It’s time to define that relationship – Contractor vs. Employee (part 2)

Recently, I shared with you how to determine whether it was time to define or redefine your relationship with your worker, designating them as either an independent contractor or an employee. If you missed that blog post, or want a quick review of what we discussed, you can visit Part 1 hereWe left off by sharing some resources from the IRS to help you make the best possible determination of your worker relationship (fun homework!). So, here you are, after making your determination, you are ready to take that step and define your relationship. Let me walk you through a few essential steps when you have determined that it’s time to define that relationship – Contractor vs. Employee.

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What do you do if it’s time to re-define the relationship?

What do you need to do when you want to move someone from a subcontractor to an employee? If you and the subcontractor have decided to take it to the next level, the subcontractor must fill out a W-4 form. You’ll use the form to begin withholding and filing employer taxes. If you have a payroll service provider, then provide them with the completed W-4 form.

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On the other hand, what if you want to ‘keep it in the subcontractor zone’, what boundaries do you need to comply with? The first step is for the subcontractor to complete a W-9 form for you, so that you can provide them with a 1099 tax form at the end of the year. Next, look at some key questions involving the behavioral, financial and other elements of the relationship to ensure that the subcontractor maintains certain quantifiable controls on those aspects.

You may want consider formalizing a relationship in writing, with a service agreement, to spell out which party is responsible for controlling the aspects of the business evaluated above (Behavioral, financial, and type of relationship). A business owner may be confused or frustrated by this less than absolute method of determination, so the more documentation you have of your evaluation process and reasoning, the better.


You may want consider formalizing a relationship in writing
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Still not going to be able to sleep at night, wondering if you made the right determination, and wondering what would happen if you were wrong?

What if I’m wrong – what are the risks?

Small businesses often need to perform risk analysis to mitigate their potential consequences of a decision. So, I get it, I understand where this question is coming from. Let’s briefly look at what can happen if you misclassify a worker. According to the IRS, they will treat this misclassification in two ways:

  • If they deem that you have no reasonable basis for your determination, you may be held liable for employment taxes for that worker.
  • If they deem that you do have a reasonable basis for determination, but were just wrong, you may be relieved from having to pay employment taxes for that worker. If you find yourself in this situation, you can read up on the specifics here.

Most businesses don’t want to be wrong – and don’t want to end up in a situation where they are facing potential consequences or the headache and time involved with getting a mess sorted out. So what can you do to gain some peace of mind? Let’s look at some best practices to consider.

What is the best-practice for defining the relationship?

Unfortunately, there is not a “Magic ‘8’ ball” answer to whether that service provider is an employee or not. It’s not always a clear-cut ‘yes’ or ‘no’, as we already uncovered. A best practice is to regularly evaluate your relationship with your worker, reviewing the key factors of your relationship to determine which party retains control over that aspect of the work.

Relationships sometimes start off in a specific category and over time, evolve into another. Although it is not sufficient evidence on its own, keeping a clear, written agreement in place may help to define the responsibilities and controls over the and provide both the business and the worker some clarity and peace of mind. Ultimately, the determination is based on how the parties work together, so try to keep an objective eye on the relationship to make sure boundaries are clear and enforced.

Closing

I’ve just shared with you some tips on what to do when it’s time to define that relationship – Contractor vs. Employee, to hopefully shed some light on the often-confusing determination. If you are interested in more tips about the Human Resource-side of your small business, keep an eye out for future blog where we’ll explore which payroll processing services may be right for your business. We’ll do a side by side comparison of some of our recommended choices, including QuickBooks Full Service Payroll, and a new-to-us payroll service called Gusto, among others. Stay tuned, it will be fun!

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