The use of contract workers has exploded in the last decade, particularly in the tech industry. According to a 2018 NPR/Marist poll, one in five workers is a contract worker and by 2028, contractors and freelancers could make up half of the workforce. It is still unclear how the current labor shortage that has arisen out of the Covid-19 pandemic will affect the balance of employees and contractors.
For payroll tax purposes, small business owners must classify their workers as employees (W-2) or contractors (1099). When a worker seems to partially fall into both categories, choosing which category to place them in can be confusing. It can also be tempting to make a quick decision early on and fail to reassess the classification even as the worker’s role changes over time. While employee classification may not seem like something that requires a lot of thought, issues with classification can arise, most commonly when a business is audited by the IRS or Department of Labor or when a worker brings up a concern and/or files for unemployment benefits – which can trigger an audit.
What is the difference between a contract worker and an employee?
Employees are on a company’s payroll. They receive wages for their work and taxes are withheld on the employees’ behalf. The employer is also required to pay for half of each employee’s Social Security and Medicare taxes. Employers often provide employees benefits such as health insurance and paid vacation days. A contractor is an independent worker who is paid by the project, through commission, or by the hour but does not receive benefits such as health insurance. The contractor is required to cover the entire portion of their Social Security and Medicare taxes.
If your business is audited and auditors determine that you have been incorrectly classifying a worker as a contractor instead of an employee, you could be liable for paying back wages such as overtime, back taxes, and even fines or penalties.
Signs That You are Misclassifying an Employee as a 1099 Contract Worker
If you are feeling unsure about any of the classifications for your workers, read on for signs that you have a contractor who is really an employee:
1. Your contract worker is doing the same job as your employees
A contractor is typically hired to handle certain tasks that your employees do not handle such as social media marketing or book keeping. If you have a contractor who is performing the same tasks and duties as your employees, you should likely be classifying them as an employee.
2. Your contractor is being paid a salary
Contractors are most often paid by the project or on a commission basis. In some cases, an hourly rate is appropriate. If your contractor is being paid a salary like your employees, it is time to consider whether they are really an employee.
3. Your contractor is working for you on an indefinite or ongoing basis
If you are working with a contractor that is providing work on an indefinite, ongoing and regular basis rather than by the project or for a set period of time, you may actually have an employee.
4. Your contractor is expected to follow company procedures to complete their work
If your contractor is expected to follow all employee company procedures or processes to complete their assignments, that is a sign that your contractor should be classified as an employee. Generally, contractors should have more leeway about how they choose to complete their projects than an employee; the focus should be on the end result.
5. You are providing benefits to your contract worker
Contractors do not receive benefits such as paid time off, health insurance, or 401k matching. If you are providing these types of benefits to a worker then they should be classified as an employee, not a contractor.
While there may not be a hard and fast checklist that a business owner can use to determine whether a worker should be classified as an employee or contractor, the signs we discussed in this article are some things to consider. It’s important to know that the default classification is employee; there are no penalties for classifying someone as an employee who may be acting more like a contractor. So, if you are unsure, it is always safest to choose employee status.
Partnering with Makai HR
Feeling overwhelmed with employer laws? That’s okay; we’ve got you covered through HR outsourcing! When you partner with Makai HR you can get on with the business you are trying to grow while we take care of your employee needs from payroll to taxes, health insurance/benefits and worker’s compensation. You also gain peace of mind that you are compliant with all of Hawaii’s employer laws (if you’ve ever looked you know that the list is very long and changes happen). When choosing a PEO to partner with, there are many things to consider including cost, services, and technology solutions.
With the cost of doing business in Hawaii at record highs, we know how important it is to keep labor costs in line with revenue. Our plans are priced competitively and include value-added services like time-in/time-out systems. Our three tiers of PEO service plans are tailored to the size of your business and specific needs. We offer a 100% paperless solution which means that your employees can manage their needs through a computer, tablet, or phone. We can truly improve your employees’ work benefits while freeing you up to run your business.
What are you waiting for? Companies that partner with a PEO benefit from 7-9% faster growth, 10-14% lower employee turnover; and they are 50% less likely to go out of business. Contact us today to get started!