no providing benefits. They simply get a check or wire transfer or EFT or whatever. 

Shawn: Yeah, it’s easier on the compliance aspect because you only have to file tax, you know, the 1099 yearly as the, as opposed to employee taxes or employer taxes which are quarterly, you’re making deposits for taxes throughout the year. So there’s a lot more compliance with an employee versus an independent contractor. 

Michelle: Yeah. 

Shawn: But, you know, on the con side is, you know, have you met all the requirements to be able to treat the independent contractor as an independent contractor? So you have to really, you know, look at those rules that we talked about to make sure that you’re not going to be hit under audit with additional penalties in interest for misclassifying a worker. 

Michelle: Yeah. Yeah. And if you do have a true independent contractor scenario, you tend to have less control over that person and you have to be okay with that. You know, they will make their own schedule or they will follow when they’re doing the work as long as they’re performing the work to the agreed upon contract. You know, again, they have control over that and they also have control over who they ask to help them do that work. So if it’s written that something is sensitive as far as security goes or the client has an NDA or something like that, then that’s a different circumstance. But they really, the independent contractor really does have control over what they’re doing and how they’re doing it. 

Shawn: Yeah. And as you say, let’s say there’s some sort of nondisclosure agreement. You’re some of your business, you know, some of your business records and client list stuff like could be at risk for, you know, for these independent contractors to take them with them. Yeah. 

Michelle: So at the end of the year, let’s talk about real quick the filing requirements for some of these things. We talk a little bit about payroll taxes so an employee and let’s get everyone kind of educated on the verbiage here because many people say, oh, I have somebody working for me and I get to issue them a W-2. And I say, well, are they an employee or are they an independent contractor on another an independent contractor? Okay. Well, they’re not getting a W-2. Right. So let’s get the verbiage right on each of these. And so an employee, you would have quarterly payroll returns required to be filed. Whenever you have employees, you typically remit those taxes on a quarterly basis. And at the end of the year, they would get a W-2, so an employee gets a W-2 and then an independent contractor is paid simply by check throughout the year. You do get them to sign a W-9, which basically gives you their information about how they’re end of year 1099 is issued to them in that W-9 form. So you would receive a signed W-9 back from them. And then at the end of the year, a 1099 is produced and provided to them. 

Shawn: Yeah. And you know, not to confuse all of that, but, you know, some businesses that do provide services that are, you know, independent contractors, they’re not required to be issued a 1099 if they’re organized and taxed as a corporation, a C corporation or an S corporation. 

Michelle: So and that’s where that W-9 comes in and how important it is to get that right. 

Shawn: That W-9, you know, we suggest, you know, when when you if you have an independent contractor, that you get the independent contractor agreement, the proof of insurance and the W-9 all at the time before they start their work so that you have all of the all the paperwork that you need for that person. And that W-9 they tell you what their tax status is, and then you can determine whether there’s 1099 required for that person based on their tax status. Or you hire someone like us to help you. 

Michelle: To help you with that. Right. Awesome. So today we talked about independent contractors, the common rules, the common law rules, some of the safe harbor rules. And then we talked about the pros and cons and then the filing requirements that are typically done at year end. And you know, what a great synopsis of this topic. And I know it’s going to be a hot topic because so many people ask us these questions. 

Shawn: So it’s not going away anytime soon. 

Michelle: No, no. It is actually increasing. I think so. All right. Well, thank you so much for joining us today and make sure that you like and subscribe to our YouTube channel and follow us for some of our upcoming content and check some of our old content out. We have a lot of great information out there for people who are self-employed and who are running small businesses and new to being in business. Thanks so much, guys. Take care. 

Shawn: See ya next time. 

Michelle: If you find this podcast helpful, then like, subscribe, and follow us on social media.