The American Institute of Professional Bookkeepers sends me bookkeeping tips and one arrived in my inbox today that was very useful. I recently wrote an article about the dangers of classifying an Employee as an Independent Contractor. The main point was that if the IRS believes that a person has not been classified correctly then the employer is liable for its share of FICA and FUTA. Additionally the employer must also pay additional penalties equal to 20% of the FICA that should have been withheld. This if is the employer complied a 1099 and treated them as an Independent Contractor. If they employer did not compile a 1099 then the penalty increases to 40% of Fica and 3% of wages.
The AIPB gave the following handy tips that will help clear up any confusion regarding Independent Contractors. Here are a few mistakes to avoid.
- Not having a written contract. For a regular long-term worker, you need a written contract spelling out the responsibilities of each party. Otherwise, you are unlikely to win a dispute over the worker’s status.
One of the main differences between an Independent Contractor and an Employee is the amount of direction the Independent Contractor receives. If they are required to be in the office at a specific time and must follow the Employer’s protocol, it is likely that the Employee is being classified incorrectly. Many people choose to classify employees as Independent Contractors because they find payroll to be a difficult task. I find that working with a bookkeeper and payroll service makes this much easier. The payroll service will know the recent changes in payroll and the bookkeeper can easily download the payroll into Quickbooks or any other accounting software. This takes the guesswork out of withholdings and tax payments. There is never a question about what is owed and if the payroll taxes have been paid on time.
If this person is truly an Independent Contractor then a written contract is key, especially if there is ever a dispute regarding pay or work assignments. It makes the business arrangement transparent and leaves little room for mistakes. Take a moment to talk about your expectations first and save a headache later.
- Reimbursing expenses. Similar to providing tools and supplies, but with the distinction between ICs and employees less clear. As a rule, the more expenses that you reimburse, the less likely the worker is to be an IC.
Usually the Independent Contractor has worked in expenses into their bill/fee, so reimbursing is not necessary. When working with clients we do not bill for copies, paper or other office essentials. This is a normal part of doing business and can raise a red flag for the IRS in the event of an audit.
- Paying by the hour. Hourly wages are common for some professionals, such as attorneys, accountants and plumbers. But Wood believes paying by the hour or other increment of time period is a sign that a worker is an employee rather than an IC for most kinds of work. Better: Paying by the project or piece.
Again this relates to tip one. Work out the business arrangement and then get it in writing. If for some reason there is a dispute regarding billing, you both will have something to refer back to.
It is beneficial for those small business owners who have their hands in the finances to be up to date with current bookkeeping/accounting standards. After all, the burden of the business often falls on the business owner and it is essential to be “in the know”. I recommend that business owners take a course in bookkeeping and accounting, hire a professional bookkeeper who works with your accountant/CPA and join this mailing list: http://www.aipb.org. I have no financial incentive to get you to join. I just like to see that everyone has the facts to make good business decisions. They often send tips out like this and one might just prevent a costly mistake from happening.
… Until next time.
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