||Ask the Small Biz Adviser
Employee or contractor: What's the difference?
Dear Small Biz Adviser:
If I have four employees who will be working for about four months
and they are all students making minimum wage, how would I go about
paying them? Would I have to take out state and federal taxes? Or
do I just give them a 1099?
Yours is a classic case of knowing the difference between independent
contractor or contract labor and employee status. Begin by reviewing
the Internal Revenue Service FAQ
page on employee-contract labor. More details are in IRS Publication
Supplemental Tax Guide.
In short, here are some of the guidelines:
- A person generally is an independent contractor
only if you (the payer) have the right to control or direct only
the result of the work performed. The payer has no control over
the means or the methods implemented to deliver those results.
- Under common law there are four categories of independent
contractors who will still be defined as employees under statutory
law. They include drivers, insurance sales agents, individuals
who work at home and full-time traveling or city salespersons.
Details are on page 3 of Publication 15-A.
- There are two categories of statutory nonemployees,
including direct sellers and licensed real estate agents. View
page 4 of Publication 15-A for the details.
- Independent contractors are more likely to have
unreimbursed expenses than employees.
- The independent most often has substantial, if
not complete investment, in the facilities he or she uses to conduct
- Independent contractors generally are free to seek
out business opportunities from employers in addition to you.
- An employee is generally paid a wage or salary
by the hour, day, week or other category of time. The independent
contractor is usually paid a flat fee. Exceptions in some contractor
professions include lawyers who can be paid by the hour.
- An independent contractor can make a profit or
- The payer's control over when and where to work,
tools used, what workers to hire or assist in the work, the order
and sequence of work and which individual performs specific tasks
are further evidence of employment.
Again, read the publications I noted above for the
full details. All conditions defined for contract labor must be
met to avoid having to treat the individual as an employee. If so,
the Form 1099 is issued. Review the IRS publication, Instructions
for Form 1099-MISC, for more details.
Otherwise, employee status requires you to perform
the following for the IRS:
- Have each new employee fill out Form W-4, the Employees
Withholding Allowance Certificate to determine exemptions and
note the Social Security number.
- Withhold Social Security, Medicare and income tax
deductions for transmittal to the IRS via a tax account set up
at your local bank.
- Match Social Security and Medicare deductions for
Review the IRS publication, Wage
and Tax Statement and Transmittal of Wage and Tax Statements,
for the complete details.
It is quite obvious why many employers prefer to contract
their labor needs instead of hiring employees. The cost of matching
Social Security and Medicare deductions is eliminated. The paperwork
process for a Form 1099 is so much simpler and less tedious than
W-2s , W-4s and maintenance of the tax account.
I cannot advise you which direction to take. The nature
of your business, the tasks the students will be given and the amount
of control you need over the performance of their jobs will more
likely influence your decision. Given that they will work for minimum
wage will not be as burdensome on expense accounts, but the paperwork
and bookkeeping cannot be avoided.
I wish you well with your decision.
-- Posted: July 19, 2001