Independent Contractors vs. Employees

Throughout various stages, your startup or small business may work with independent contractors (“I.C.s”) to meet the ever-changing needs of your company. Using I.C.s allows you to pay for services, such as software/app development and sales, without the need to have a fixed employee salary or providing benefits, and thus, potentially saving your business money. However, the IRS has specific guidelines for determining if the people who work for you are I.C.s or if they are really employees.

Independent Contractors

I.C.s work for your business on a contract basis. You can control the scope of the work, such as defining what type of software/application you would like built, but not when the work is done. An I.C. operates independently, personally or under a business name, provides their own tools, sets their own hours, and potentially has more than one client. You should have a contract with them that specifies (among other things) the details of the project, and they will invoice you when the project is complete.

A strong independent contractor agreement should specify that:

  • the I.C. must keep your company information confidential;
  • the I.C. cannot solicit business from your clients for a set period of time;
  • you own the I.C.’s work/work product during and after completion of the project; and
  • termination rights.

You need to collect a Form W-9 from the independent contractor. If you pay the I.C. more than $600 in a year, you must file Form 1099 with the IRS.

Employees

If your worker is an employee, you have the legal right to; (a) control how and when the employee does the work, and (b) maintain control of the business and financial aspects of the project. In many cases, you may provide training, benefits, and periodic evaluations.

If your worker is an employee, you must file Form W-2 with the IRS and withhold Social Security and Medicare taxes.

Consequences of Misclassifying Workers

If the IRS discovers that you have been treating I.C.s as employees, your startup or small business could be subjected to the following penalties:

  • $50 for each W-2 that your business failed to file because you misclassified a worker as an I.C. rather than an employee.
  • 1.5 percent of the worker’s wages as a penalty.
  • 40 percent of the Social Security and Medicare that your business failed to withhold from the worker.
  • The entire employer’s portion of the Social Security and Medicaid taxes.
  • Daily accruing interest from the date the Social Security and Medicare taxes should have been paid.
  • 0.5 percent of the unpaid tax liability as to the Failure to Pay Taxes penalty, accruing monthly up to 25 percent of the total tax liability.
  • Up to $1,000 fine and one year in jail for each misclassified worker.

Protect Yourself with an Experienced Startup Attorney

Misclassifying I.C.s and employees can have serious consequences for your startup or small business. The Law Office of Elliott J. Brown is dedicated to providing your business with information and legal guidance. Call us today at (732) 490-8200 or contact us online to learn how we can help you.

*Each State has its own employment laws in conjunction with U.S. Federal Laws and various U.S. Gov’t Agency regulations. You should discuss the consequences of misclassification with an employment attorney in your state

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As a startup or small business owner, you have endless decisions to make for your company. One of the most important is how you can protect yourself from personal liability. While many business owners like the freedom of operating as a sole proprietorship, this business structure leaves your personal assets unprotected from your business liabilities. If your business struggles to pay its debts, your creditors may go after your personal assets.

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