One of the biggest liabilities for small business owners is improperly classifying workers.

Recently, a number of our local day spas and salons were fined for incorrectly classifying workers as independent contractors when in the eyes of state and federal tax officers they are deemed employees. Many businesses were also fined for failing to file the mandatory 1099 forms for all contractors’ they used in their business. It is a good idea to annually review filing responsibilities for all your employees and workers and set up a structure that limits your businesses’ liability.

 “It’s an important issue for the IRS because worker misclassification may give a competitive advantage to the business using independent contractors,” according to Don Segal, the acting employment tax policy program manager for the Internal Revenue Service. The IRS analyzes tax information, trying to find entrepreneurs who may misclassify workers as independent contractors instead of employees. The reality is that it is easier for the IRS to collect taxes from business owners than from independent contractors.

Business Owners also file state taxes and the State Franchise Tax Board and the Employee Development Department has a reciprocal agreement with the IRS. Cross-matching state and federal returns allows for the IRS and the EDD to find misclassification mistakes.

The definition of an “employee” is anyone who performs services for you where you control what will be done and how it will be done. With an independent contractor, the business has the right to control or direct only the result of the work done by the contractor, not the means and methods of accomplishing the result. There is a twenty point check list that business owners and managers can refer to that defines independent contractor work.

As a business owner that uses independent contractors you can establish operational procedures to protect yourself and your business. For every contractor be sure to maintain completed W-9 forms, contractors’ business licenses and certificates of insurance. We also recommend having an Independent Contractor Agreement form signed by the business owner and the contractor for each job. You should have invoices, business cards, telephone listings and other documentation showing that the contractor operates a business.

Additionally business owners will need to complete and file Form 1099-MISC, which is used to report payments made in the course of a trade or business to another person or business that is not an employee. This is mandatory if the contractor is paid more than $600 in a calendar year. Business owners need to give the contractor a copy, and send one to the IRS. There is a $50 per-form penalty for failing to file the form.

The IRS has two useful publications for helping to classify your workers.  Publication 15-A, Employer’s Supplemental Tax Guide and Publication 1779, Independent Contractor or Employee. Both publications can be found at www.irs.gov.

If you have questions of whether your workers are contractors or employees you can call the NVC SBDC for free and confidential counseling.

The SBDC also provides complementary Business Rx  of your business if you have been operating for over a year, have multiple employees and financials. For these resources contact the SBDC at 253-3210.