1099 vs W-2: How should classify your workers?

When you own a business, eventually you need to hire someone to help you out. What you need to decide then is whether or not you are hiring an employee, who will need to be issued a W-2 at the end of the year, or an independent contractor, who might need a 1099.

Your Requirements with a W-2

When you decide to hire a freelancer, or other type of help, as an employee, you need your hire to fill out a W-4. You use this information to figure out how much you should be withholding from his or her paycheck for taxes. When you have employees, you are required to withhold federal and state taxes, as well as withhold taxes for Social Security and Medicare.

All of this requires planning and paperwork, and it's important that you make sure that you get it right. Each quarter, you will send in these tax payments to the government, on behalf of the worker and on behalf of yourself (remember that you pay a portion of the Social Security tax for your employees). You are required to issue your employee a W-2, with multiple copies so that the employee can attach the W-2 with his or her federal and state tax forms.

Your Requirements with a 1099

Things get a little simpler when you have an independent contractor, and only need to worry about the 1099. You need to have the contractor fill out a W-9. However, you only have to issue the 1099 if you pay the contractor $600 or more during the course of the year. So, if you pay a contractor a total of $550 during the year, you don't have to issue a 1099.

When you have the 1099 filled out, you are responsible for sending a copy to the contractor and to the IRS. Many employers are leaning toward 1099 contractors due to the simplicity of the process, and, of course, the fact that an independent contractor has to pay his or her own Social Security tax, meaning that the employer doesn't have to pick up the tab.

Don't Misclassify Your Workers

Of course, the IRS takes it very seriously if you misclassify workers. You can pay hefty fines if you classify an employee (who should have a W-2) as a contractor (who should have a 1099). Before you decide that it would be a good idea to classify all of your hires as independent contractors, it's a good idea to determine whether they really fit that description.

Employees

Understand that employees are those that are told how to accomplish their work. Here are some of the indications that you are hiring an employee:

• You provide instructions about where and when to work. You have control over how the person works.
• You provide training for employees in order for them to perform tasks in a particular way.
• Work is done on your business premises, especially on a very regular basis.
• Payment is made by the hour, or on a salary basis, rather than being given on a per-project or straight commission basis.
• You provide office equipment, tools, and travel expense costs to the hire.
• You can specify that the hire work for no one else.

The main thing, though, is control. If you have significant control over the hire, and his or her work environment, he or she is most likely an employee.

Independent Contractors

In general, independent contractors are paid by the project, rather than drawing a regular paycheck. Additionally, a contractor does work independently. You don't tell this person what computer software to use, or specify work hours. An independent contractor can work on your project in the middle of the night if he or she wants, rather than being required to work on it between 9 and 5. Contractors have their own equipment and tools, and can work for more than one client at a time.

Make sure that when you do your paperwork, you do it properly, classifying workers as they should be classified. When in doubt, consult a tax professional, or issue a W-2 to be safe.

Photo: chadmiller