Proper Classification of Workers in Small Business Accounting

During recessionary times, many small businesses are relying on “contractors” to carry on their business. Please note that proper classification of workers between contractors and employees is essential.

Failure to classify employees/contractors properly can expose you to paying for the employment taxes on the misclassified contractors plus up to 120% penalty, not to mention the professional fees involved in defending yourself and filing amended payroll tax returns. Your payroll service provider will most likely not make the amendments.

For a full discussion of who is an employee and who is a contractor, please refer to http://www.irs.gov/businesses/small/article/0,,id=99921,00.html. While there are many technicalities involved, you can start with the premise that more control you as employer have over the worker (in terms when and where the work is done, how it is done, providing the tools and supplies necessary to perform the work), the more likely it is the worker is an employee. On the other hand if you engage an expert to work with you on a specified project, and such expert is free to determine how the work is done, the project is supported by a written contract with a specific end date, you are on much surer ground to classify such expert as a “contractor”.

Please note that for the “contractor” classification to prevail, you must file 1099-MISC form with the IRS on a timely basis.

We encourage you to talk to your legal advisor about how to classify workers.

Prepared by Dev Purkayastha, CEO, Indevia Accounting Inc. www.indevia.com
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*This article is provided as a matter of general interest. It is not an expert opinion. The author strongly encourages readers to consult their professional adviser for questions arising out of this article.