Every New Year’s, we all make our list of the things we are going to do differently in the coming year. We tend to look at all the things we maybe didn’t get so right this year and plan how we can do it better for next year. For some it is the hope to lose those extra few holiday pounds. For others it is to exercise more or eat better. As a business owner, have you ever considered reviewing how you paid your employees this year? It may seem like an odd question, but it’s really not. The amount of payment is not the issue as much as how you paid them. Do you have employees…or do you have independent contractors on your payroll?
“Why does it matter whether I pay someone that does work for me as an independent contractor rather than an employee?” It matters for one reason: Money. At the end of the day, the IRS wants what rightfully belongs to it as well as ensuring that those employed are adequately protected. By paying someone as an independent contractor rather than an employee, you are essentially passing your expenses off to them. Having an employee is costly. This is why payroll is generally one of the largest expenses to a business. When you “1099” someone who should be paid as an employee, you are forcing them to pay what amounts to your portion of the payroll expense (which is highly frowned upon by the IRS).
Would you ask your employee to pay for your advertising, repairs to your building, or your inventory? No, you would not. It is not their responsibility. Those are deductible expenses to your business. So it is with payroll. Not only are you costing the employee by asking them to pay your portion of their taxes, you are costing yourself a valuable tax deduction. As most have experienced, there are strict regulations governing the expensing of larger ticket items each year. For example, any assets purchased that are not covered under Section 179 must be expensed over a number of years, depending on what the item is. Payroll is an expense immediately deductible in the year it is paid.
This is not to suggest that an excessive payroll is needed. In fact, having more employees than your business needs can be detrimental. It is as important to know how many employees you really need as it is to pay them all correctly. The question then becomes, “how do I know who is an employee?” For this, we turn to the IRS 20 Factor Test.
The IRS 20 Factor Test was created as a detailed way to help employers determine who should, in fact, be labeled an employee and who is truly an independent contractor. There are three main issues regarding who is an employee: Behavior, Finances, Relationship. How these are applicable is laid out in IRS 20 Factor Test. The following questions will help you determine whether or not you have any employee:
- Do you tell this person how to do their job?
- Do you (or another of your employees) teach this person how to do their job for your company?
- Does the person perform services for your business that your business depends on?
- EXAMPLES: Waiter serving food, driver making deliveries for you, retail sales worker serving during store hours.
- Do you control how your employees do your work?
- Do you hire, supervise, and pay?
- Do you purchase (or reimburse for) any and all materials the employee uses during the course of his or her job?
- Is the relationship between you and the employee ongoing?
- This means that there is no ending date for the job the employee does for you.
- Do you set and control the hours the employee works for you? Can you tell them they must work during a certain period of time?
- Does the employee work solely for you while on your clock?
- This does not include someone working part-time for multiple employers.
- REMEMBER: One employee having multiple part-time jobs does not make them an independent contractor.
- Does the employee work at your office?
- Even if the employee does work from home or another location, if you can control when and how they work they are most likely an employee.
- Do you pay your employee on a set schedule?
- EXAMPLES: Weekly, Bi-weekly, Semi-monthly, Monthly
- Do you provide all of the tools and materials for the employee to complete the assigned workload?
- Do you control what expenses are reimbursable for your employees?
- Can your employee realize either profit or loss from the business activities he or she performs?
- Can their expenses that exceed their revenue for conducting business result in a loss on their tax return?
- Does the employee perform his or her services solely for you (as opposed to advertising the services as available to the public)?
- Can you terminate, fire, or discharge this person at any time and for any reason (within legal limits)?
If you have answered yes to even one of these questions, it is possible that you have an employee and not an Independent Contractor. It is always better to review your employees and be sure that you are classifying them correctly than find out when the IRS is assessing fines and penalties. While you can perform a self audit, sometimes you can still have questions. TJS Deemer Dana would be more than happy to help you assess your payroll and address any issues you have. Please make an appointment to speak with a payroll specialist and we will help you get to where you need to be!
For additional information on the IRS 20 Factor Test, please visit the IRS website at www.IRS.gov.
Written by: Miriam Holtzclaw
Internal Revenue Service. (2015, Nov 02). Behavioral Control. Retrieved Dec 18, 2015, from www.IRS.gov: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Behavioral-Control
Internal Revenue Service. (2015, Nov 02). Financial Control. Retrieved Dec 18, 2015, from www.IRS.gov: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Financial-Control
Internal Revenue Service. (2015, Aug 05). Independent Contractor (Self-Employed) or Employee? Retrieved Dec 18, 2015, from www.IRS.gov: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee
Internal Revenue Service. (2015, Nov 09). Type of Relationship. Retrieved Dec 18, 2015, from www.IRS.gov: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Type-of-Relationship
Miami Dade College. (2015). IRS 20 Factor Test on Employement Status. Retrieved Dec 18, 2015, from www.mdc.edu: https://www.mdc.edu/hr/Operations/AFS/IRSFactorTest.pdf