Small Business Worker Classification: 1099 Form Or W2?

The self-employed contribute nearly $1 trillion to the United States economy. This contribution has grown dramatically during the last five years, as the tumultuous economic climate has resulted an increased frequency of layoffs among skilled employees who go on to start their own micro-businesses (companies with no more than 10 employees. There is no doubt that these new small businesses are creating jobs as they grow, but hiring workers can be complicated for very small businesses. When hiring additional workers, the owners of small businesses confront piles of paperwork and legal obstacles. Is the worker an employee, or an independent contractor? Should he or she receive a 1099 form, or a W2? Even if you use specialized accounting software or online bookkeeping services, you can end up in trouble with the IRS if you don’t determine the correct tax classification for your workers.

How To Determine Tax Classification

As a small business accountant, reaching a point at which you need to hire other workers to help manage the needs of new and existing clients is a huge milestone. If you started out as a one-person operation, this step can change the nature of your business. For each position you create, you must determine the proper tax classification. Many small businesses think that this distinction is a matter of choice, but the IRS is all about rules. Keith Hall, National Tax Advisor for the National Association for the Self-Employed, explains that figuring out “whether a new worker is an employee or an independent contractor can be tough. …You can’t just choose which one is easiest. It really depends on who calls the shots day to day.” These classifications allow you to pay your workers correctly, and to report those payments correctly to the IRS at the end of the year. In order to determine whether a worker should be categorized as an employee or and independent contractor, the IRS uses a multi-step checklist to define the nature of the position. You can do the same.

1099 Form Or W2?

If you control when, where, and how the worker in question performs his or her job-related tasks, he or she is probably an employee. As the owner of the business, you are required to withhold income and payroll tax, file a Form W2, and possibly contribute to the employee’s retirement plan. On the other hand, if the worker controls his or her own work product (and especially if he or she provides similar services to other clients or customers in addition to you), the worker is probably an independent contractor. Independent contractors are responsible for their taxes and tax forms, such as Schedule C, Profit or Loss from Business, and Schedule SE, Self Employment Tax. Payments to independent contractors are reported on a 1099 form.

Small Business Worker Classification

Hall emphasizes the importance of getting this classification right from the get-go. “The IRS can certainly come in later and second guess,” he says, “which could potentially lead to penalties and interest if taxes were underpaid.” If you need help determining the correct classification for your workers, you can download the “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” form (Form SS-8) for www.IRS.gov.

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