Hiring Temporary or Part-time Workers as Contractors

It’s tempting to hire staff as contractors; skipping costs for insurance, payroll taxes and administrative time.  It’s particularly tempting in bringing someone on-board on a trial basis or for part-timers.

The IRS has 20 factors to consider to determine if a worker is an employee or a contractor.  The US Department of Labor works in close cooperation with the IRS and more or less follows the same criteria.  Your state’s division of unemployment will have their own factors.  It’s worth the time to review the criteria for all 3, which I won’t list for brevity’s sake.  You can find the factors used by all 3 quickly with a Google search.  Be cautious with non-official information (yes, that includes this article).

The overriding principle for any determination list I’ve ever seen is, “If it feels like an employee, it’s an employee.”  The IRS, Department of Labor and 34 states’ Divisions of Employment share information regarding employee versus contractor determinations.

More specifically, what is the risk to a business that mis-classifies an employee as a contractor?

It is quite commonplace for workers classified as contractors who, upon termination, immediately filed for unemployment.  If they are determined by the state to be an employee, they will receive unemployment. This is the ball that tips the chain reaction.

What happens next:

  • The employee will file taxes the next year. Once they attempt to complete their taxes and encounter the onerous Self-Employment Tax, they may also contact the IRS.  If they don’t contact the IRS, there’s a very good chance the state’s Division of Employment will do so.
  • The business will need to retroactively process prior year payroll.
    • The business will likely consider the amount paid as the worker’s gross pay
    • The company should consider obtaining a W-4 from the worker
    • The company is liable to the taxing authorities for all taxes, including employee taxes.
      • Then, the company will have to obtain reimbursement from the ex-employee for the employee’s share (best of luck to you).
    • The company will need to refile the federal and state payroll tax returns for the affected quarters and year-end forms, including issuing a W-2 to the added employee.
    • If the employee does not reimburse the company for the employee’s share of payroll taxes, they have been legally enriched and should receive a 1099-Misc. Alternatively, the business could increase the employee’s gross pay and forgo reimbursement.

How much will this cost?  Here’s an estimate built upon a real example:

Estimated Costs to Recategorize $10,000 from 1099 to Wages 

 

Employee

Employer

Social Security

660.98

660.98

Medicare

147.13

147.13

Fed WH

1,500.00

 
State WH

450.00

 
State Unemployment  

648.49

Fed Unemployment  

64.85

Payroll Service Fee (2 quarters plus Year-end)  

1,400.00

Est Tax Penalties/Interest  

1,497.85

Statutory Penalty for filing incorrect 1099  

520.00

Statutory Penalty for not filing W-2  

520.00

Low estimate of Legal Fees  

750.00

Total Legally Recoverable Costs

2,758.11

 
Total Legally Non-recoverable Costs  

6,209.30

Total Additional Costs **  

8,967.41

** Costs do not include distraction from productive activities in the company.

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